Toggle SGML Header (+)


Section 1: 10-Q (10-Q)

sret_10Q_for_Q2_Q3

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 


☒ Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended September 30, 2017

 

Or

 

☐ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from ------------to------------

 


Commission File Number: 000-54295

 

Sterling Real Estate Trust

d/b/a Sterling Multifamily Trust

(Exact name of registrant as specified in its charter)

 

North Dakota

90-0115411

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

1711 Gold Drive South, Suite 100, Fargo, North Dakota

58103

(Address of principal executive offices)

(Zip Code)

 

(701) 353-2720

(Registrant’s telephone number, including area code)

 

(Former name, former address and formal fiscal year, if changed since last report)

 

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

 

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

 

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

 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

 

 

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

 

 

 

Class

 

Outstanding at November  6, 2017

Common Shares of Beneficial Interest,
$0.01 par value per share

 

8,516,368

 

 

 


 

Table of Contents

STERLING REAL ESTATE TRUST

 

INDEX

 

Page

 

No.

 

 

PART I.  FINANCIAL INFORMATION 

 

 

 

Item 1.  Financial Statements (unaudited):

3

Consolidated Balance Sheets – as of September 30, 2017 and December 31, 2016  

3

Consolidated Statements of Operations and Other Comprehensive Income – Three and nine months ended September 30, 2017 and 2016  

4

Consolidated Statement of Shareholders’ Equity – Nine months ended September 30, 2017 

5

Consolidated Statements of Cash Flows –  Nine months ended September 30, 2017 and 2016  

6

Notes to Consolidated Financial Statements 

8

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 

35

Item 3.  Quantitative and Qualitative Disclosures About Market Risk 

50

Item 4.  Controls and Procedures 

50

 

 

PART II.  OTHER INFORMATION 

 

 

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds 

51

Item 6.  Exhibits 

52

Signatures 

53

 

 

 


 

Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

as of September 30, 2017 (UNAUDITED) and December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

    

2017

    

2016

 

 

(in thousands)

ASSETS

 

 

 

 

 

 

Real estate investments

 

$

648,856

 

$

622,975

Cash and cash equivalents

 

 

20,991

 

 

12,034

Restricted deposits and funded reserves

 

 

7,894

 

 

7,213

Investment in unconsolidated affiliates

 

 

2,785

 

 

3,653

Due from related party

 

 

 2

 

 

34

Receivables

 

 

4,748

 

 

4,258

Prepaid expenses

 

 

862

 

 

433

Notes receivable

 

 

 —

 

 

600

Financing and lease costs, less accumulated amortization of $1,875 in 2017 and $1,720 in 2016

 

 

776

 

 

950

Assets held for sale

 

 

 —

 

 

2,482

Lease intangible assets, less accumulated amortization of $12,491 in 2017 and $10,770 in 2016

 

 

13,863

 

 

15,852

Other assets

 

 

 5

 

 

29

 

 

 

 

 

 

 

Total Assets

 

$

700,782

 

$

670,513

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

Mortgage notes payable, net

 

$

402,465

 

$

390,479

Special assessments payable

 

 

1,214

 

 

480

Dividends payable

 

 

6,404

 

 

5,925

Due to related party

 

 

617

 

 

957

Tenant security deposits payable

 

 

4,049

 

 

3,851

Subordinated debt

 

 

175

 

 

175

Lease intangible liabilities, less accumulated amortization of $1,324 in 2017 and $1,122 in 2016

 

 

1,846

 

 

2,075

Accounts payable - trade

 

 

474

 

 

438

Retainage payable

 

 

420

 

 

288

Liabilities related to assets held for sale

 

 

 —

 

 

125

Fair value of interest rate swaps

 

 

88

 

 

145

Deferred insurance proceeds

 

 

1,475

 

 

102

Accrued expenses and other liabilities

 

 

8,672

 

 

6,818

Total Liabilities

 

 

427,899

 

 

411,858

 

 

 

 

 

 

 

COMMITMENTS and CONTINGENCIES - Note 16

 

 

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

Beneficial interest

 

 

89,023

 

 

84,727

Noncontrolling interest

 

 

 

 

 

 

Operating partnership

 

 

180,725

 

 

170,138

Partially owned properties

 

 

3,223

 

 

3,935

Accumulated other comprehensive loss

 

 

(88)

 

 

(145)

Total Shareholders' Equity

 

 

272,883

 

 

258,655

 

 

 

 

 

 

 

 

 

$

700,782

 

$

670,513

 

See Notes to Consolidated Financial Statements

 

3


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED September 30, 2017 and 2016 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

September 30,

 

September 30,

 

2017

    

2016

    

2017

    

2016

 

(in thousands, except per share data)

 

(in thousands, except per share data)

Income from rental operations

 

 

 

Real estate rental income

$

27,088

 

$

25,365

 

$

80,606

 

$

76,075

Tenant reimbursements

 

1,567

 

 

1,523

 

 

4,592

 

 

4,547

 

 

28,655

 

 

26,888

 

 

85,198

 

 

80,622

Expenses

 

 

 

 

 

 

 

 

 

 

 

Expenses from rental operations

 

 

 

 

 

 

 

 

 

 

 

Interest

 

4,690

 

 

4,636

 

 

13,938

 

 

13,740

Depreciation and amortization

 

5,427

 

 

5,471

 

 

16,170

 

 

16,711

Real estate taxes

 

3,186

 

 

2,360

 

 

8,389

 

 

7,020

Property management fees

 

3,137

 

 

2,771

 

 

9,163

 

 

8,095

Utilities

 

1,918

 

 

1,709

 

 

6,463

 

 

5,715

Repairs and maintenance

 

6,170

 

 

6,288

 

 

16,103

 

 

15,703

Insurance

 

376

 

 

339

 

 

1,112

 

 

1,022

Loss on lease terminations

 

 —

 

 

25

 

 

146

 

 

299

 

 

24,904

 

 

23,599

 

 

71,484

 

 

68,305

Administration of REIT

 

 

 

 

 

 

 

 

 

 

 

Administrative expenses

 

61

 

 

71

 

 

290

 

 

301

Advisory fees

 

714

 

 

669

 

 

2,114

 

 

1,971

Acquisition and disposition expenses

 

 —

 

 

299

 

 

1,375

 

 

1,526

Trustee fees

 

12

 

 

14

 

 

44

 

 

46

Legal and accounting

 

98

 

 

83

 

 

385

 

 

343

 

 

885

 

 

1,136

 

 

4,208

 

 

4,187

Total expenses

 

25,789

 

 

24,735

 

 

75,692

 

 

72,492

Income from operations

 

2,866

 

 

2,153

 

 

9,506

 

 

8,130

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

Equity in income of unconsolidated affiliates

 

373

 

 

298

 

 

743

 

 

820

Other income

 

20

 

 

24

 

 

73

 

 

62

Gain (Loss) on sale of real estate and non-real estate investments

 

(3)

 

 

 —

 

 

2,049

 

 

(320)

Gain on change in control of real estate investments

 

 —

 

 

 —

 

 

2,186

 

 

 —

Gain (Loss) on involuntary conversion

 

 —

 

 

48

 

 

189

 

 

(89)

 

 

390

 

 

370

 

 

5,240

 

 

473

Net income

$

3,256

 

$

2,523

 

$

14,746

 

$

8,603

Net income (loss) attributable to noncontrolling interest:

 

 

 

 

 

 

 

 

 

 

 

Operating Partnership

 

2,264

 

 

1,814

 

 

10,147

 

 

6,109

Partially owned properties

 

(90)

 

 

(176)

 

 

(222)

 

 

(502)

Net income attributable to Sterling Real Estate Trust

$

1,082

 

$

885

 

$

4,821

 

$

2,996

 

 

 

 

 

 

 

 

 

 

 

 

Net income per common share, basic and diluted

$

0.13

 

$

0.11

 

$

0.59

 

$

0.38

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

Net income

$

3,256

 

$

2,523

 

$

14,746

 

$

8,603

Other comprehensive gain (loss) - change in fair value of interest rate swaps

 

17

 

 

33

 

 

57

 

 

28

Comprehensive income

 

3,273

 

 

2,556

 

 

14,803

 

 

8,631

Comprehensive income attributable to noncontrolling interest

 

2,185

 

 

1,661

 

 

9,964

 

 

5,626

Comprehensive income attributable to Sterling Real Estate Trust

$

1,088

 

$

895

 

$

4,839

 

$

3,005

 

See Notes to Consolidated Financial Statements

 

4


 

Table of Contents

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY 

FOR THE NINE MONTHS ENDED September 30, 2017 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Noncontrolling

 

 

 

 

 

 

 

 

 

 

 

 

Distributions

 

Total

 

Interest

 

Accumulated

 

 

 

 

 

Common

 

Paid-in

 

in Excess of

 

Beneficial

 

Operating

 

Partially Owned

 

Comprehensive

 

 

 

 

    

Shares

    

Capital

    

Earnings

    

Interest

    

Partnership

    

Properties

    

Income (Loss)

    

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

BALANCE AT DECEMBER 31, 2016

 

8,001

 

$

106,207

 

$

(21,480)

 

$

84,727

 

$

170,138

 

$

3,935

 

$

(145)

 

$

258,655

Shares issued pursuant to trustee compensation plan

 

 4

 

 

59

 

 

 

 

 

59

 

 

 

 

 

 

 

 

 

 

 

59

Contribution of assets in exchange for the issuance of noncontrolling interest shares

 

 

 

 

 

 

 

 

 

 

 

 

 

14,378

 

 

 —

 

 

 

 

 

14,378

Shares/units redeemed

 

(41)

 

 

(634)

 

 

 

 

 

(634)

 

 

(896)

 

 

 —

 

 

 

 

 

(1,530)

Dividends declared

 

 

 

 

 

 

 

(6,111)

 

 

(6,111)

 

 

(12,909)

 

 

 —

 

 

 

 

 

(19,020)

Dividends reinvested - stock dividend

 

247

 

 

3,836

 

 

 

 

 

3,836

 

 

 

 

 

 

 

 

 

 

 

3,836

Issuance of shares under optional purchase plan

 

134

 

 

2,192

 

 

 

 

 

2,192

 

 

 

 

 

 

 

 

 

 

 

2,192

UPREIT units converted to REIT common shares

 

 8

 

 

133

 

 

 

 

 

133

 

 

(133)

 

 

 —

 

 

 

 

 

 —

Change in fair value of interest rate swaps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

57

 

 

57

Distributions paid to consolidated real estate entity noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 —

 

 

(490)

 

 

 

 

 

(490)

Net income

 

 

 

 

 

 

 

4,821

 

 

4,821

 

 

10,147

 

 

(222)

 

 

 

 

 

14,746

BALANCE AT SEPTEMBER 30, 2017

 

8,353

 

$

111,793

 

$

(22,770)

 

$

89,023

 

$

180,725

 

$

3,223

 

$

(88)

 

$

272,883

 

See Notes to Consolidated Financial Statements

 

 

5


 

Table of Contents

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED September 30, 2017 and 2016 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

September 30,

 

    

2017

    

2016

 

 

(in thousands)

OPERATING ACTIVITIES

 

 

 

 

 

 

Net income

 

$

14,746

 

$

8,603

Adjustments to reconcile net income to net cash from operating activities

 

 

 

 

 

 

(Gain) loss on sale of real estate investments

 

 

(2,072)

 

 

316

Loss on sale of non-real estate investments

 

 

23

 

 

 4

(Gain) loss on involuntary conversion

 

 

(189)

 

 

89

(Gain) on change in control of real estate investment

 

 

(2,186)

 

 

 —

Loss on lease terminations

 

 

146

 

 

299

Equity in income of unconsolidated affiliates

 

 

(743)

 

 

(820)

Distributions of earnings of unconsolidated affiliates

 

 

80

 

 

816

Depreciation

 

 

14,270

 

 

13,882

Amortization

 

 

1,855

 

 

2,751

Amortization of debt issuance costs

 

 

561

 

 

517

Effects on operating cash flows due to changes in

 

 

 

 

 

 

Restricted deposits - tenant security deposits

 

 

(150)

 

 

(85)

Restricted deposits - real estate tax and insurance escrows

 

 

577

 

 

20

Due from related party

 

 

32

 

 

60

Receivables

 

 

(81)

 

 

(286)

Prepaid expenses

 

 

(430)

 

 

66

Other assets

 

 

24

 

 

135

Due to related party

 

 

(532)

 

 

(8)

Tenant security deposits payable

 

 

176

 

 

67

Accounts payable - trade

 

 

(96)

 

 

(561)

Accrued expenses and other liabilities

 

 

1,707

 

 

934

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

 

27,718

 

 

26,799

INVESTING ACTIVITIES

 

 

 

 

 

 

Purchase of real estate investment properties

 

 

(3,718)

 

 

(7,352)

Capital expenditures and tenant improvements

 

 

(9,122)

 

 

(7,518)

Proceeds from sale of real estate investments

 

 

4,442

 

 

1,404

Restricted deposits - exchange escrow

 

 

(4,328)

 

 

 —

Proceeds from involuntary conversion

 

 

1,937

 

 

915

Investment in unconsolidated affiliates

 

 

(294)

 

 

(67)

Distributions in excess of earnings received from unconsolidated affiliates

 

 

743

 

 

325

Restricted deposits - replacement reserve escrows

 

 

(952)

 

 

(819)

Notes receivable issued

 

 

 —

 

 

(24)

Notes receivable payments received

 

 

642

 

 

 7

NET CASH USED IN INVESTING ACTIVITIES

 

 

(10,650)

 

 

(13,129)

FINANCING ACTIVITIES

 

 

 

 

 

 

Payments for financing, debt issuance and lease costs

 

 

(442)

 

 

(431)

Principal payments on special assessments payable

 

 

(420)

 

 

(657)

Proceeds from issuance of mortgage notes payable and subordinated debt

 

 

23,916

 

 

20,271

Principal payments on mortgage notes payable

 

 

(16,632)

 

 

(9,857)

Advances on lines of credit

 

 

 —

 

 

6,669

Payments on lines of credit

 

 

 —

 

 

(6,669)

Proceeds from issuance of shares under optional purchase plan

 

 

2,192

 

 

1,599

Shares/units redeemed

 

 

(1,530)

 

 

(1,765)

Dividends/distributions paid

 

 

(15,195)

 

 

(13,126)

NET CASH USED IN FINANCING ACTIVITIES

 

 

(8,111)

 

 

(3,966)

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

 

8,957

 

 

9,704

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

 

12,034

 

 

6,461

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

20,991

 

$

16,165

 

See Notes to Consolidated Financial Statements

6


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED September 30, 2017 and 2016 (UNAUDITED) (Continued)

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

September 30,

 

    

2017

    

2016

 

 

(in thousands)

SCHEDULE OF CASH FLOW INFORMATION

 

 

 

 

 

Cash paid during the period for interest, net of capitalized interest

 

$

13,954

 

$

13,776

 

 

 

 

 

 

 

SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

 

Dividends reinvested

 

$

3,836

 

$

3,543

Dividends declared and not paid

 

 

2,067

 

 

1,893

UPREIT distributions declared and not paid

 

 

4,336

 

 

3,912

UPREIT units converted to REIT common shares

 

 

133

 

 

435

Stock issued pursuant to trustee compensation plan

 

 

59

 

 

60

Acquisition of assets in exchange for the issuance of noncontrolling interest units in UPREIT

 

 

14,378

 

 

16,940

Increase in land improvements due to increase in special assessments payable

 

 

1,141

 

 

772

Unrealized gain on interest rate swaps

 

 

57

 

 

28

Acquisition of assets with new financing

 

 

3,264

 

 

2,662

Acquisition of assets through assumption of debt and liabilities

 

 

1,367

 

 

78

Capitalized interest and real estate taxes related to construction in progress

 

 

126

 

 

66

Acquisition of assets with accounts payable

 

 

572

 

 

413

Acquisition of assets with 1031 exchange funds

 

 

4,278

 

 

 —

 

See Notes to Consolidated Financial Statements

 

 

7


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Note 1 - Organization

 

Sterling Real Estate Trust (“Sterling”, “the Trust” or “the Company”) is a registered, but unincorporated business trust organized in North Dakota in November 2002.  Sterling has elected to be taxed as a Real Estate Investment Trust (“REIT”) under Sections 856-860 of the Internal Revenue Code, which requires that 75% of the assets of a REIT must consist of real estate assets and that 75% of its gross income must be derived from real estate. The net income of the REIT is allocated in accordance with the stock ownership in the same fashion as a regular corporation. 

 

Sterling previously established an operating partnership (“Sterling Properties, LLLP”) and transferred all of its assets and liabilities to the operating partnership in exchange for general partnership units. As the general partner, Sterling has management responsibility for all activities of the operating partnership. As of September 30, 2017 and December 31, 2016, Sterling owned approximately 32.28% and 32.41%, respectively, of the operating partnership.

 

NOTE 2 – PRINCIPAL ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2016, which have previously been filed with the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from this report on Form 10-Q pursuant to the rules and regulations of the SEC.

 

The results for the interim periods shown in this report are not necessarily indicative of future financial results. The accompanying consolidated balance sheet as of September 30, 2017 and consolidated statements of operations and other comprehensive income, consolidated statement of shareholders’ equity, and consolidated statements of cash flows for the three and nine months ended September 30, 2017 and 2016, as applicable, have not been audited by our independent registered public accounting firm. In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly our consolidated financial statements as of and for the three and nine months ended September 30, 2017. These adjustments are of a normal recurring nature.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of Sterling,  Sterling Properties, LLLP, and wholly-owned limited liability companies. All significant intercompany transactions and balances have been eliminated in consolidation.

 

Additionally, we evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation (“ASC 810”).  In determining whether we have a requirement to consolidate the accounts of an entity, management considers factors such as our ownership interest, our authority to make decisions and contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity (“VIE”) for which we have both: a) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance, and b) the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.

 

 

8


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Principal Business Activity

 

Sterling currently owns directly and indirectly 164 properties.  The Trust’s 115 residential properties are located in North Dakota, Minnesota, Missouri and Nebraska and are principally multifamily apartment buildings.  The Trust owns 49 commercial properties primarily located in North Dakota with others located in Arkansas, Colorado, Iowa, Louisiana, Michigan, Minnesota, Mississippi, Nebraska, Texas and Wisconsin. The commercial properties include retail, office, industrial, restaurant and medical properties.  Presently, the Trust’s mix of properties is 71.0% residential and 29.0% commercial (based on cost) and total $648,856 in real estate investments at September 30, 2017. Effective January 1, 2016, Sterling’s acquisition strategy and focus is solely on multifamily apartment properties.  We currently have no plans to dispose of our existing commercial properties.

 

 

 

 

 

 

 

 

 

Residential Property

    

Location

    

No. of Properties

    

Units

 

 

North Dakota

 

96

 

5,828

 

 

Minnesota

 

16

 

3,027

 

 

Missouri

 

1

 

164

 

 

Nebraska

 

2

 

316

 

 

 

 

115

 

9,335

 

 

 

 

 

 

 

Commercial Property

    

Location

    

No. of Properties

    

Sq. Ft

 

 

North Dakota

 

20

 

805,000

 

 

Arkansas

 

2

 

29,000

 

 

Colorado

 

1

 

13,000

 

 

Iowa

 

1

 

33,000

 

 

Louisiana

 

1

 

15,000

 

 

Michigan

 

1

 

12,000

 

 

Minnesota

 

15

 

683,000

 

 

Mississippi

 

1

 

15,000

 

 

Nebraska

 

1

 

16,000

 

 

Texas

 

1

 

7,000

 

 

Wisconsin

 

5

 

63,000

 

 

 

 

49

 

1,691,000

 

 

Concentration of Credit Risk

 

Our cash balances are maintained in various bank deposit accounts. The bank deposit amounts in these accounts may exceed federally insured limits at various times throughout the year.

 

Use of Estimates

 

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

 

Real Estate Investments

 

Real estate investments are recorded at cost less accumulated depreciation.  Ordinary repairs and maintenance are expensed as incurred. 

9


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

 

The Company allocates the purchase price of each acquired investment property accounted for as a business combination based upon the estimated acquisition date fair value of the individual assets acquired and liabilities assumed, which generally include (i) land, (ii) building and other improvements, (iii) in-place lease value intangibles, (iv) acquired above and below market lease intangibles, (v) any assumed financing that is determined to be above or below market, (vi) the value of customer relationships and (vii) goodwill, if any. Transaction costs related to acquisitions accounted for as business combinations are expensed as incurred and included within “Administration of REIT expenses” in the

accompanying consolidated statements of operations and other comprehensive income.

 

The Company elected to early adopt ASU 2017-01, Business Combinations, on a prospective basis as of July 1, 2017. This new guidance clarifies the definition of a business and provides a screen to determine when an integrated set of assets and activities is not  considered a business and, thus, accounted for as an asset acquisition as opposed to a business combination. Refer to the “Recent Accounting Pronouncements” section within Note 2 to the consolidated financial statements. Under this new guidance, the Company expects most acquisitions of investment property will meet this screen and, thus, be accounted for as asset acquisitions. The Company allocates the purchase price of each acquired investment property that is accounted for as an asset acquisition based upon the relative fair value of the individual assets acquired and liabilities assumed, which generally include (i) land, (ii) building and other improvements, (iii) in-place lease value intangibles, (iv) acquired above and below market lease intangibles, (v) any assumed financing that is determined to be above or below market and (vi) the value of customer relationships. Asset acquisitions do not give rise to goodwill and the related transaction costs are capitalized and included with the allocated purchase price.

 

For tangible assets acquired, including land, building and other improvements, the Company considers available comparable market and industry information in estimating acquisition date fair value. Key factors considered in the calculation of fair value of both real property and intangible assets include the current market rent values, “dark” periods (building in vacant status), direct costs estimated with obtaining a new tenant, discount rates, escalation factors, standard lease terms, and tenant improvement costs. The Company allocates a portion of the purchase price to the estimated acquired in-place lease value intangibles based on factors available in third party appraisals or cash flow estimates of the property prepared by our internal analysis.  These estimates are based upon cash flow projections for the property, existing leases, lease origination costs for similar leases as well as lost rental payments during an assumed lease-up period. The Company also evaluates each acquired lease as compared to current market rates. If an acquired lease is determined to be above or below market, the Company allocates a portion of the purchase price to such above or below market leases based upon the present value of the difference between the contractual lease payments and estimated market rent payments over the remaining lease term. Renewal periods are included within the lease term in the calculation of above and below market lease values if, based upon factors known at the acquisition date, market participants would consider it reasonably assured that the lessee would exercise such options. Fair value estimates used in acquisition accounting, including the discount rate used, require the Company to consider various factors, including, but not limited to, market knowledge, demographics, age and physical condition of the property, geographic location, and size and location of tenant spaces within the acquired investment property.

 

The portion of the purchase price allocated to acquired in-place lease value intangibles is amortized on a straight-line basis over the life of the related lease as amortization expense. The Company incurred amortization expense pertaining to acquired inplace lease value intangibles of $370 and $459 for the three months ended September 30, 2017 and 2016, respectively and $1,141 and $1,567 for the nine months ended September 30, 2017 and 2016, respectively.

 

The portion of the purchase price allocated to acquired above and below market lease intangibles is amortized on a straight-line basis over the life of the related lease as an adjustment to rental income. Amortization pertaining to above market lease intangibles of $56 and $57 for the three months ended September 30, 2017 and 2016, respectively, was recorded as a reduction to income from rental operations. Amortization pertaining to below market lease intangibles of $70 and $78 for

10


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

the three months ended September 30, 2017 and 2016, respectively, was recorded as an increase to income from rental operations.  Amortization pertaining to above market lease intangibles of $169 and $174 for the nine months ended September 30, 2017 and 2016, respectively, was recorded as a reduction to income from rental operations. Amortization pertaining to below market lease intangibles of $214 and $253 for the nine months ended September 30, 2017 and 2016, respectively, was recorded as an increase to income from rental operations.

 

Furniture and fixtures are stated at cost less accumulated depreciation. Expenditures for renewals and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Expenditures for routine maintenance and repairs, which do not add to the value or extend useful lives, are charged to expense as incurred.

 

Depreciation is provided for over the estimated useful lives of the individual assets using the straight-line method over the following estimated useful lives:

 

 

 

 

 

Buildings and improvements

    

40 years

Furniture, fixtures and equipment

 

5-9 years

 

Depreciation expense for the three months ended September 30, 2017 and 2016 totaled $4,816 and $4,625, respectively. Depreciation expense for the nine months ended September 30, 2017 and 2016 totaled $14,270 and $13,882, respectively.

 

The Company’s investment properties are reviewed for potential impairment at the end of each reporting period whenever events or changes in circumstances indicate that the carrying value may not be recoverable. At the end of each reporting period, the Company separately determines whether impairment indicators exist for each property. 

 

Examples of situations considered to be impairment indicators include, but are not limited to:

 

·

a substantial decline or continued low occupancy rate;

·

continued difficulty in leasing space;

·

significant financially troubled tenants;

·

a change in plan to sell a property prior to the end of its useful life or holding period;

·

a significant decrease in market price not in line with general market trends; and

·

any other quantitative or qualitative events or factors deemed significant by the Company’s management or board of trustees.

 

If the presence of one or more impairment indicators as described above is identified at the end of the reporting period or throughout the year with respect to an investment property, the asset is tested for recoverability by comparing its carrying value to the estimated future undiscounted cash flows.  An investment property is considered to be impaired when the estimated future undiscounted cash flows are less than its current carrying value.  When performing a test for recoverability or estimating the fair value of an impaired investment property, the Company makes complex or subjective assumptions which include, but are not limited to:

 

·

projected operating cash flows considering factors such as vacancy rates, rental rates, lease terms, tenant financial strength, demographics, holding period and property location;

·

projected capital expenditures and lease origination costs;

·

projected cash flows from the eventual disposition of an operating property using a property specific capitalization rate;

·

comparable selling prices; and

·

property specific discount rates for fair value estimates as necessary.

11


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

 

To the extent impairment has occurred, the Company will record an impairment charge calculated as the excess of the carrying value of the asset over its fair value for impairment of investment properties.  Based on evaluation, there were no impairment losses during the nine months ended September 30, 2017 and 2016. 

 

Properties Held for Sale

 

We account for our properties held for sale in accordance with ASC 360, Property, Plant and Equipment (“ASC 360”), which addresses financial accounting and reporting in a period in which a component or group of components of an entity either has been disposed of or is classified as held for sale. 

 

In accordance with ASC 360, at such time as a property is held for sale, such property is carried at the lower of: (1) its carrying amount, or (2) fair value less costs to sell.  In addition, a property being held for sale ceases to be depreciated.  We classify operating properties as properties held for sale in the period in which all of the following criteria are met:

 

·

management, having the authority to approve the action, commits to a plan to sell the asset;

·

the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;

·

an active program to locate a buyer and other actions required to complete the plan to sell the asset has been initiated;

·

the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within one year;

·

the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and

·

given the actions required to complete the plan to sell the asset, it is unlikely that significant changes to the plan would be made or that the plan would be withdrawn.

 

The results of operations of a component of an entity that either has been disposed of or is classified as held-for-sale under the requirements of ASC 360 shall be reported in discontinued operations in accordance with ASC 205, Presentation of Financial Statements (“ASC 205”) if such disposal or classification represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.

 

There were no properties classified as held for sale at September 30, 2017.  There was one retail property classified as held for sale at December 31, 2016.  See Note 17.

 

Construction in Progress

 

The Company capitalizes direct and certain indirect project costs incurred during the development period such as construction, insurance, architectural, legal, interest and other financing costs, and real estate taxes.  At such time as the development is considered substantially complete, the capitalization of certain indirect costs such as real estate taxes and interest and financing costs cease and all project-related costs included in construction in process are reclassified to land and building and other improvements.

 

Cash and Cash Equivalents

 

We classify highly liquid investments with a maturity of three months or less when purchased as cash equivalents.

12


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

 

Investment in Unconsolidated Affiliates

 

We account for unconsolidated affiliates using the equity method of accounting per guidance established under ASC 323, Investments – Equity Method and Joint Ventures (“ASC 323”). The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for our share of equity in the affiliates’ earnings, contributions and distributions. We evaluate the carrying amount of the investments for impairment in accordance with ASC 323. Unconsolidated affiliates are reviewed for potential impairment if the carrying amount of the investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until the carrying amount is fully recovered. The evaluation of an investment in an affiliate for potential impairment can require our management to exercise significant judgments. No impairment losses were recorded related to the unconsolidated affiliates for the nine months ended September 30, 2017 and 2016.

 

We use the equity method to account for investments that qualify as variable interest entities where we are not the primary beneficiary and entities that we do not control or where we do not own a majority of the economic interest but have the ability to exercise significant influence over the operations and financial policies of the investee.  We will also use the equity method for investments that do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810.  For a joint venture accounted for under the equity method, our share of net earnings and losses is reflected in income when earned and distributions are credited against our investment in the joint venture as received.

 

In determining whether an investment in a limited liability company or tenant in common is a variable interest entity, we consider: the form of our ownership interest and legal structure; the size of our investment; the financing structure of the entity, including the necessity of subordinated debt; estimates of future cash flows; our and our partner’s ability to participate in the decision making related to acquisitions, dispositions, budgeting and financing on the entity; and obligation to absorb losses and preferential returns.  As of September 30, 2017, our tenant in common arrangements do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810.

 

As of September 30, 2017 and December 31, 2016, the unconsolidated affiliates held total assets of $23,930 and $26,140 and mortgage notes payable of $17,561 and $20,017, respectively.

 

The operating partnership previously owned a 40.26% interest as a tenant in common in a single asset limited liability company which owns a 144 unit residential, multifamily apartment complex in Bismarck, North Dakota. The property was encumbered by a first mortgage with a balance at December 31, 2016 of $2,190. As of May 1, 2017, there was a change in control over the real estate investment, with the operating partnership acquiring the other tenant in common’s 59.74% ownership interest in the property (see Note 18).  We estimated the property had a fair value of approximately $10,080.  The operating partnership assumed a loan of $1,295 and issued $4,727 of limited partnership units for a total purchase price of approximately $6,022.  The company accounted for this as a business combination and recognized a gain on change in control of real estate investment of $2,186 in the second quarter of 2017 as a result of remeasuring the carrying value to fair value.

 

The operating partnership is a 50% owner of Grand Forks Marketplace Retail Center as a tenant in common through 100% ownership in a limited liability company.  Grand Forks Marketplace Retail Center has approximately 183,000 square feet of commercial space in Grand Forks, North Dakota. The property is encumbered by a non-recourse first mortgage with a balance at September 30, 2017 and December 31, 2016 of $10,743 and $10,891, respectively. The Company is jointly and severally liable for the full mortgage balance.

 

13


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

The operating partnership owns a 66.67% interest as tenant in common in an office building with approximately 75,000 square feet of commercial rental space in Fargo, North Dakota. The property is encumbered by a first mortgage with a balance at September 30, 2017 and December 31, 2016 of $6,818 and $6,936, respectively. The Company is jointly and severally liable for the full mortgage balance.

 

Receivables

 

Receivables consist primarily of amounts due for rent. The receivables are non-interest bearing.  The carrying amount of receivables is reduced by an amount that reflects management’s best estimates of the amounts that will not be collected.  As of September 30, 2017 and December 31, 2016, management determined no allowance was necessary for uncollectible receivables.

 

Financing and Lease Costs

 

Financing costs have been capitalized and are being amortized over the life of the financing (line of credit) using the effective interest method.  Unamortized financing costs are written off when debt is retired before the maturity date and included in interest expense at that time. 

 

Lease costs incurred in connection with new leases have been capitalized and are being amortized over the life of the lease using the straight-line method. We record the amortization of leasing costs in depreciation and amortization on the consolidated statements of operations and comprehensive income. If an applicable lease terminates prior to the expiration of its initial lease term, we write off the carrying amount of the costs to amortization expense.

 

Debt Issuance Costs

 

We amortize external debt issuance costs using the effective interest rate method, over the estimated life of the related debt. We record debt issuance costs related to notes and mortgage notes, net of amortization, on our consolidated balance sheets as an offset to their related debt. We record debt issuance costs related to revolving lines of credit on our consolidated balance sheets as financing fees, regardless of whether a balance on the line of credit is outstanding. We record the amortization of all debt issuance costs as interest expense.

 

Lease Intangible Assets

 

Lease intangibles are a purchase price allocation recorded on property acquisition. The lease intangibles represent the estimated value of in-place leases, tenant relationships and the value of leases with above or below market lease terms. Lease intangibles are amortized over the term of the related lease.

 

The carrying amount of intangible assets is regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset. Based on the review, management determined no impairment charges were necessary at September 30, 2017 and December 31, 2016.

 

Noncontrolling Interest

 

A noncontrolling interest in a subsidiary (minority interest) is in most cases an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and separate from the parent company’s equity.  In addition, consolidated net income is required to be reported at amounts that include the amounts attributable to both the

14


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

parent and the noncontrolling interest and the amount of consolidated net income attributable to the parent and the noncontrolling interest are required to be disclosed on the face of the consolidated statements of operations and comprehensive income. 

 

Operating Partnership: Interests in the operating partnership held by limited partners are represented by operating partnership units.  The operating partnership’s income is allocated to holders of units based upon the ratio of their holdings to the total units outstanding during the period. Capital contributions, distributions, syndication costs, and profits and losses are allocated to noncontrolling interests in accordance with the terms of the operating partnership agreement.

 

Partially Owned Properties: The Company reflects noncontrolling interests in partially owned properties on the balance sheet for the portion of properties consolidated by the Company that are not wholly owned by the Company.  The earnings or losses from those properties attributable to the noncontrolling interests are reflected as noncontrolling interests in partially owned properties in the consolidated statement of operations and comprehensive income.

 

Syndication Costs

 

Syndication costs consist of costs paid to attorneys, accountants, and selling agents, related to the raising of capital. Syndication costs are recorded as a reduction to beneficial and noncontrolling interest.

 

Federal Income Taxes

 

We have elected to be taxed as a REIT under the Internal Revenue Code, as amended. A REIT calculates taxable income similar to other domestic corporations, with the major difference being a REIT is entitled to a deduction for dividends paid. A REIT is generally required to distribute each year at least 90% of its taxable income. If it chooses to retain the remaining 10% of taxable income, it may do so, but it will be subject to a corporate tax on such income. REIT shareholders are taxed on REIT distributions of ordinary income in the same manner as they are taxed on other corporate distributions.

 

We intend to continue to qualify as a REIT and, provided we maintain such status, will not be taxed on the portion of the income that is distributed to shareholders. In addition, we intend to distribute all of our taxable income; therefore, no provisions or liabilities for income taxes have been recorded in the financial statements.

 

Sterling conducts its business activity as an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) through its Operating Partnership – Sterling Properties, LLLP.  The Operating Partnership is organized as a limited liability limited partnership. Income or loss is allocated to the partners in accordance with the provisions of the Internal Revenue Code 704(b) and 704(c). UPREIT status allows non-recognition of gain by an owner of appreciated real estate if that owner contributes the real estate to a partnership in exchange for a partnership interest. The conversion of a partnership interest to shares of beneficial interest in the REIT will be a taxable event to the limited partner.

 

We follow ASC Topic 740, Income Taxes, to recognize, measure, present and disclose in our consolidated financial statements uncertain tax positions that we have taken or expect to take on a tax return. As of September 30, 2017 and December 31, 2016 we did not have any liabilities for uncertain tax positions that we believe should be recognized in our consolidated financial statements. We are no longer subject to Federal and State tax examinations by tax authorities for years before 2013.

 

The operating partnership has elected to record related interest and penalties, if any, as income tax expense on the consolidated statements of operations and other comprehensive income.

 

15


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Revenue Recognition

 

We derive over 95% of our revenues from tenant rents and other tenant-related activities. We lease multifamily units under operating leases with terms of one year or less. Rental income and other property revenues are recorded when due from tenants and recognized monthly as earned pursuant to the terms of the underlying leases.  Other property revenues consist primarily of laundry, application and other fees charged to tenants. 

 

We lease commercial space primarily under long-term lease agreements. Commercial tenant rents include base rents, expense reimbursements (such as common area maintenance, real estate taxes and utilities), and a straight-line rent adjustment. We record base rents on a straight-line basis. The monthly base rent income according to the terms of our leases is adjusted so that an average monthly rent is recorded for each tenant over the term of its lease. The straight-line rent adjustment increased revenue by $59 and $124 for the three months ended September 30, 2017 and 2016, respectively. The straight-line rent adjustment increased revenue by $186 and $391 the nine months ended September 30, 2017 and 2016, respectively. The straight-line receivable balance included in receivables on the consolidated balance sheets as of September 30, 2017 and December 31, 2016 was $3,526 and $3,362, respectively. We receive payments for expense reimbursements from substantially all our multi-tenant commercial tenants throughout the year based on estimates. Differences between estimated recoveries and the final billed amounts, which generally are immaterial, are recognized in the subsequent year.

 

Commercial properties are leased to tenants under terms expiring at various dates through 2034. Lease terms often include renewal options.  For the nine months ended September 30, 2017 and 2016, gross revenues from commercial property rentals, including CAM income (common area maintenance) of $4,592 and $4,547, respectively, totaled $20,619 and $20,632, respectively

 

Earnings per Common Share

 

Basic earnings per common share is computed by dividing net income available to common shareholders (the “numerator”) by the weighted average number of common shares outstanding (the “denominator”) during the period. Sterling had no dilutive potential common shares as of September 30, 2017 and 2016, and therefore, basic earnings per common share was equal to diluted earnings per common share for both periods.

 

For the three months ended September 30, 2017 and 2016, Sterling’s denominators for the basic and diluted earnings per common share were approximately 8,356,000 and 7,891,000, respectively. For the nine months ended September 30, 2017 and 2016, Sterling’s denominators for the basic and diluted earnings per common share were approximately 8,234,000 and 7,791,000, respectively.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB and International Accounting Standards Board issued their final standard on revenue from contracts with customers, which was issued by the FASB as Accounting Standards Update 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. ASU 2014-09, which establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers, supersedes most current GAAP applicable to revenue recognition and converges U.S. and international accounting standards in this area. The core principle of the new guidance is that revenue shall only be recognized when an entity has transferred control of goods or services to a customer and for an amount reflecting the consideration to which the entity expects to be entitled for such exchange. Additionally, lease contracts are specifically excluded from ASU 2014-09. In July 2015, the FASB decided to defer the effective date for annual reporting periods beginning after December 15, 2017.  Early adoption is permitted beginning on the original effective date of periods beginning after December 15, 2016. Upon adoption, ASU 2014-09 allows for full retrospective

16


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

adoption applied to all periods presented or modified retrospective adoption with the cumulative effect of initially applying the standard recognized at the date of initial application. We have performed a review of the requirements of the new guidance and have identified which of our revenue streams will be within the scope of ASU 2014-09.  We are working through an adoption plan which includes a review of transactions supporting each revenue stream to determine the impact of accounting treatment under ASU 2014-09, an evaluation of the method of adoption and assessing changes that might be necessary to information technology systems, processes and internal controls to capture new data and address changes in financial reporting. We will adopt this standard effective as of January 1, 2018 and will utilize the cumulative effect transition method of adoption. The adoption of this guidance will not have a material impact on our financial position or results of operations. We expect this standard will have an impact on the disclosure of certain lease and non-lease components of revenue from leases upon the adoption of the update ASU 2016-02, Leases, but will not have a material impact on “total revenues.”

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which amends existing accounting standards for lease accounting, including by requiring lessees to recognize most leases on the balance sheet and making certain changes to lessor accounting. The standard will take effect for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 with earlier application permitted. The Company is evaluating the impact of ASU No. 2016-02 on its financial position and results of operations.

 

In January 2017, the FASB issued a new standard which clarifies the definition of a business. The standard's objective is to add additional guidance that assists companies in determining whether transactions should be accounted for as an asset acquisition or a business combination. The new standard first requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the set is not a business. If this threshold is not met, the entity next evaluates whether the set meets the requirement that a business include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. Among other differences, transaction costs associated with asset acquisitions are capitalized while those associated with business combinations are expensed as incurred. In addition, purchase price in an asset acquisition is allocated on a relative fair value basis while in a business combination it is generally measured at fair value. The Company early adopted the new standard as allowed effective July 1, 2017. The Company concluded that substantially all of its transactions will now be accounted for as asset acquisitions, which means transaction costs will largely be capitalized as noted above.  The adoption of this pronouncement resulted in the Company’s acquisition of investment property subsequent to July 1, 2017 to qualify as asset acquisition and as such, the related transaction costs of $158 were capitalized.

 

In November 2016, the FASB issued ASU No. 2016-18 to require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and early adoption is permitted. The pronouncement requires a retrospective transition method of adoption. Upon adoption, the Company will include amounts generally described as restricted cash within the beginning-of-period, change and end-of-period total amounts on the statement of cash flows rather than within an activity on the statement of cash flows.

 

In August 2016, the FASB issued ASU No. 2016-15 to provide guidance for areas where there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not currently anticipate that the guidance will have a material impact on its consolidated financial statements.

17


 

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017 and 2016 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

 

Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying Consolidated Financial Statements.

 

Reclassifications

 

Certain amounts previously reported in our quarterly report ended September 30, 2016 have been reclassified to conform to the consolidated balance sheet, statement of operations and cash flows presentations in 2017. 

 

NOTE 3 – segment reporting

 

We report our results in two reportable segments: residential and commercial properties. Our residential properties include multifamily properties. Our commercial properties include retail, office, industrial, restaurant and medical properties. We assess and measure operating results based on net operating income (“NOI”), which we define as total real estate segment revenues less real estate expenses (which consist of real estate taxes, property management fees, utilities, repairs and maintenance, insurance and direct administrative costs). We believe NOI is an important measure of operating performance even though it should not be considered an alternative to net income or cash flow from operating activities. NOI is unaffected by financing, depreciation, amortization, legal and professional fees and certain general and administrative expenses.  The accounting policies of each segment are consistent with those described in Note 2 of this report.

 

Segment Revenues and Net Operating Income

 

The revenues and net operating income for the reportable segments (residential and commercial) are summarized as follows for the three and nine months ended September 30, 2017 and 2016, along with reconciliations to the consolidated financial statements. Segment assets are also reconciled to Total Assets as reported in the consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 2017

 

Three months ended  September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Residential

    

Commercial

    

Total

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

 

(in thousands)

Income from rental operations

 

$

21,863

 

$

6,792

 

$

28,655

 

$

20,081

 

$

6,807

 

$

26,888

Expenses from rental operations

 

 

12,764

 

 

2,023

 

 

14,787

 

 

11,547

 

 

1,920

 

 

13,467

Net operating income

 

$

9,099

 

$

4,769

 

$

13,868

 

$

8,534

 

$

4,887

 

$

13,421

Interest

 

 

 

 

 

 

 

 

4,690

 

 

 

 

 

 

 

 

4,636

Depreciation and amortization

 

 

 

 

 

 

 

 

5,427

 

 

 

 

 

 

 

 

5,471

Administration of REIT

 

 

 

 

 

 

 

 

885

 

 

 

 

 

 

 

 

1,136

Loss on lease terminations

 

 

 

 

 

 

 

 

 —

 

 

 

 

 

 

 

 

25

Other (income)/expense

 

 

 

 

 

 

 

 

(390)

 

 

 

 

 

 

 

 

(370)

Net income

 

 

 

 

 

 

 

$

3,256