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Section 1: 10-Q (10-Q)

ARCP 3.31.2014 10-Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________ to __________
Commission file number: 001-35263

AMERICAN REALTY CAPITAL PROPERTIES, INC.
(Exact name of registrant as specified in its charter) 
Maryland
 
45-2482685
(State or other  jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
405 Park Ave., 15th Floor, New York, NY
 
10022
(Address of principal executive offices)
 
(Zip Code)
(212) 415-6500
(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 x No ¨

Indicate by check mark whether the registrant 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Nox

The number of outstanding shares of the registrant’s common stock on May 7, 2014 was 769,995,602 shares.








AMERICAN REALTY CAPITAL PROPERTIES, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

FORM 10-Q
March 31, 2014

 
Page
 
 



Table of Contents

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
AMERICAN REALTY CAPITAL PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
(Unaudited)
 
 
March 31, 2014
 
December 31, 2013
ASSETS
 
 
 
 
Real estate investments, at cost:
 
 
 
 
Land
 
$
3,226,615

 
$
1,378,865

Buildings, fixtures and improvements
 
11,841,722

 
5,291,031

Land and construction in progress
 
40,459

 
21,839

Acquired intangible lease assets
 
2,209,747

 
758,376

Total real estate investments, at cost
 
17,318,543

 
7,450,111

Less: accumulated depreciation and amortization
 
(422,355
)
 
(269,684
)
Total real estate investments, net
 
16,896,188

 
7,180,427

Investment in unconsolidated entities
 
105,775

 

Investment in direct financing leases, net
 
65,723

 
66,112

Investment securities, at fair value
 
213,803

 
62,067

Loans held for investment, net
 
98,185

 
26,279

Cash and cash equivalents
 
83,067

 
52,725

Restricted cash
 
55,559

 
35,921

Intangible assets, net
 
371,634

 

Deferred costs and other assets, net
 
294,694

 
279,109

Goodwill
 
2,287,122

 
102,419

Due from affiliates
 
8,550

 

Total assets
 
$
20,480,300

 
$
7,805,059

 
 
 
 
 
LIABILITIES AND EQUITY
 
 
 
 
Mortgage notes payable, net
 
$
4,234,668

 
$
1,301,114

Corporate bonds, net
 
2,545,884

 

Convertible debt, net
 
973,737

 
972,490

Credit facilities
 
2,415,800

 
1,969,800

Other debt, net
 
148,809

 
104,804

Below-market lease liabilities, net
 
287,199

 
77,789

Accounts payable and accrued expenses
 
143,860

 
808,900

Deferred rent, derivative and other liabilities
 
195,826

 
40,271

Distributions payable
 
4,414

 
10,278

Due to affiliates
 
217

 

Total liabilities
 
10,950,414

 
5,285,446

 
 
 
 
 
Series D preferred stock, $0.01 par value, 21,735,008 shares (part of 100,000,000 aggregate preferred shares authorized) issued and outstanding at March 31, 2014 and December 31, 2013, respectively
 
269,299

 
269,299

 
 
 
 
 
Preferred stock (excluding Series D Preferred Stock), $0.01 par value, 100,000,000 shares authorized and 42,654,919 and 42,199,547 shares issued and outstanding at March 31, 2014 and December 31, 2013
 
427

 
422

Common stock, $0.01 par value, 1,500,000,000 and 750,000,000 shares authorized and 769,931,938 and 239,234,725 issued and outstanding at March 31, 2014 and December 31, 2013, respectively
 
7,699

 
2,392

Additional paid-in capital
 
10,305,815

 
2,939,287

Accumulated other comprehensive income
 
13,397

 
7,666

Accumulated deficit
 
(1,365,467
)
 
(867,436
)
Total stockholders’ equity
 
8,961,871

 
2,082,331

Non-controlling interests
 
298,716

 
167,983

Total equity
 
9,260,587

 
2,250,314

Total liabilities and equity
 
$
20,480,300

 
$
7,805,059


The accompanying notes are an integral part of these statements.

1

Table of Contents

AMERICAN REALTY CAPITAL PROPERTIES, INC.
  
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
(Unaudited)
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Revenues:
 
 
 
 
Rental income
 
$
244,445

 
$
40,987

Direct financing lease income
 
1,006

 

Operating expense reimbursements
 
21,096

 
1,910

Cole Capital revenue
 
54,067

 

Total revenues
 
320,614

 
42,897

Operating expenses:
 
 
 
 
Cole Capital reallowed fees and commissions
 
34,436

 

Acquisition related
 
11,884

 
10,327

Merger and other transaction related
 
222,192

 
137,769

Property operating
 
29,627

 
2,549

General and administrative
 
26,839

 
1,454

Equity based compensation
 
22,510

 
881

Depreciation and amortization
 
165,363

 
26,753

Total operating expenses
 
512,851

 
179,733

Operating loss
 
(192,237
)
 
(136,836
)
Other (expense) income:
 
 
 
 
Interest expense, net
 
(116,712
)
 
(6,056
)
Other income, net
 
5,512

 
853

Loss on derivative instruments, net
 
(20,197
)
 
(5
)
Gain on disposition of properties, net
 
2,979

 

Gain on sale of investments
 

 
451

Total other expenses, net
 
(128,418
)
 
(4,757
)
Net loss from continuing operations
 
(320,655
)
 
(141,593
)
Discontinued operations:
 
 
 
 
Loss from operations of held for sale properties
 

 
(16
)
Gain on held for sale properties
 

 
14

Net loss from discontinued operations
 

 
(2
)
Net loss
 
(320,655
)
 
(141,595
)
Net loss attributable to non-controlling interests
 
11,974

 
432

Net loss attributable to the Company
 
(308,681
)
 
(141,163
)
Less: Dividends attributable to preferred shares
 
(22,427
)
 

Less: Dividends attributable to participating securities
 
(1,205
)
 

Net loss attributable to common stockholders
 
$
(332,313
)
 
$
(141,163
)
 
 
 
 
 
 
 
 
 
 
Basic and diluted net loss per share attributable to common stockholders
 
$
(0.61
)
 
$
(0.84
)

The accompanying notes are an integral part of these statements.

2

Table of Contents

AMERICAN REALTY CAPITAL PROPERTIES, INC.
  
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands, except for per share data)
(Unaudited)

 
 
Three Months Ended March 31,
 
 
2014
 
2013
Net loss attributable to common stockholders
 
$
(332,313
)
 
$
(141,163
)
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
Designated derivatives, fair value adjustments
 
2,636

 
(1,177
)
Unrealized gain on investment securities, net
 
3,095

 
428

Total other comprehensive income (loss)
 
5,731

 
(749
)
 
 
 
 
 
Total comprehensive loss
 
$
(326,582
)
 
$
(141,912
)

The accompanying notes are an integral part of these statements.


3

Table of Contents

AMERICAN REALTY CAPITAL PROPERTIES, INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except for share data)
(Unaudited)

 
 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number
of Shares
 
Par
Value
 
Number
of Shares
 
Par
Value
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income
 
Accumulated
Deficit
 
Total Stock-holders’ Equity
 
Non-Controlling Interests
 
Total Equity
Balance, December 31, 2013
 
42,199,547

 
$
422

 
239,234,725

 
$
2,392

 
$
2,939,287

 
$
7,666

 
$
(867,436
)
 
$
2,082,331

 
$
167,983

 
$
2,250,314

Issuance of common stock
 

 

 
524,305,318

 
5,243

 
7,324,217

 

 

 
7,329,460

 

 
7,329,460

Offering costs
 

 

 

 

 
(1,715
)
 

 

 
(1,715
)
 

 
(1,715
)
Conversion of Common OP Units to common stock
 

 

 
951,708

 
10

 
13,444

 

 

 
13,454

 
(13,454
)
 

Conversion of Preferred OP Units to Series F Preferred Stock
 
455,372

 
5

 

 

 
9,404

 

 

 
9,409

 
(9,409
)
 

Issuance of RSUs, net
 

 

 
5,440,187

 
54

 
(1,332
)
 

 

 
(1,278
)
 

 
(1,278
)
Amortization of restricted shares and LTIPs
 

 

 

 

 
22,510

 

 

 
22,510

 

 
22,510

Distributions declared on common stock
 

 

 

 

 

 

 
(165,718
)
 
(165,718
)
 

 
(165,718
)
Issuance of OP Units
 

 

 

 

 

 

 

 

 
153,884

 
153,884

Distributions to non-controlling interest holders
 

 

 

 

 

 

 

 

 
(9,589
)
 
(9,589
)
Distributions to participating securities
 

 

 

 

 

 

 
(1,205
)
 
(1,205
)
 

 
(1,205
)
Distributions to preferred shareholders
 

 

 

 

 

 

 
(22,427
)
 
(22,427
)
 

 
(22,427
)
Contributions from non-controlling interest holders
 

 

 

 

 

 

 

 

 
279

 
279

Non-controlling interests retained in Cole Merger
 

 

 

 

 

 

 

 

 
20,996

 
20,996

Net loss
 

 

 

 

 

 

 
(308,681
)
 
(308,681
)
 
(11,974
)
 
(320,655
)
Other comprehensive income
 

 

 

 

 

 
5,731

 

 
5,731

 

 
5,731

Balance, March 31, 2014
 
42,654,919

 
$
427

 
769,931,938

 
$
7,699

 
$
10,305,815

 
$
13,397

 
$
(1,365,467
)
 
$
8,961,871

 
$
298,716

 
$
9,260,587


The accompanying notes are an integral part of this statement.

4

Table of Contents

AMERICAN REALTY CAPITAL PROPERTIES, INC. 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Cash flows from operating activities:
 
 

 
 

Net loss
 
$
(320,655
)
 
$
(141,595
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Issuance of OP Units
 
153,884

 
108,247

Depreciation
 
111,015

 
21,474

Amortization of intangible lease assets
 
40,159

 
5,279

Amortization of deferred costs
 
38,064

 
1,222

Amortization of above- and below-market leases, net
 
358

 
68

Amortization of intangible assets
 
13,992

 

Amortization of discounts and premiums
 
(18,411
)
 

Gain on disposition of properties
 
(2,979
)
 
(14
)
Equity based compensation
 
22,510

 
3,260

Equity in income of unconsolidated entities
 
(251
)
 

Loss on derivative instruments
 
8,048

 
5

Gain on sale of investments, net
 

 
(451
)
Loss on extinguishment of debt
 
15,681

 

Changes in assets and liabilities:
 
 
 
 
Investment in direct financing leases
 
(3,104
)
 

Deferred costs and other assets, net
 
3,348

 
(4,710
)
Due from affiliates
 
(8,349
)
 

Accounts payable and accrued expenses
 
(148,052
)
 
(1,960
)
Deferred rent, derivative and other liabilities
 
(12,365
)
 
1,024

Due to affiliates
 
981

 

Net cash used in operating activities
 
(106,126
)
 
(8,151
)
Cash flows from investing activities:
 
 
 
 
Investments in real estate and other assets
 
(672,856
)
 
(412,628
)
Acquisition of a real estate business, net of cash acquired
 
(681,510
)
 

Capital expenditures
 
(4,796
)
 

Principal repayments received from borrowers
 
3,062

 

Investments in unconsolidated entities
 
(2,500
)
 

Return of investment from unconsolidated entities
 
941

 

Proceeds from disposition of properties
 
60,036

 

Investment in intangible assets
 
(258
)
 

Deposits for real estate investments
 
(55,029
)
 
(7,769
)
Uses and refunds of deposits for real estate investments
 
137,688

 

Purchases of investment securities
 

 
(63,269
)
Line of credit advances to affiliates
 
(36,000
)
 

Line of credit repayments from affiliates
 
39,100

 

Proceeds from sale of investment securities
 

 
44,198

Net cash used in investing activities
 
(1,212,122
)
 
(439,468
)
Cash flows from financing activities:
 
 
 
 
Proceeds from mortgage notes payable
 
669,336

 

Payments on mortgage notes payable
 
(739,087
)
 

Payments on other debt
 
(4,938
)
 

Proceeds from credit facilities
 
2,131,000

 
675,000

Payments on credit facilities
 
(2,994,000
)
 
(159,604
)
Proceeds from corporate bonds
 
2,545,760

 

Payments of deferred financing costs
 
(43,037
)
 
(24,587
)
Common stock repurchases
 

 
(350,522
)
Proceeds from issuances of common stock
 

 
1,317,389

Payments of offering costs and fees related to stock issuances
 
(1,715
)
 
(138,578
)
Consideration to Former Manager for internalization
 

 
(3,035
)
Contributions from non-controlling interest holders
 
279

 
750

Distributions to non-controlling interest holders
 
(9,589
)
 
(921
)
Distributions paid
 
(201,485
)
 
(40,636
)
Payments to affiliates, net
 

 
(526
)
Change in restricted cash
 
(3,934
)
 
(179
)
Net cash provided by financing activities
 
1,348,590

 
1,274,551

Net change in cash and cash equivalents
 
30,342

 
826,932

Cash and cash equivalents, beginning of period
 
52,725

 
292,575

Cash and cash equivalents, end of period
 
$
83,067

 
$
1,119,507

Supplemental Disclosures:
 
 
 
 
Cash paid for interest
 
$
52,518

 
$
1,363

Cash paid for income taxes
 

 
222

Non-cash investing and financing activities:
 
 
 
 
Common stock issued through distribution reinvestment plan
 

 
7,498

The accompanying notes are an integral part of these statements.

5

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)


Note 1 — Organization
American Realty Capital Properties, Inc. (the “Company” or “ARCP”) is a self-managed Maryland corporation incorporated on December 2, 2010 that qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning in the taxable year ended December 31, 2011. On September 6, 2011, the Company completed its initial public offering (the “IPO”). The Company’s common stock trades on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “ARCP”.
The Company operates through two business segments, Real Estate Investment (“REI”) and its private capital management business, Cole Capital (“Cole Capital”), as further discussed in Note 5 — Segment Reporting. Substantially all of the Company’s REI segment is conducted through ARC Properties Operating Partnership, L.P., a Delaware limited partnership (the “OP”). The Company is the sole general partner and holder of 96.9% of the equity interests in the OP as of March 31, 2014. As of March 31, 2014, certain affiliates of the Company and certain unaffiliated investors are limited partners and owners of 2.5% and 0.6%, respectively, of the equity interests in the OP. Under the limited partnership agreement of the OP, after holding units of limited partner interests in the OP (“OP Units”) for a period of one year, unless otherwise consented to by the Company, holders of OP Units have the right to redeem the OP Units for the cash value of a corresponding number of shares of the Company’s common stock or, at the option of the OP, a corresponding number of shares of the Company’s common stock. The remaining rights of the holders of OP Units are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP’s assets. Substantially all of the Cole Capital segment is conducted through Cole Capital Advisors, Inc. (“CCA”), an Arizona corporation. CCA is treated as a taxable REIT subsidiary (“TRS”) under Section 856 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”).
Prior to January 8, 2014, ARC Properties Advisors, LLC (the Company’s “Former Manager”), a wholly owned subsidiary of AR Capital, LLC (“ARC”), managed the Company’s affairs on a day-to-day basis, with the exception of certain acquisition, accounting and portfolio management services performed by employees of the Company. In August 2013, the Company’s board of directors determined that it was in the best interests of the Company and its stockholders to become self-managed, and the Company completed its transition to self-management on January 8, 2014. In connection with becoming self-managed, the Company terminated the management agreement with its Former Manager at no internalization cost to the Company, entered into employment and incentive compensation arrangements with its executives and acquired from its Former Manager certain assets necessary for its operations. See Note 19 — Related Party Transactions and Arrangements for further discussion.
The Company has advanced its investment objectives by not only growing its net lease portfolio through organic acquisitions but also through strategic mergers and acquisitions. See Note 2 — Mergers and Acquisitions for further discussion.
On March 13, 2014, the Company announced a plan to spin off substantially all of its multi-tenant shopping center properties into a newly formed publicly traded entity expected to qualify as a REIT, American Realty Capital Centers, Inc., that will operate under the name “ARCenters” and that is expected to trade on The NASDAQ Global Market under the symbol “ARCM”. The OP is expected to retain a 25% ownership stake of ARCM’s outstanding shares of common stock. The spin-off will be effected through a pro rata taxable special distribution of one share of ARCenters common stock for every 10 shares of the Company’s common stock and every 10 OP Units. The initial Form 10 registration statement relating to the spin-off was filed with the U.S. Securities and Exchange Commission (“SEC”) on April 5, 2014 and the distribution is expected to be completed in the second quarter of 2014. The Company’s board of directors has unanimously approved a plan to pursue the spin-off. The transaction is subject to certain conditions, including declaration by the SEC that ARCenters’ registration statement is effective, filing and approval of ARCenters’ listing application with The NASDAQ Global Market, customary third-party consents, and formal approval and declaration of the specified distribution by the Company’s board of directors. The Company may, at any time and for any reason until the proposed transaction is complete, abandon the spin-off or modify or change its terms.

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Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Note 2 — Mergers and Acquisitions
Completed Mergers and Significant Acquisitions
American Realty Capital Trust III, Inc. Merger
On December 14, 2012, the Company entered into an Agreement and Plan of Merger (the “ARCT III Merger Agreement”) with American Realty Capital Trust III, Inc. (“ARCT III”) and certain subsidiaries of each company. The ARCT III Merger Agreement provided for the merger of ARCT III with and into a subsidiary of the Company (the “ARCT III Merger”). The ARCT III Merger was consummated on February 28, 2013.
Pursuant to the terms and subject to the conditions set forth in the ARCT III Merger Agreement, each outstanding share of common stock of ARCT III, including restricted shares which became vested, was converted into the right to receive (i) 0.95 of a share of the Company’s common stock (the “ARCT III Exchange Ratio”) or (ii) $12.00 in cash. In addition, each outstanding unit of equity ownership of ARCT III’s operating partnership (“ARCT III OP”) was converted into the right to receive 0.95 of the same class of unit of equity ownership in the OP.
Upon the closing of the ARCT III Merger on February 28, 2013, the Company paid an aggregate of $350 million in cash for 29.2 million shares that elected cash consideration, or 16.5% of the then outstanding shares of ARCT III’s common stock (which is equivalent to 27.7 million shares of the Company’s common stock based on the ARCT III Exchange Ratio). In addition, 140.7 million shares of the Company’s common stock were issued in exchange for 148.1 million shares of ARCT III’s common stock adjusted for the ARCT III Exchange Ratio.
Upon the consummation of the ARCT III Merger, American Realty Capital Trust III Special Limited Partner, LLC (the “ARCT III Special Limited Partner”), the holder of the special limited partner interest in the ARCT III OP, was entitled to subordinated distributions of net sales proceeds from the ARCT III OP which resulted in the issuance of units of limited partner interests in the ARCT III OP, when after applying the ARCT III Exchange Ratio, resulting in the issuance of an additional 7.3 million OP Units to affiliates of the Company’s Former Manager. The parties had agreed that such OP Units would be subject to a minimum one-year holding period from the date of issuance before being exchangeable into the Company’s common stock.
Also in connection with the ARCT III Merger, the Company entered into an agreement with ARC and its affiliates to internalize certain functions performed by them prior to the ARCT III Merger, reduce certain fees paid to affiliates, purchase certain corporate assets and pay certain merger related fees. See Note 19 — Related Party Transactions and Arrangements.
Accounting Treatment for the ARCT III Merger
The Company and ARCT III, from inception to the ARCT III Merger date, were considered to be entities under common control. Both entities’ advisors were wholly owned subsidiaries of ARC. ARC and its related parties had significant ownership interests in the Company and ARCT III through the ownership of shares of common stock and other equity interests. In addition, the advisors of both entities were contractually eligible to receive potential fees for their services to both of the companies including asset management fees, incentive fees and other fees and continued to receive fees from the Company prior to the Company’s transition to self-management. Due to the significance of these fees, the advisors and ultimately ARC were determined to have a significant economic interest in both companies in addition to having the power to direct the significant activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The acquisition of an entity under common control is accounted for on the carryover basis of accounting, whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the ARCT III Merger date. In addition, U.S. GAAP requires the Company to present historical financial information as if the merger had occurred as of the beginning of the earliest period presented. Therefore, the accompanying consolidated financial statements including the notes thereto are presented as if the ARCT III Merger had occurred on January 1, 2013.
CapLease, Inc. Merger
On May 28, 2013, the Company entered into an Agreement and Plan of Merger (the “CapLease Merger Agreement”) with CapLease, Inc., a Maryland corporation (“CapLease”), and certain subsidiaries of each company. The CapLease Merger Agreement provided for the merger of CapLease with and into a subsidiary of the Company (the “CapLease Merger”).

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Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

On November 5, 2013, the Company completed the CapLease Merger. Pursuant to the terms of the CapLease Merger Agreement, each outstanding share of common stock of CapLease, other than shares owned by the Company, CapLease or any of their respective wholly owned subsidiaries, was converted into the right to receive $8.50. Each outstanding share of preferred stock of CapLease, other than shares owned by the Company, CapLease or any of their respective wholly owned subsidiaries, was converted into the right to receive an amount in cash equal to the sum of $25.00 plus all accrued and unpaid dividends on such shares of preferred stock. In addition, in connection with the merger of CapLease, LP with and into the OP, each outstanding unit of equity ownership of CapLease’s operating partnership, other than units owned by CapLease or any wholly owned subsidiary of CapLease, was converted into the right to receive $8.50. Vesting of CapLease’s outstanding restricted stock was accelerated and restricted stock and any outstanding performance shares were fully earned and received $8.50 per share. In total, cash consideration of $920.7 million was paid to CapLease’s common and preferred shareholders.
Accounting Treatment for the CapLease Merger
The CapLease Merger has been accounted for under the acquisition method of accounting under U.S. GAAP. Under the acquisition method of accounting, the assets acquired and liabilities assumed from CapLease have been recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values is recorded as goodwill. Results of operations for CapLease are included in the Company’s consolidated financial statements from the date of acquisition.
American Realty Capital Trust IV, Inc. Merger
On July 1, 2013, the Company entered into an Agreement and Plan of Merger, as amended on October 6, 2013 and October 11, 2013, (the “ARCT IV Merger Agreement”) with American Realty Capital Trust IV, Inc., a Maryland corporation (“ARCT IV”), and certain subsidiaries of each company. The ARCT IV Merger Agreement provided for the merger of ARCT IV with and into a subsidiary of the OP (the “ARCT IV Merger”). The Company consummated the ARCT IV Merger on January 3, 2014.
Pursuant to the terms of the ARCT IV Merger Agreement, as amended, each outstanding share of common stock of ARCT IV, including unvested restricted shares that vested in conjunction with the ARCT IV Merger, was exchanged for (i) $9.00 in cash, (ii) 0.5190 of a share of the Company’s common stock (the “ARCT IV Exchange Ratio”) and (iii) 0.5937 of a share of a new series of preferred stock of the Company designated as the 6.70% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) and each outstanding unit of ARCT IV’s operating partnership (“ARCT IV OP Unit”), other than ARCT IV OP Units held by the American Realty Capital Trust IV Special Limited Partner, LLC, (the “ARCT IV Special Limited Partner”) and American Realty Capital Advisors IV, LLC (the “ARCT IV Advisor") was exchanged for (i) $9.00 in cash, (ii) 0.5190 of an OP Unit and (iii) 0.5937 of a OP Unit designated as Series F Preferred Units (“Series F OP Units”). In total, the Company paid $650.9 million in cash, issued 36.9 million shares of common stock and 42.2 million shares of Series F Preferred Stock, and issued 0.7 million units of Series F OP units and 0.6 million OP Units to the former ARCT IV shareholders and ARCT IV OP Unit holders in connection with the consummation of the ARCT IV Merger. In addition, each outstanding ARCT IV Class B Unit (as defined below) and each outstanding ARCT IV OP Unit held by the ARCT IV Special Limited Partner and the ARCT IV Advisor was converted into 2.3961 OP Units, resulting in the Company issuing 1.2 million OP Units.
On January 3, 2014, the OP entered into a Contribution and Exchange Agreement (the “ARCT IV Contribution and Exchange Agreement”) with the ARCT IV OP, ARCT IV Special Limited Partner and ARC Real Estate Partner, LLC, an entity under common ownership with the Former Manager. The ARCT IV Special Limited Partner was entitled to receive certain distributions from the ARCT IV OP, including the subordinated distribution of net sales proceeds resulting from an “investment liquidity event” (as defined in the agreement of limited partnership of the ARCT IV OP). The ARCT IV Merger constituted an “investment liquidity event,” as a result of which the ARCT IV Special Limited Partner, in connection with management’s successful attainment of the 6.0% performance hurdle and the return to ARCT IV’s stockholders of approximately $358.3 million in addition to their initial investment, was entitled to receive a subordinated distribution of net sales proceeds from the ARCT IV OP equal to approximately $63.2 million. Pursuant to the ARCT IV Contribution and Exchange Agreement, the ARCT IV Special Limited Partner contributed its interest in the ARCT IV OP, inclusive of the subordinated distribution proceeds received, to the ARCT IV OP in exchange for 2.8 million equity units of the ARCT IV OP, based on agreed upon price per share of $22.50. The fair value of these units at date of issuance was $78.2 million and has been included in merger and other transaction costs in the accompanying consolidated statement of operations for the three months ended March 31, 2014. Upon consummation of the ARCT IV Merger, these equity units were immediately converted to 6.7 million OP Units after application of the exchange ratio of 2.3961 per share. In conjunction with the ARCT IV Merger Agreement, the ARCT IV Special Limited Partner agreed to a minimum two-year holding period for these OP units before converting them to shares of Company common stock.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

In addition, as part of the ARCT IV Contribution and Exchange Agreement, ARC Real Estate Partners, LLC, contributed $750,000 in cash to the ARCT IV OP, effective prior to the consummation of the ARCT IV Merger, in exchange for ARCT IV OP Units. Upon the consummation of the ARCT IV Merger, these equity units converted at an exchange ratio of 2.3961 OP Units per ARCT IV OP Unit, resulting in the Company issuing 0.1 million OP Units.
Accounting Treatment for the ARCT IV Merger
The Company and ARCT IV, from inception to the ARCT IV Merger date, were considered to be entities under common control. Both entities’ advisors were wholly owned subsidiaries of ARC. ARC and its related parties had ownership interests in the Company and ARCT IV through the ownership of shares of common stock and other equity interests. In addition, the advisors of both entities were contractually eligible to receive potential fees for their services to both of the companies including asset management fees, incentive fees and other fees and had continued to receive fees from the Company prior to the Company’s transition to self-management. Due to the significance of these fees, the advisors and ultimately ARC were determined to have a significant economic interest in both companies in addition to having the power to direct the activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with U.S. GAAP. The acquisition of an entity under common control is accounted for on the carryover basis of accounting, whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the ARCT IV Merger date. In addition, U.S. GAAP requires the Company to present historical financial information as if the entities were combined for each period presented. Therefore, the accompanying consolidated financial statements including the notes thereto are presented as if the ARCT IV Merger, including the impact of the equity transactions entered to consummate the merger, had occurred on January 1, 2013.
Fortress Portfolio Acquisition
On July 24, 2013, ARC and another related entity, on behalf of the Company and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with affiliates of funds managed by Fortress Investment Group LLC (“Fortress”) for the purchase of 196 properties owned by Fortress, for an aggregate contract purchase price of $972.5 million, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs, which were allocated to the Company based on the pro rata fair value of the properties acquired by the Company relative to the fair value of all 196 properties to be acquired from Fortress. Of the 196 properties, 120 properties were allocated to and assigned by the Company (the “Fortress Portfolio”). On October 1, 2013, the Company closed on 41 of the 120 properties with a total purchase price of $200.3 million, exclusive of closing costs. During the three months ended March 31, 2014, the Company closed the acquisition of the remaining 79 properties in the Fortress Portfolio for an aggregate contract purchase price of $400.9 million, exclusive of closing costs. The total purchase price of the Fortress Portfolio was $601.2 million, exclusive of closing costs.
Cole Real Estate Investments, Inc. Merger
On October 22, 2013, the Company entered into an agreement and plan of merger (the “Cole Merger Agreement”) with Cole Real Estate Investments, Inc. (“Cole”), a Maryland corporation, and a wholly owned subsidiary of the Company. The Cole Merger Agreement provided for the merger of Cole with and into a wholly owned subsidiary of the Company (the “Cole Merger”). The Company consummated the Cole Merger on February 7, 2014 (the “Cole Acquisition Date”).
Pursuant to the terms of the Cole Merger Agreement, each share of common stock of Cole issued and outstanding immediately prior to the effectiveness of the Cole Merger, including unvested restricted stock units (“RSUs”) and performance stock units that vested in conjunction with the Cole Merger, other than shares owned by the Company, any subsidiary of the Company or any wholly owned subsidiary of Cole, was converted into the right to receive either (i) 1.0929 shares of common stock, par value $0.01 per share, of the Company (the “Stock Consideration”) or (ii) $13.82 in cash (the “Cash Consideration” and together with the Stock Consideration, the “Merger Consideration”). Approximately 98% of all outstanding Cole holders received Stock Consideration and approximately 2% of outstanding Cole shares elected to receive Cash Consideration, pursuant to the terms of the Cole Merger Agreement, resulting in the Company issuing approximately 520.8 million shares of Company common stock and paying $181.8 million to holders of Cole shares based on their elections.
In addition, the Company issued approximately 2.8 million shares of Company common stock, in the aggregate, to certain executives of Cole pursuant to letter agreements entered into between the Company and such individuals concurrently with the execution of the Cole Merger Agreement, as previously disclosed by the Company. Additionally, effective as of the Cole Acquisition Date, the Company issued, but has not yet allocated, 0.4 million shares with dividend equivalent rights commensurate with the Company’s common stock.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Accounting Treatment for the Cole Merger
The Cole Merger has been accounted for under the acquisition method of accounting under U.S. GAAP. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Cole have been recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values is recorded as goodwill. Results of operations for Cole are included in the Company’s consolidated financial statements subsequent to the Cole Acquisition Date.
Inland Portfolio Acquisition
On August 8, 2013, ARC and another related entity, on behalf of the Company and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with Inland American Real Estate Trust, Inc. (“Inland”) for the purchase of the equity interests of 67 companies owned by Inland for an aggregate contract purchase price of approximately $2.3 billion, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs. Of the 67 companies, the equity interests of 10 companies (the “Inland Portfolio”) were allocated to the Company for a purchase price of approximately $501.0 million, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs, which was allocated to the Company based on the pro rata fair value of the Inland Portfolio relative to the fair value of all 67 companies to be acquired from Inland by the Company and the other entities sponsored directly or indirectly by ARC. The Inland Portfolio is comprised of 33 properties. As of March 31, 2014, the Company had closed on 32 of the 33 properties for a total purchase price of $288.2 million, exclusive of closing costs. The Company does not consider it probable to close on the remaining one property.
Note 3 — Summary of Significant Accounting Policies
The consolidated financial statements of the Company included herein were prepared in conformity with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The information furnished includes all adjustments and accruals of a normal recurring nature, which, in the opinion of management, are necessary for a fair presentation of results for the interim periods. The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results for the entire year or any subsequent interim period.
These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2013 of the Company, which are included on Form 10-K filed with the SEC on February 27, 2014. There have been no significant changes to these policies during the three months ended March 31, 2014, other than the updates described below.
Reclassification
Certain reclassifications have been made to the previously issued historical financial statements of the Company to conform to this presentation.
Investment in Unconsolidated Entities
Investment in Unconsolidated Joint Ventures
Investment in unconsolidated joint ventures as of March 31, 2014 consisted of the Company’s interest in six joint ventures that owned six properties (the “Unconsolidated Joint Ventures”). As of March 31, 2014, the Company owned aggregate equity investments of $100.7 million in the Unconsolidated Joint Ventures. The Company accounts for the Unconsolidated Joint Ventures using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over operating and financial policies of these investments. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the joint ventures’ earnings and distributions.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Investment in Managed REITs
As of March 31, 2014, the Company owned aggregate equity investments of $5.1 million in the following publicly registered, non-traded REITs: Cole Credit Property Trust, Inc. (“CCPT”); Cole Credit Property Trust IV, Inc. (“CCPT IV”); Cole Corporate Income Trust, Inc. (“CCIT”); Cole Real Estate Income Strategy (Daily NAV), Inc. (“INAV”); Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”) and Cole Credit Property Trust V, Inc. (“CCPT V,” and collectively with CCPT, CCPT IV, CCIT INAV and CCIT II the “Managed REITs”). The Company accounts for these investments using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over the Managed REITs’ operating and financial policies through its advisory and property management agreements with the respective Managed REITs. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective Managed REIT’s earnings and distributions.
Leasehold Improvements and Property and Equipment
The Company leases its office facilities under operating leases. Leasehold improvements related to these are recorded at cost less accumulated amortization. Leasehold improvements are amortized over the lesser of the estimated useful life or remaining lease term.
Property and equipment, which primarily include office furniture, fixtures and equipment and computer hardware and software, are stated at cost less accumulated depreciation. Property and equipment are depreciated on a straight-line method over the estimated useful lives of the assets, which range from five to seven years. The Company reassesses the useful lives of its property and equipment and adjusts the future monthly depreciation expense based on the new useful life, as applicable. If the Company disposes of an asset, the asset and related accumulated depreciation are written off upon disposal.
Impairments
Investment in Unconsolidated Entities
The Company is required to determine whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of any of its investment in the unconsolidated entities. If an event or change in circumstance has occurred, the Company is required to evaluate its investment in the unconsolidated entity for potential impairment and determine if the carrying amount of its investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying amount is fully recovered. The evaluation of an investment in an unconsolidated entity for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions.  The use of different judgments and assumptions could result in different conclusions. No impairment indicators were identified, and no impairment losses were recorded related to the Company’s unconsolidated entities for the period from the Cole Acquisition Date to March 31, 2014.
Leasehold Improvements and Property and Equipment
Leasehold improvements and property and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If this review indicates that the carrying amount of the asset is not recoverable, the Company records an impairment loss, measured at fair value by estimated discounted cash flows or market appraisals. No impairments of leasehold improvements or property or equipment were identified during the three months ended March 31, 2014.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Program Development Costs
The Company pays for organization, registration and offering expenses associated with the sale of common stock of the Managed REITs.  The reimbursement of these expenses by the Managed REITs is limited to a certain percentage of the proceeds raised from their offerings, in accordance with their respective advisory agreement and charter. Such expenses paid by the Company on behalf of the Managed REITs in excess of these limits that are expected to be collected are recorded as program development costs. The Company assesses the collectability of the program development costs, considering the offering period and historical and forecasted sales of shares under the Managed REITs’ respective offering and reserves for any balances considered not collectible. No reserves were recorded as of March 31, 2014, as the Company expects to be reimbursed for all of the program development costs by the Managed REITs as additional proceeds from their respective offerings are raised. Program development costs are included in deferred costs and other assets, net in the accompanying consolidated balance sheets.
Due from Affiliates
The Company receives or may be entitled to receive compensation and reimbursement for services primarily relating to the Managed REITs’ offerings and the investment, management, financing and disposition of their respective assets. Refer to Note 19 — Related Party Transaction and Arrangements for further explanation.
Reportable Segments
The Company has concluded that it has two reportable segments as it has organized its operations into two segments for management and internal financial reporting purposes, Real Estate Investment and Cole Capital. The identification and aggregation of reportable segments requires the Company’s management to exercise certain judgments. Refer to Note 5 — Segment Reporting for further information.
Revenue Recognition - Cole Capital
Revenue consists of securities sales commissions and dealer manager fees, real estate acquisition fees, property management fees, advisory fees, asset management fees and performance fees for services relating to the Managed REITs’ offerings and the investment and management of their respective assets, in accordance with the respective advisory and dealer manager agreements. The Company records revenue related to acquisition fees, securities sales commissions and dealer manager fees upon completion of a transaction and advisory, asset and property management fees as services are performed. The Company is also reimbursed for certain costs incurred in providing these services. Securities sales commission and dealer manager reimbursements are recorded as revenue as the expenses are incurred. Other reimbursements are recorded as revenue when reimbursements are reasonably assured.
Income Taxes
The Company currently qualifies and has elected to be taxed as a REIT for federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. As a REIT, except as discussed below, the Company generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the dividends paid deduction and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the Company maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, and federal income and excise taxes on its undistributed income.
The Company conducts substantially all of its Cole Capital business operations through a taxable REIT subsidiary (“TRS”). A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States, and as a result, the Company files income tax returns in the U.S. federal jurisdiction and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

The Company provides for income taxes in accordance with current authoritative accounting and tax guidance. The tax expense or benefit related to significant, unusual or extraordinary items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or the tax environment changes.
Repurchase Agreements
In certain circumstances the Company may obtain financing through a repurchase agreement. The Company evaluates the initial transfer of a financial instrument and the related repurchase agreement for sale accounting treatment. In instances where the Company maintains effective control over the transferred securities, the Company accounts for the transaction as a secured borrowing, and accordingly, both the securities and related repurchase agreement payable are recorded separately in the accompanying consolidated balance sheets in investment securities, at fair value and other debt, net, respectively. In instances where the Company does not maintain effective control over the transferred securities, the Company accounts for the transaction as a sale of securities for proceeds consisting of cash and a forward purchase contract.
Recent Accounting Pronouncements
In April 2014, the U.S. Financial Accounting Standards Board issued Accounting Standards Update, 2014-08 Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which amends the reporting requirements for discontinued operations by updating the definition of a discontinued operation to be a component of an entity that represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, resulting in fewer disposals that qualify for discontinued operations reporting yet the pronouncement also requires expanded disclosures for discontinued operations. The Company adopted ASU 2014-08 effective January 1, 2014. Starting with the first quarter of 2014, the results of operations for all qualifying disposals and properties classified as held for sale that were not previously reported in discontinued operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 will be presented within income from continuing operations on the accompanying consolidated statements of income.
Note 4 — Acquisitions of CapLease and Cole
CapLease Acquisition
On November 5, 2013 (the “CapLease Acquisition Date”), the Company completed the CapLease Merger, an acquisition of a real estate investment trust that primarily owned and managed a diversified portfolio of single tenant commercial real estate properties subject to long-term leases, the majority of which were net leases, to high credit quality tenants, by acquiring 100% of the outstanding common stock and voting interests of CapLease. The acquisition was accounted for using the acquisition method of accounting in accordance with ASC 805, Business Combinations. The Company’s consolidated financial statements include the results of operations of CapLease subsequent to the CapLease Acquisition Date.
The purchase price includes a cash payment of $920.7 million, which was funded by the Company through additional borrowings under its revolving credit facility and the credit facility assumed from CapLease. See Note 12 — Other Debt and Note 13 — Credit Facilities.
The purchase price allocation for the CapLease Merger is considered preliminary, and additional adjustments may be recorded during the measurement period in accordance with U.S. GAAP. The purchase price allocation will be finalized as the Company receives additional information relevant to the acquisition, including a final valuation of the assets purchased and liabilities assumed.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

The preliminary purchase price for the acquisition was allocated to assets acquired and liabilities assumed based on their estimated fair value. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the CapLease Acquisition Date initially recorded, as well as measurement period adjustments made and the revised estimated fair values of the assets acquired and liabilities assumed at the CapLease Acquisition Date (in thousands):
 
 
 
Preliminary
 
 
 
Amounts Previously Recognized as of the CapLease Acquisition Date (1)
 
Measurement Period Adjustments
 
Adjusted Amounts Recognized as of the CapLease Acquisition Date
Fair value of consideration given
 
$
920,697

 
$

 
$
920,697

 
 
 
 
 
 
 
 
Assets purchased, at fair value:
 
 
 
 
 
 
Land
 
235,843

 
(2,778
)
 
233,065

Buildings, fixtures and improvements
 
1,596,481

 
(8,147
)
 
1,588,334

Land and construction in process
 
12,352

 

 
12,352

Acquired intangible lease assets
 
191,964

 
(1,102
)
 
190,862

Total real estate investments
 
2,036,640

 
(12,027
)
 
2,024,613

Cash and cash equivalents
 
41,799

 

 
41,799

Investment securities
 
60,730

 

 
60,730

Loans held for investment
 
26,457

 

 
26,457

Restricted cash
 
29,159

 

 
29,159

Deferred costs and other assets, net
 
21,564

 

 
21,564

Deferred costs
 
325

 

 
325

Total identifiable assets purchased
 
2,216,674

 
(12,027
)
 
2,204,647

 
 
 
 
 
 
 
Liabilities assumed, at fair value:
 
 
 
 
 
 
Mortgage notes payable
 
1,037,510

 

 
1,037,510

Secured credit facility
 
121,000

 

 
121,000

Other debt
 
114,208

 

 
114,208

Below-market leases
 
57,058

 

 
57,058

Derivative liabilities
 
158

 

 
158

Accounts payable and accrued expenses
 
46,484

 
517

 
47,001

Deferred rent, derivative and other liabilities
 
8,867

 

 
8,867

Total liabilities assumed
 
1,385,285

 
517

 
1,385,802

 
 
 
 
 
 
 
Non-controlling interest retained by third party
 
567

 

 
567

 
 
 
 
 
 
 
Net identifiable assets acquired by Company
 
830,822

 
(12,544
)
 
818,278

Goodwill
 
$
89,875

 
$
12,544

 
$
102,419

____________________________________
(1)
As reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

After the December 31, 2013 financial statements were issued, the Company received final purchase and sale agreements for two properties that were sold to third parties during the first quarter of 2014.  After giving consideration to the sales price of these properties, the Company has estimated that the fair value of these properties originally acquired as part of the CapLease Merger to be $12.0 million.  As a result of the sale, the carrying amount of real estate investments was retrospectively decreased by $12.0 million as of the CapLease Acquisition Date, with a corresponding increase to goodwill in the accompanying consolidated balance sheet as of December 31, 2013.  The impact to depreciation expense recognized during the year ended December 31, 2013 was not significant, and, therefore, the Company has not retrospectively adjusted its consolidated statements of operations. In addition to the adjustment above, the Company identified $0.5 million of additional accrued expenses that were outstanding as of the CapLease Acquisition Date.
Management is in the process of further evaluating the purchase price accounting. The fair value of real estate investments and below-market leases have been estimated by the Company with the assistance of third-party valuation firms. Based on a preliminary analysis received to date, the estimated fair value of these assets and liabilities total $2.0 billion and $57.1 million, respectively. The recorded values represent the estimated fair values related to such assets and liabilities. Upon completion of the analysis, including a review of the appraisals and assessment of current market rates, changes to the estimated fair values may result. Such post-closing adjustments are customary in nature in accordance with ASC 805, Business Combinations.
The ascribed value of the noncontrolling interest has been estimated based on the fair value of the percentage ownership of The Woodlands, Texas development activity not held by the Company. See to Note 6 Real Estate Investments.
The fair value of the remaining CapLease assets and liabilities have been calculated in accordance with the Company’s policy on purchase price allocation, as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
Goodwill of approximately $102.4 million is expected to be assigned to the REI segment upon completion of the valuation. The goodwill recognized is attributed to the enhancement of the Company’s year-round rental revenue stream, expected synergies and the assembled work force at CapLease.
The pro forma consolidated statements of operations in Note 6 — Real Estate Investments are presented as if CapLease had been included in the consolidated results of the Company for the entire periods ended March 31, 2014 and 2013.
Cole Acquisition
On February 7, 2014, the Company completed its acquisition of Cole, as discussed in Note 2 — Mergers and Acquisitions. The Company accounted for the Cole Merger as a business combination under the acquisition method of accounting. Therefore, the Company’s consolidated financial statements include the results of operations of Cole subsequent to the Cole Acquisition Date.
Fair Value of Consideration Transferred
The Company is in the process of gathering certain additional information in order to finalize its assessment of the fair value of the consideration transferred; thus, the fair values of currently recorded assets and liabilities are subject to change. The estimated fair value of the consideration transferred at the Cole Acquisition Date totaled approximately $7.5 billion and consisted of the following (in thousands):
 
As of Cole Acquisition
Date (Preliminary)
Estimated Fair Value of Consideration Transferred:
 
Cash
$
181,775

Common stock
7,285,868

Total consideration transferred
$
7,467,643

The fair value of the 520.8 million shares of common stock issued, excluding those common shares transferred to former Cole executives, was determined based on the closing market price of the Company’s common stock on the Cole Acquisition Date.

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Allocation of Consideration
The consideration transferred pursuant to the Cole Merger Agreement was allocated to the assets acquired and liabilities assumed for the REI segment and Cole Capital, based upon their preliminary estimated fair values as of the Cole Acquisition Date. The Company is in the process of gathering certain additional information in order to finalize its assessment of the fair value of certain intangible assets; thus, the provisional measurements of intangible assets and goodwill are subject to change. Such post-closing adjustments are customary in nature in accordance with ASC 805, Business Combinations. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed by segment at the Cole Acquisition Date (in thousands):
 
Preliminary
 
REI Segment
 
Cole Capital
 
Total as of Cole Acquisition Date
Identifiable Assets Acquired at Fair Value:
 
 
 
 
 
Land
$
1,737,390

 
$

 
$
1,737,390

Buildings, fixtures and improvements
5,898,895

 

 
5,898,895

Land and construction in process

 

 

Acquired intangible lease assets
1,323,614

 

 
1,323,614

Total real estate investments
8,959,899

 

 
8,959,899

Investment in unconsolidated entities
100,659

 
3,307

 
103,965

Investment securities, at fair value
151,197

 

 
151,197

Loans held for investment, net
72,326

 

 
72,326

Cash and cash equivalents
130,747

 
20,413

 
151,160

Restricted cash
15,704

 

 
15,704

Intangible assets

 
385,368

 
385,368

Deferred costs and other assets
45,081

 
50,893

 
95,974

Due from affiliates

 
3,301

 
3,301

Total identifiable assets acquired
9,475,613

 
463,282

 
9,938,894

 
 
 
 
 
 
Identifiable Liabilities Assumed at Fair Value:
 
 
 
 
 
Mortgage notes payable, net
2,719,072

 

 
2,719,072

Credit facilities
1,309,000

 

 
1,309,000

Other debt
49,013

 

 
49,013

Below-market lease liabilities
212,377

 

 
212,377

Accounts payable and accrued expenses
73,441

 
60,468

 
133,909

Deferred rent, derivative and other liabilities
42,764

 
110,529

 
153,293

Dividends payable
6,271

 

 
6,271

Contingent consideration
3,606

 
48,373

 
51,979

Due to affiliates

 
44

 
44

Total liabilities assumed
4,415,544

 
219,414

 
4,634,958

 

 

 

Noncontrolling interests
20,996

 

 
20,996

 
 
 
 
 
 
Net identifiable assets acquired
5,039,073

 
243,868

 
5,282,940

Goodwill
1,628,571

 
556,132

 
2,184,703

Net assets acquired
$
6,667,644

 
$
800,000

 
$
7,467,643


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Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

The fair value of real estate investments and below-market lease liabilities allocated to the REI segment have been estimated by the Company with the assistance of a third-party valuation firm. Based on a preliminary analysis received to date, the estimated fair value of these assets and liabilities total $9.0 billion and $212.4 million, respectively. The recorded values represent the estimated fair values related to such assets and liabilities. Upon completion of the analysis, including a review of the appraisals and assessment of current market rates, changes to the estimated fair values may result.
The intangible assets acquired primarily consist of management and advisory contracts that the Company has with the Managed REITs and are subject to an estimated useful life of approximately four years. The Company recorded $14.0 million of amortization expense for the period from the Cole Acquisition Date to March 31, 2014. The estimated amortization expense for the remainder of the year ending December 31, 2014 is $72.6 million. The estimated amortization expense for each of the years ending December 31, 2015, 2016 and 2017 is $96.3 million and the estimated amortization expense for the year ending December 31, 2018 is $9.8 million.
Goodwill of approximately $1.6 billion is expected to be assigned to the REI segment upon completion of the external valuation. The goodwill recognized is attributed to the enhancement of the Company’s year-round rental revenue stream, realized and expected synergies, the impact of the merger on lowering the Company’s cost of capital, as well as the benefits of critical mass, improved portfolio diversification, and enhanced access to capital markets. Goodwill of approximately $556.1 million is expected to be assigned to Cole Capital upon completion of the external valuation. The goodwill is primarily supported by management’s belief that Cole Capital brings an established management platform with numerous strategic benefits including growth from new income streams and the ability to offer new products. None of the goodwill is expected to be deductible for income tax purposes.
The fair value of the remaining Cole assets and liabilities have been calculated in accordance with the Company’s policy on purchase price allocation, as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
The amounts of revenue and net income related to Cole property acquisitions and Cole Capital included in the accompanying consolidated statements of operations from the Cole Acquisition Date to the period ended March 31, 2014 was $162.6 million and $0.7 million respectively.
The pro forma consolidated statements of operations in Note 6 — Real Estate Investments are presented as if Cole had been included in the consolidated results of the Company for the entire periods ended March 31, 2014 and 2013.
Note 5 — Segment Reporting
The Company operates under two segments, REI and Cole Capital.
REI - Through its REI segment, the Company acquires, owns and operates a diverse portfolio of core commercial real estate investments primarily consisting of single-tenant, freestanding commercial real estate properties. The Company focuses on investing in properties that are net leased to credit tenants, which are generally large public companies with investment-grade ratings and other creditworthy tenants. The Company’s long-term business strategy is to acquire a diverse portfolio consisting of approximately 70.0% long-term leases and 30.0% medium-term, with an average portfolio remaining primary lease term of approximately 10 to 12 years. The Company considers properties that are leased on a “medium-term” basis to mean properties originally leased long-term (ten years or longer) that currently have a primary remaining lease duration of generally three to eight years, on average. The Company expects this investment strategy to provide for stable income from credit tenants and to provide for growth opportunities from re-leasing of current below market leases. As of March 31, 2014, the Company owned 3,809 properties comprising 101.8 million square feet of single and multi-tenant retail and commercial space located in 49 states, which include properties owned through consolidated joint ventures. As of March 31, 2014, the rentable space at these properties was 98.9% leased with a weighted average remaining lease term of 10.2 years. As of March 31, 2014, the Company also owned 25 commercial mortgage-backed securities (“CMBS”), 14 loans held for investment and, through the Unconsolidated Joint Ventures, had interests in six properties comprising 1.6 million rentable square feet of commercial and retail space.

17

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Cole Capital - Cole Capital is contractually responsible for managing the Managed REITs’ affairs on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs’ behalf, and recommending to each of the Managed REIT’s respective board of directors an approach for providing investors with liquidity. Cole Capital serves as the dealer manager and distributes shares of common stock for certain Managed REITs and advises them regarding offerings, manages relationships with participating broker-dealers and financial advisors and provides assistance in connection with compliance matters relating to the offerings. Cole Capital receives compensation and reimbursement for services relating to the Managed REITs’ offerings and the investment, management, financing and disposition of their respective assets, as applicable. Cole Capital also develops new REIT offerings, including obtaining regulatory approvals from the SEC, the Financial Industry Regulatory Authority, Inc. (“FINRA”) and various jurisdictions for such offerings.
The Company allocates certain operating expenses, such as audit and legal fees, board of director fees, employee related costs and benefits and general overhead expenses between its two segments. The following tables present a summary of the comparative financial results and total assets for each business segment (in thousands):
 
Three Months Ended March 31,
 
2014
 
2013
REI:
 
 
 
Rental income
$
244,445

 
$
40,987

Direct financing lease income
1,006

 

Operating expense reimbursements
21,096

 
1,910

Total real estate investment revenues
266,547

 
42,897

Acquisition related
11,884

 
10,327

Merger and other transaction related
222,192

 
137,769

Property operating expenses
29,627

 
2,549

General and administrative expenses
7,750

 
1,454

Equity based compensation
22,510

 
881

Depreciation and amortization
151,004

 
26,753

Total operating expenses
444,967

 
179,733

Operating loss
(178,420
)
 
(136,836
)
Interest expense, net
(116,717
)
 
(6,056
)
Other income, net
322

 
853

Loss on derivative instruments, net
(20,197
)
 
(5
)
Gain on disposition of properties, net
2,979

 

Gain on sale of investments

 
451

Total other expenses, net
(133,613
)
 
(4,757
)
Net loss from continuing operations
(312,033
)
 
(141,593
)
Discontinued operations:
 
 
 
Loss from operations of held for sale properties

 
(16
)
Gain on held for sale properties

 
14

Net loss from discontinued operations

 
(2
)
Net loss
$
(312,033
)
 
$
(141,595
)
 
 
 
 

18

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

 
 
 
 
 
Three Months Ended March 31,
 
2014
 
2013
Cole Capital:
 
 
 
Dealer manager and distribution fees, selling commissions and offering reimbursements
$
42,453

 
$

Transaction service fees
4,559

 

Management fees and reimbursements
7,055

 

Total Cole Capital revenues
54,067

 

Cole Capital reallowed fees and commissions
34,436

 

General and administrative expenses
19,089

 

Depreciation and amortization
14,359

 

Total operating expenses
67,884

 

Total other income
5,195

 

Net loss
$
(8,622
)
 
$

 
 
 
 
Total Company:
 
 
 
Total revenues
$
320,614

 
$
42,897

Total operating expenses
512,851

 
179,733

Total other expense
(128,418
)
 
(4,757
)
Loss from continuing operations
(320,655
)
 
(141,593
)
Loss from discontinued operations

 
(2
)
Net loss
$
(320,655
)
 
$
(141,595
)
 
Total Assets
 
March 31, 2014
 
December 31, 2013
Real Estate Investment
$
19,480,029

 
$
7,805,059

Cole Capital
1,000,271

 

Total Company
$
20,480,300

 
$
7,805,059


19

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Note 6 — Real Estate Investments
Excluding the Cole Merger and the ARCT IV Merger, the Company acquired interests in 215 commercial properties, including five land parcels, for an aggregate purchase price of $936.1 million during the three months ended March 31, 2014 (the “2014 Acquisitions”). The Company is in the process of obtaining and reviewing the final third-party appraisals for the 2014 Acquisitions, as such, the fair value of the related asset acquired and liabilities assumed during the three months ended March 31, 2014 are provisionally allocated. The following table presents the allocation of the fair value of the assets acquired and liabilities assumed during the periods presented (dollar amounts in thousands):
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Real estate investments, at cost:
 
 
 
 
Land
 
$
133,903

 
$
74,700

Buildings, fixtures and improvements
 
694,935

 
291,664

Total tangible assets
 
828,838

 
366,364

Acquired intangible assets:
 
 
 
 
In-place leases
 
120,421

 
45,223

Above-market leases
 
11,559

 

Assumed intangible liabilities:
 
 
 
 
Below-market leases
 
(1,156
)
 

Fair value adjustment of assumed notes payable
 
(23,589
)
 

Total purchase price of assets acquired, net
 
936,073

 
411,587

Notes payable assumed
 
263,217

 

Cash paid for acquired real estate investments
 
$
672,856

 
$
411,587

Number of properties acquired
 
215

 
112

The following table presents unaudited pro forma information as if all of the 2014 Acquisitions and the Cole Merger and ARCT IV Merger, as discussed in Note 2 — Mergers and Acquisitions, were completed on January 1, 2013 for each period presented below. These amounts have been calculated after applying the Company’s accounting policies and adjusting the results of acquisitions to reflect the additional depreciation and amortization and interest expense that would have been charged had the acquisitions occurred on January 1, 2013. Additionally, the unaudited pro forma net loss attributable to stockholders was adjusted to exclude acquisition related expenses of $11.9 million and $10.3 million for the three months ended March 31, 2014 and 2013, respectively and merger and other transaction related expenses of $222.2 million and $137.8 million for the three months ended March 31, 2014 and 2013, respectively. These costs were recognized in the pro forma information for the three months ended March 31, 2013 (in thousands):
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Pro forma revenues
 
$
413,780

 
$
44,330

Pro forma net income (loss) attributable to stockholders
 
$
(20,374
)
 
$
6,056


20

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

ARCT IV GE Capital Portfolio
After the ARCT IV December 31, 2013 financial statements were issued, ARCT IV completed its review of the final appraisals received from third party firms for certain properties included in the ARCT IV GE Capital Portfolio. After giving consideration to the appraisals of these properties, the Company has estimated that the fair value of the land, building, fixtures and improvements, acquired leases assets and acquired lease liabilities to be $183.2 million, $300.4 million, $47.0 million, and $7.8 million, respectively. Additionally, as part of ARCT IV’s review of the final appraisals, assets that were classified as direct financing leases were reclassified into real estate investments. As a result of these adjustments, the carrying amount land, acquired leases assets and acquired lease liabilities was retrospectively increased by $40.7 million, $2.7 million, and $7.8 million, respectively, as of the date ARCT IV acquired the ARCT IV GE Capital Portfolio. In addition, the carrying amount of buildings, fixtures and improvements and investments in direct financing leases was decreased by $32.1 million and $3.5 million, respectively as of the same date. These adjustments to carrying value are reflected in the accompanying consolidated balance sheet as of December 31, 2013.  The impact to depreciation expense recognized during the year ended December 31, 2013 was not significant, and therefore, the Company has not retrospectively adjusted its consolidated statements of operations.
Future Lease Payments
The following table presents future minimum base rental cash payments due to the Company over the next five years and thereafter. These amounts exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to sales thresholds and increases in annual rent based on exceeding certain economic indexes among other items (in thousands):
 
 
Future Minimum Operating Lease
Base Rent Payments
 
Future Minimum
Direct Financing Lease Payments (1)
April 1, 2014 - December 31, 2014
 
$
921,815

 
$
3,802

2015
 
1,152,446

 
4,757

2016
 
1,127,440

 
4,674

2017
 
1,075,967

 
4,273

2018
 
1,021,150

 
3,183

Thereafter
 
7,251,560

 
10,052

Total
 
$
12,550,378

 
$
30,741

____________________________________
(1) 47 properties are subject to direct financing leases and, therefore, revenue is recognized as direct financing lease income on the discounted cash flows of the lease payments. Amounts reflected are the cash rent on these respective properties.
Net Investment in Direct Financing Leases
The components of the Company’s net investment in direct financing leases as of March 31, 2014 and December 31, 2013 are as follows (in thousands):
 
 
March 31, 2014
 
December 31, 2013
Future minimum lease payments receivable
 
$
31,001

 
$
33,729

Unguaranteed residual value of property
 
47,089

 
46,172

Unearned income
 
(12,367
)
 
(13,789
)
Net investment in direct financing leases
 
$
65,723

 
$
66,112


21

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Development Activities
During the three months ended March 31, 2014, the Company acquired five land parcels, upon which single tenant commercial properties will be developed. Based on budgeted construction costs, the remaining costs to complete the buildings is estimated to be $7.9 million in aggregate. The land acquired for an aggregate amount of $4.6 million is included in land in the accompanying consolidated balance sheet. In addition, during the three months ended March 31, 2014, the Company substantially completed the development of a 450,000 square foot distribution warehouse in Columbia, South Carolina. The build-to-suit project has an estimated total investment of $22.0 million. As of March 31, 2014, the Company had a total investment of $20.1 million, including capitalized interest of $37,000, and estimated remaining investment of $1.9 million related to the development project.
Prior to the CapLease Acquisition Date, CapLease entered into an agreement with a major Texas-based developer to develop a 150,000 square foot speculative office building in The Woodlands, Texas, adjacent to and part of the same development as an existing office building owned by CapLease since 2012. Costs of the project, which are budgeted to be $34.0 million, are scheduled to be funded by equity contributions from the Company and its developer partner, and $17.0 million of advances during the construction period under a development loan entered into with Amegy Bank. All equity contributions are scheduled to be borne as follows: the Company, 90%; and the developer, 10%; except for cost overruns, which will be borne 50% by each. Because the Company has a controlling financial interest in the investment, it consolidates the investment for financial accounting purposes. The Company has an option to purchase, and the developer the option to sell to the Company, in each case at fair market value, the developer’s interest in the project upon (i) substantial completion of the project and (ii) leases being entered into for 95% of the square footage of the project. Construction activity and funding of the project commenced during the quarter ended September 30, 2013 and is expected to be completed during the second half of 2014. As of March 31, 2014, the Company had a total investment of $12.3 million, including capitalized interest of $45,000, and estimated remaining investment of $21.7 million related to the development project.
Tenant Concentration
The following table lists the tenants of the Company whose annualized rental income, determined on a straight-line basis, represented greater than 10% of consolidated annualized rental income as of March 31, 2013. Annualized rental income for net leases is rental income as of the period reported, which includes the effect of tenant concessions such as free rent, as applicable. There were no tenants exceeding 10% of consolidated annualized rental income March 31, 2014.
 
 
March 31,
Tenant
 
2014
 
2013
Dollar General
 
*
 
12.0%
Citizens Bank
 
*
 
12.0%
____________________________________
* The tenants’ annualized rental income was not greater than 10% of total consolidated annualized rental income for all portfolio properties as of the period specified.
No other tenant represents more than 10% of total consolidated annualized rental income for the periods presented.
Geographic Concentration
As of March 31, 2014, properties located in Texas represented 12.2% of consolidated annualized rental income determined on a straight-line basis. There were no geographic concentrations exceeding 10% of consolidated annualized rental income at March 31, 2013.
Note 7 — Investment Securities, at Fair Value
Investment securities are considered available-for-sale and, therefore, increases or decreases in the fair value of these investments are recorded in accumulated other comprehensive income (loss) as a component of equity on the consolidated balance sheets unless the securities are considered to be other than temporarily impaired at which time the losses are reclassified to expense.

22

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

The following tables detail the unrealized gains and losses on investment securities as of March 31, 2014 and December 31, 2013 (in thousands):
 
 
March 31, 2014

 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Investments in real estate fund
 
$
1,605

 
$
43

 
$

 
$
1,648

CMBS
 
209,076

 
3,546

 
(467
)
 
212,155

Total
 
$
210,681

 
$
3,589

 
$
(467
)
 
$
213,803

 
 
December 31, 2013
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Investments in real estate fund
 
$
1,589

 
$

 
$
(105
)
 
$
1,484

CMBS
 
60,452

 
498

 
(367
)
 
60,583

Total
 
$
62,041

 
$
498

 
$
(472
)
 
$
62,067

CMBS
In connection with the Cole Merger, the Company acquired 15 CMBS with an estimated aggregate fair value of $151.2 million as of the Cole Acquisition Date. As of March 31, 2014, the Company owned 25 CMBS with an estimated aggregate fair value of $212.2 million. As of March 31, 2014, certain of these securities were pledged as collateral under repurchase agreements (the “Repurchase Agreements”), as discussed in Note 12 — Other Debt. As of December 31, 2013, the Company owned 10 CMBS with an estimated aggregate fair value of $60.6 million.
As of March 31, 2014, the fair value of six CMBS was below its amortized cost. The Company evaluated each of the securities for other-than-temporary impairment at March 31, 2014, and determined that no other-than-temporary impairment charges on its securities were appropriate. The Company believes that none of the unrealized losses on investment securities are other-than-temporary because management expects the Company will receive all contractual principal and interest related to these investments. In addition, the Company did not have the intent to sell the securities or believe it would be required to sell them as of March 31, 2014.
The scheduled maturity of the Company’s CMBS as of March 31, 2014 is as follows (in thousands):
 
 
March 31, 2014
 
 
Amortized Cost
 
Fair Value
Due within one year
 
$

 
$

Due after one year through five years
 
1,325

 
1,348

Due after five years through ten years
 
178,885

 
181,055

Due after ten years
 
28,866

 
29,752

 
 
$
209,076

 
$
212,155

Investment in Real Estate Fund
As of March 31, 2014, the Company had investments in a real estate fund that is sponsored by an affiliate of the Former Manager of the Company and which invests primarily in equity securities of other publicly traded REITs.

23

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Note 8 — Loans Held for Investment
Loans Held for Investment
During the three months ended March 31, 2014, in connection with the Cole Merger, the Company acquired two mortgage notes receivable, each of which is secured by an office building. The mortgage notes had a fair value of $72.3 million as of the Cole Acquisition Date. As of December 31, 2013, the Company owned 12 loans held for investment, which were acquired in connection with the CapLease Merger and consist predominantly of mortgage loans on properties subject to leases to investment grade tenants. The loans had a fair value of $26.5 million at the CapLease Merger Date. At March 31, 2014, the Company owned 14 loans held for investment, which had a carrying value of $98.2 million and carried interest rates ranging from 5.28% to 7.24%. As of December 31, 2013, the loans held for investment had a carrying value of $26.3 million and carried interest rates ranging from 5.28% to 7.24%. The fair value adjustment is being amortized to interest expense in the consolidated statements of operations over the lives of the secured terms.
The Company’s loan portfolio is comprised primarily of fully amortizing or nearly fully amortizing first mortgage loans on commercial real estate leased to a single tenant. Payments of debt service on the Company’s loans is, in substantially all cases, funded directly by rent payments paid into a lockbox account by the underlying tenant. Therefore, the Company’s monitoring of the credit quality of its loans held for investment is focused primarily on an analysis of the tenant, including review of tenant credit ratings (including changes in ratings) and other measures of tenant credit quality, trends in the tenant’s industry and general economic conditions, and an analysis of measures of collateral coverage, such as an estimate of the loan’s loan-to-value (“LTV”) ratio (principal amount outstanding divided by estimated value of the property) and its remaining term until maturity. As of March 31, 2014 and December 31, 2013, the Company had no reserve for loan loss.
Note 9 — Deferred Costs and Other Assets, Net
Deferred costs and other assets, net consisted of the following as of March 31, 2014 and December 31, 2013 (amounts in thousands):
 
 
March 31, 2014
 
December 31, 2013
Deferred costs, net
 
$
116,094

 
$
119,731

Accounts receivable, net (2)
 
54,684

 
16,538

Straight-line rent receivable
 
28,995

 
19,009

Prepaid expenses
 
21,247

 
5,379

Leasehold improvements, property and equipment, net (1)
 
19,979

 
1,451

Restricted escrow deposits
 
19,154

 
101,814

Derivative assets, at fair value
 
9,829

 
9,189

Other assets
 
24,712

 
5,998

 
 
$
294,694

 
$
279,109

____________________________________
(1) Amortization expense for leasehold improvements totaled $197,000 for the three months ended March 31, 2014. Accumulated amortization was $250,000 and $53,000 as of March 31, 2014 and December 31, 2013, respectively. Depreciation expense for property and equipment totaled $275,000 for the three months ended March 31, 2014. Accumulated depreciation was $355,000 and $80,000 as of March 31, 2014 and December 31, 2013, respectively.
(2) Allowance for doubtful accounts was $908,000 and $187,000 as of March 31, 2014 and December 31, 2013, respectively.

24

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Note 10 — Fair Value of Financial Instruments
The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The guidance defines three levels of inputs that may be used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 — Unobservable inputs that reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be infrequent.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of March 31, 2014, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. As of March 31, 2014, the Company’s interest rate cap derivative measured at fair value on a recurring basis was zero and was classified in Level 2 of the fair value hierarchy.

25

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

The following table presents information about the Company’s assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):


Quoted Prices
in Active
Markets
Level 1

Significant Other
Observable
Inputs
Level 2

Significant
Unobservable
Inputs
Level 3

Balance as of
March 31, 2014
Assets:








Investments in real estate fund
 
$

 
$
1,648

 
$

 
$
1,648

CMBS
 

 

 
212,155

 
212,155

Interest rate swap assets


 
9,829

 


9,829

Total assets
 
$

 
$
11,477

 
$
212,155

 
$
223,632

Liabilities:
 
 
 
 
 
 
 
 
Interest rate swap liabilities

$

 
$
(8,737
)
 
$


$
(8,737
)
Series D Preferred Stock embedded derivative


 

 
(26,734
)

(26,734
)
Contingent consideration arrangements
 

 

 
(4,903
)
 
(4,903
)
Total liabilities

$


$
(8,737
)

$
(31,637
)

$
(40,374
)









 
 
 
 
 
 
 
 
 


Quoted Prices
in Active
Markets
Level 1

Significant Other
Observable
Inputs
Level 2

Significant
Unobservable
Inputs
Level 3

Balance as of December 31, 2013
Assets:
 
 
 
 
 
 
 
 
Investments in real estate fund
 
$

 
$
1,484

 
$

 
$
1,484

CMBS
 

 

 
60,583

 
60,583

Interest rate swap assets
 

 
9,189

 

 
9,189

Total assets
 
$

 
$
10,673

 
$
60,583

 
$
71,256

Liabilities:
 
 
 
 
 
 
 
 
Interest rate swap liabilities
 
$

 
$
(1,719
)
 
$

 
$
(1,719
)
Series D Preferred Stock embedded derivative
 

 

 
(16,736
)
 
(16,736
)
Total liabilities
 
$

 
$
(1,719
)
 
$
(16,736
)
 
$
(18,455
)
Investments in real estate fund — The fair value of the Company’s investments in real estate fund are based published pricing.
CMBS — The fair values of the Company’s CMBS are valued using broker quotations, collateral values, subordination levels and liquidity of the individual securities.
Derivatives — The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.
Series D Preferred Stock embedded derivative — The valuation of this derivative instrument is determined using a binomial option pricing model. Key inputs in the model include the expected term, risk-free interest rate, volatility and dividend yield.

26

Table of Contents
AMERICAN REALTY CAPITAL PROPERTIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

Contingent Consideration Arrangements — The contingent consideration arrangements are carried at fair value and are valued using Level 3 inputs. The fair value of the contingent payments related to property acquisitions is determined based on the estimated timing and probability of successfully leasing vacant space subsequent to the Company’s acquisition of certain properties. The estimated fair value of the property-related contingent consideration arrangements totaled $4.9 million as of March 31, 2014 and is included in the accompanying consolidated balance sheet in deferred rent, derivative and other liabilities. There were no property related contingent consideration arrangements as of December 31, 2013.
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, due to affiliates and accounts payable approximate their carrying value on the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.
A review of the fair value hierarchy classification is conducted on a quarterly basis. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1 and Level 2 or Level 3 of the fair value hierarchy during the three months ended March 31, 2014.
The following is a reconciliation of the beginning and ending balance for the changes in instruments with Level 3 inputs in the fair value hierarchy for the three months ended March 31, 2014 (in thousands):
 
 
CMBS
 
Series D Preferred Stock Embedded Derivative
 
Contingent Consideration
Arrangements
 
Total
Beginning Balance as of December 31, 2013
 
$
60,583

 
$
(16,736
)
 
$

 
$
43,847

Total gains and losses:
 
 
 
 
 
 
 
 
Unrealized gain included in other comprehensive income, net
 
2,948

 

 

 
2,948

Changes in fair value included in net income, net
 

 
(9,998
)
 
(1,297
)
 
(11,295
)
Purchases, issuances, settlements and amortization:
 
 
 
 
 
 
 
 
Purchases/issuances
 
151,197

 

 
(3,606
)
 
147,591

Amortization included in net income, net
 
(2,573
)
 
$

 

 
(2,573
)
Ending balance as of March 31, 2014
 
$
212,155

 
$
(26,734
)
 
$
(4,903
)
 
$
180,518