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Section 1: 10-K (10-K)

ck0001424182-10k_20171231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

For the fiscal year ended December 31, 2017

OR

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

For the transition period from _______ to _______

Commission file number 000-55774

 

BROADSTONE NET LEASE, INC.

(Exact name of registrant as specified in its charter)

 

 

Maryland

26-1516177

(State or other jurisdiction of
incorporation or organization)

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

800 Clinton Square Rochester, New York

14604

(Address of principal executive offices)

(Zip Code)

 

(585) 287-6500

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934: None

Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934: Common Stock, par value $0.001 per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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

(Do not check if a smaller reporting company)

Smaller reporting company

Emerging growth company  

 

 

 

 

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

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

There is no established market for the registrant’s shares of common stock.  There were approximately 16,367,512 shares of common stock held by non-affiliates as of June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, for an aggregate market value of $1,309,400,960, assuming a market value of $80 per share, the offering price per share as of June 30, 2017, in the registrant’s ongoing private offering exclusive of any available discounts for certain categories of purchasers.

There were 19,377,844 shares of the Registrant’s common stock, $0.001 par value per share, outstanding as of March 1, 2018.

Documents Incorporated by Reference

Part III, Items 10, 11, 12, 13, and 14 of this annual report incorporate by reference certain specific portions of Broadstone Net Lease, Inc.’s definitive proxy statement for its 2018 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of the registrant’s fiscal year. Only those portions of the proxy statement that are specifically incorporated by reference herein shall constitute a part of this annual report.

 

 

 


BROADSTONE NET LEASE, INC.

TABLE OF CONTENTS

 

 

 

 

 

Page

 

 

 

 

 

 

Cautionary Note Regarding Forward-Looking Statements

 

2

 

 

 

 

 

 

 

PART I

 

 

 

 

 

 

 

Item 1.

 

Business

 

3

 

 

 

 

 

Item 1A.

 

Risk Factors

 

18

 

 

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

36

 

 

 

 

 

Item 2.

 

Properties

 

36

 

 

 

 

 

Item 3.

 

Legal Proceedings

 

36

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

36

 

 

 

 

 

 

 

PART II

 

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

37

 

 

 

 

 

Item 6.

 

Selected Financial Data

 

46

 

 

 

 

 

Item 7.

 

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

 

47

 

 

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

67

 

 

 

 

 

Item 8.

 

Financial Statements and Supplementary Data

 

69

 

 

 

 

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

146

 

 

 

 

 

Item 9A.

 

Controls and Procedures

 

146

 

 

 

 

 

Item 9B.

 

Other Information

 

146

 

 

 

 

 

 

 

PART III

 

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

147

 

 

 

 

 

Item 11.

 

Executive Compensation

 

147

 

 

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

147

 

 

 

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

147

 

 

 

 

 

Item 14.

 

Principal Accountant Fees and Services

 

153

 

 

 

 

 

 

 

PART IV

 

 

 

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

154

 

 

 

 

 

Item 16.

 

Form 10-K Summary

 

154

 

1


Cautionary Note Regarding Forward-Looking Statements

Except where the context suggests otherwise, as used in this Form 10-K, the terms “we,” “us,” “our,” and “our company” refer to Broadstone Net Lease, Inc., a Maryland corporation, and, as required by context, Broadstone Net Lease, LLC, a New York limited liability company, which we refer to as our “Operating Company,” and to their respective subsidiaries.

This Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), regarding, among other things, our plans, strategies, and prospects, both business and financial. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments. Forward-looking statements can be identified by the use of forward-looking terminology such as, but not limited to, “may,” “should,” “expect,” “anticipate,” “estimate,” “would be,” “intend,” “believe,” or “continue” or the negative or other variations of comparable terminology.

Forward-looking statements are inherently subject to risks, uncertainties, and assumptions. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic, and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe that our plans, intentions, and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations.

The following are some, but not all, of the assumptions, risks, uncertainties, and other factors that could cause our actual results to differ materially from those presented in our forward-looking statements:

 

Our ability to generate cash flows sufficient to pay our dividends to stockholders or meet our debt service obligations.

 

Our ability to achieve our investment objectives and growth plans.

 

Our dependence upon the financial health and performance of our Manager and Asset Manager and their ability to retain or hire key personnel.

 

We may be subject to substantial third-party fees, in some instances to affiliated third parties.

 

Potential conflicts of interest because of our UPREIT structure (as defined below) and the relationship with our Manager and Asset Manager.

 

General business and economic conditions, fluctuating interest rates, and volatility and uncertainty in the credit markets and broader financial markets.

 

Competition in the acquisition and disposition of properties and in the leasing of our properties, which may impact our ability to acquire, dispose of, or lease properties on advantageous terms.

 

Risks associated with investing in real estate, including tenant, geographic, and industry concentrations with respect to our properties; bankruptcies or insolvencies of tenants or from tenant defaults generally; impairments in the value of our real estate assets; the illiquidity of our real estate investments; potential liability relating to environmental matters; and potential damages from natural disasters, acts of terrorism, or war.

 

Our access to capital and ability to borrow money in sufficient amounts and on favorable terms.

 

Our continued qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes and compliance with REIT requirements, including the annual distribution requirements.

 

Changes in applicable laws, rules, and regulations, including the tax laws.

Additional factors that may cause risks and uncertainties include those discussed in the Item 1. “Business,” Item 1A. “Risk Factors,” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this Form 10-K is filed with the Securities and Exchange Commission (the “SEC”). Except as required by law, we do not undertake any obligation to update or revise any forward-looking statements contained in this Form 10-K.

2


Part I.

Item 1.

Business

The Company

We are an externally managed real estate investment trust formed as a Maryland corporation in 2007 to acquire and hold single-tenant, commercial real estate properties throughout the United States that are leased to the properties’ operators under long-term net leases. Under a “net lease,” the tenant occupying the leased property (usually as a single tenant) does so in much the same manner as if the tenant were the owner of the property. There are various forms of net leases, most typically classified as triple-net or double-net. Triple-net leases typically require that the tenant pay all expenses associated with the property (e.g., real estate taxes, insurance, maintenance and repairs). Double net leases typically require that the tenant pay all operating expenses associated with the property (e.g., real estate taxes, insurance and maintenance), but exclude some or all major repairs (e.g., roof, structure and parking lot). Accordingly, the owner receives the rent “net” of these expenses, rendering the cash flow associated with the lease predictable for the term of the lease. Under a net lease, the tenant generally agrees to lease the property for a significant term and agrees that it will either have no ability or only limited ability to terminate the lease or abate rent prior to the expiration of the term of the lease as a result of real estate driven events such as casualty, condemnation or failure by the landlord to fulfill its obligations under the lease.

We focus on real estate that is operated by a single tenant where the real estate is an integral part of the tenant’s business. Our diversified portfolio of real estate includes retail properties, such as quick service and casual dining restaurants, healthcare facilities, industrial manufacturing facilities, warehouse and distribution centers, and corporate offices, among others. We target properties with credit-worthy tenants that look to engage in a long-term lease relationship. Through long-term leases, our tenants are able to retain operational control of their critical locations, while conserving their debt and equity capital to fund their fundamental business operations.

As of December 31, 2017, we owned a diversified portfolio of 528 individual net leased commercial properties located in 40 states comprising approximately 15.9 million rentable square feet of operational space. As of December 31, 2017, our properties were 100% leased to 134 different commercial tenants, with no single tenant accounting for more than 4% of our annual rental stream.

We elected to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), beginning with our taxable year ended December 31, 2008. As a REIT, we are not subject to federal income tax to the extent that we meet certain requirements, including that we distribute at least 90% of our annual taxable income to our stockholders and satisfy other requirements based on the composition of our asset portfolio and sources of income.

We operate under the direction of our board of directors, which is responsible for the management and control of our affairs. Our board of directors has retained Broadstone Real Estate, LLC (the “Manager”), to provide certain property management services for our properties, and Broadstone Asset Management, LLC, a wholly owned subsidiary of the Manager (the “Asset Manager”), to manage our day-to-day affairs and implement our investment strategy, subject to our board of directors’ direction, oversight, and approval. The agreements governing the services provided by the Manager and the Asset Manager have been renewed through the year ended December 31, 2021, and will automatically renew for successive additional three-year terms thereafter, subject to earlier termination as detailed in the respective agreements (as further discussed in Item 13. “Certain Relationships and Related Transactions, and Director Independence” within this Form 10-K).

We conduct substantially all of our activities through, and all of our properties are held directly or indirectly by, the Operating Company. We are the sole managing member of the Operating Company and as of December 31, 2017, we owned approximately 92.4% of its issued and outstanding membership units, with the remaining 7.6% of its membership units held by persons who were issued membership units in exchange for their interests in properties acquired by the Operating Company.

3


As we conduct substantially all of our operations through the Operating Company, we are structured as what is referred to as an Umbrella Partnership Real Estate Investment Trust (“UPREIT”). The UPREIT structure allows a property owner to contribute their property to the Operating Company in exchange for membership units in the Operating Company and generally defer taxation of a resulting gain until the contributor later disposes of the membership units or the property is sold in a taxable transaction. The membership units of the Operating Company held by members of the Operating Company other than us are referred to herein and in our consolidated financial statements as “non-controlling interests,” “non-controlling membership units,” or “membership units,” and are convertible into shares of our common stock on a one-for-one basis, subject to certain restrictions. We allocate consolidated earnings to holders of our common stock and non-controlling membership unit holders of the Operating Company based on the weighted average number of shares of our common stock and non-controlling membership units outstanding during the year. Approximately 1.6 million non-controlling membership units were outstanding as of December 31, 2017. For the year ended December 31, 2017, the weighted average number of units outstanding was 1.5 million.

We commenced our ongoing private offering of shares of our common stock (our “private offering”) in 2007. The first closing of our private offering occurred on December 31, 2007, and we have conducted additional closings at least once every calendar quarter since then. Currently, we close sales of additional shares of our common stock monthly. We instituted a monthly cap on new and additional investments in our common stock beginning in November 2017. The cap does not apply to investments made pursuant to our distribution reinvestment plan or equity capital received in connection with UPREIT transactions. See Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities” of this Form 10-K for further information.

Our shares of common stock are sold by us at a price equal to a determined share value (the “Determined Share Value”), which is established quarterly by the committee of our board of directors comprised of our independent directors (“Independent Directors Committee”) based on the net asset value (“NAV”) of our portfolio, input from management and third-party consultants, and other such factors as the Independent Directors Committee may determine. Our determination of NAV applies valuation definitions and methodologies prescribed by the Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, in order to fair value our net assets. Our net assets are primarily comprised of our investment in rental property and debt. See further discussion related to Determined Share Value in Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Form 10-K under the caption Determined Share Value. Shares of our common stock are currently being offered in our private offering at $81.00 per share, provided that the per share offering price may be adjusted quarterly by the Independent Directors Committee based on the Determined Share Value. For the year ended December 31, 2017, we issued 3.8 million shares of our common stock in our private offering, including 0.5 million shares of common stock issued pursuant to our Distribution Reinvestment Plan (“distribution reinvestment plan” or “DRIP”). Cash received for newly issued shares totaled $263.1 million and shares with a value of $40.2 million were issued pursuant to DRIP transactions. In addition, we issued 161,418 units in our Operating Company valued at $12.9 million during the year ended December 31, 2017, in exchange for properties contributed through UPREIT transactions. We intend to use substantially all of the net proceeds from our private offering, supplemented with additional borrowings, to continue to invest in additional net leased properties and for general corporate purposes. We conduct our private offering in reliance upon the exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”), provided by Rule 506(c) of Regulation D promulgated under the Securities Act.

As of December 31, 2017, there were 18.9 million shares of our common stock issued and outstanding, and 1.6 million membership units in the Operating Company issued and outstanding.

2017 Highlights

 

Increased total revenues to $181.6 million, representing growth of 27.1% compared to the year ended December 31, 2016.

 

Generated earnings per share on a GAAP basis (as defined below), including amounts attributable to non-controlling interests, of $3.21, representing an increase of $0.45 per diluted share compared to the year ended December 31, 2016.

4


 

Generated funds from operations (“FFO”), a non-GAAP financial measure, of $6.00 per diluted share.

 

Generated adjusted funds from operations (“AFFO”), a non-GAAP financial measure, of $5.38 per diluted share.

 

Increased our monthly distribution to stockholders from $0.41 per share at December 31, 2016, to $0.415 per share in February 2017. Subsequent to year end, our board of directors increased the distribution to $0.43 per share, commencing with the payment to be made in March 2017.

 

Increased the Determined Share Value from $77.00 per share at December 31, 2016, to $81.00 at December 31, 2017, representing a 5.2% increase. The Determined Share Value will remain in effect through April 30, 2018.

 

Closed 29 real estate acquisitions totaling $683.6 million, excluding capitalized acquisition expenses, adding 124 new properties with a weighted average initial cash capitalization rate of 7.2%. The properties acquired had a weighted average lease term of 15.0 years at the time of acquisition and weighted average annual rent increases of 1.8%.

 

Received $316.2 million in investments from new and existing stockholders, including property contributed in exchange for Operating Company membership units through UPREIT transactions, and had more than 2,600 stockholders as of the end of the year.

 

Continued to focus on optimizing our portfolio by selectively pruning and strategically disposing of 13 properties, representing approximately 2.9% of our portfolio value as of December 31, 2016, for $63.3 million in net proceeds.

 

Successfully enhanced and diversified our sources of debt capital. In April 2017, we issued $150.0 million of unsecured, fixed-rate, interest-only senior notes (“Senior Notes”) through a private placement. In June 2017, together with the Operating Company, we closed an $800.0 million unsecured credit facility, which includes an accordion feature that permits an increase in the facility up to a total of $1.0 billion. In November 2017, we expanded the credit facility to $880.0 million of available borrowing capacity.

 

Collected more than 99% of rents due during 2017 and maintained a 100% leased portfolio throughout the year.

FFO and AFFO are performance measures that are not calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We present these non-GAAP measures as we believe certain investors and other users of our financial information use them as part of their evaluation of our historical operating performance. Please see our discussion in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K under the heading Net Income and Non-GAAP Measures (FFO and AFFO), which includes discussion of the definition, purpose, and use of these non-GAAP measures as well as a reconciliation of each to the most comparable GAAP measure.

Our Properties and Investment Objectives

We target acquisitions of fee simple interests in individual properties priced between $5 million and $75 million. Portfolios may be significantly larger, depending on balance sheet capacity and whether the portfolio is diversified or concentrated by tenant, geography, or brand. Our investment policy (“Investment Policy”) has three primary objectives that drive the investments we make:

 

preserve, protect, and return capital to investors,

 

realize increased cash available for distributions and long-term capital appreciation from growth in the rental income and value of our properties, and

 

maximize the level of sustainable cash distributions to our investors.

5


We primarily acquire freestanding, single-tenant commercial properties located in the United States either directly from our credit-worthy tenants in sale-leaseback transactions, where they sell us their properties and simultaneously lease them back through long-term, net leases, or through the purchase of properties already under a net lease (i.e., a lease assumption). Under either scenario, our properties are generally under lease and fully occupied at the time of acquisition. Our real estate portfolio as of December 31, 2017, is reflective of our Investment Policy, with a focus on properties in growth markets with at least ten years of lease term remaining. Throughout much of 2017, the Investment Policy required that the portfolio achieve financial returns on equity of greater than 10%, net of fees, provided that all acquisitions must have had a minimum remaining lease term of seven years and a minimum return on equity of 9.5%, unless approved by our Independent Directors Committee. As part of its regular review of our Investment Policy at its November 2017 meeting, the Independent Directors Committee approved an update to such policy to require a 9.5% minimum return on equity, net of fees, calculated based on the average return recognized across all acquisitions during a calendar year, with a minimum required return of 8.5%, net of fees, for any particular transaction. We believe the changes will allow us greater flexibility in deploying capital in investment opportunities that maximize the risk-adjusted return to our stockholders. Our criteria for selecting properties (“Property Selection Criteria”) is based on the following underwriting principles:

 

fundamental value and characteristics of the underlying real estate,

 

creditworthiness of the tenant, and

 

transaction structure and pricing.

We believe we can achieve an appropriate risk-adjusted return through these underwriting principles and conservatively project a property’s potential to generate targeted returns from current and future cash flows. We believe targeted returns are achieved through a combination of in-place income at the time of acquisition, rent growth, and a property’s potential for appreciation.

To achieve an appropriate risk-adjusted return, we maintain a diversified portfolio of real estate spread across multiple tenants, industries, and geographic locations. The following charts summarize our portfolio diversification by property type and geographic location as of December 31, 2017. The percentages below are calculated based on our contractual rental revenue over the next 12 months (“NTM Rent”) as of December 31, 2017, on a per property type basis divided by total NTM Rent. Late payments, non-payments, or other unscheduled payments are not considered in the calculation. NTM Rent includes the impact of contractual rent escalations.

6


Property Type, by % of NTM Rent

 

Property Type

 

% NTM Rent

 

Retail – casual dining

 

 

11.8

%

Retail – other

 

 

11.7

%

Retail – quick service restaurants (QSR)

 

 

10.7

%

Retail Total

 

 

34.2

%

Industrial – warehouse/distribution

 

 

11.5

%

Industrial – manufacturing

 

 

10.5

%

Industrial – flex

 

 

5.7

%

Industrial – other

 

 

3.4

%

Industrial Total

 

 

31.1

%

Healthcare – clinical

 

 

11.8

%

Healthcare – surgical

 

 

5.0

%

Healthcare – other

 

 

4.4

%

Healthcare Total

 

 

21.2

%

Office

 

 

9.7

%

Other

 

 

3.8

%

 

 

 

 

 

7


 

Top Tenant Industries

 

Industry

 

% NTM Rent

 

Restaurants

 

 

22.5

%

Healthcare Facilities

 

 

18.4

%

Home Furnishing Retail

 

 

4.9

%

Specialized Consumer Services

 

 

4.9

%

Packaged Foods & Meats

 

 

4.6

%

Auto Parts & Equipment

 

 

4.5

%

Healthcare Services

 

 

2.8

%

Industrial Conglomerates

 

 

2.3

%

Multi-line Insurance

 

 

2.1

%

Life Sciences Tools & Services

 

 

2.0

%

Distributors

 

 

2.0

%

Air Freight & Logistics

 

 

1.9

%

Industrial Machinery

 

 

1.8

%

Food Retail

 

 

1.7

%

Metal & Glass Containers

 

 

1.6

%

Top 15 Tenant Industries

 

 

78.0

%

Other (28 industries)

 

 

22.0

%

Total

 

 

100.0

%

 

Geographic Diversification, by % of NTM Rent

 

8


Substantially all of our leases are triple-net, meaning that our tenants are responsible for the maintenance, insurance, and property taxes associated with the properties they lease from us. At December 31, 2017, all of our properties are subject to leases. We do not currently engage in the development of real estate, which could cause a delay in timing between the funds used to invest in properties and the corresponding cash inflows from rental receipts. Our cash flows from operations are primarily generated through our real estate investment portfolio and the monthly lease payments under our long-term leases with our tenants.

To increase value to our stockholders, we strive to implement periodic rent escalations within our leases. As of December 31, 2017, nearly all of our leases had contractual rent escalations, with a 2.0% weighted average. A substantial majority of our leases have fixed annual rent increases, and the remaining leases have annual lease escalations based on increases in the Consumer Price Index (“CPI”), or periodic escalations over the term of the lease (e.g., a 10% increase every five years). These lease escalations mitigate exposure to fixed income streams in the case of an inflationary economic environment, and provide increased return in otherwise stable market conditions. Our focus on single-tenant, triple-net leases shifts certain risks to the tenant and shelters us from volatility in the cost of taxes, insurance, services, and maintenance of the property. An insignificant portion of our tenants have leases that are not fully triple-net, and, therefore, we bear responsibility for certain maintenance and structural component replacements (e.g., roof, structure, or parking lot) that may be required in the future, although the tenants are still required to pay all operating expenses associated with the property (e.g., real estate taxes, insurance and maintenance). In the limited circumstances where we cannot implement a triple-net lease, we attempt to limit our exposure through the use of warranties and other remedies that reduce the likelihood of a significant capital outlay during the term of the lease. We will also occasionally incur nominal property-level expenses that are not paid by our tenants. We do not currently anticipate making significant capital expenditures or incurring other significant property costs during the term of a property lease.

Due to the fact that all of our properties are leased to single tenants under long-term leases, we are not currently required to perform significant ongoing leasing activities on our properties. The leases for only three of our properties, representing less than 1% of our annual rental streams (calculated based on NTM Rent), will expire before 2020. As of December 31, 2017, the weighted average remaining term of our leases (calculated based on NTM Rent) was approximately 13.1 years, excluding renewal options, which are exercisable at the option of our tenants upon expiration of their initial lease term. Less than 5% of the properties in our portfolio are subject to leases without at least one renewal option. Furthermore, the weighted average lease term on the $683.6 million in properties acquired during the year ended December 31, 2017, was 15.0 years. More than 50% of our rental revenue is derived from leases that expire during 2030 and thereafter. As of December 31, 2017, no more than 10% of our rental revenue is derived from leases that expire in any single year in the decade between 2020 and 2030. The following chart sets forth our lease expirations based upon the terms of our leases in place as of December 31, 2017.

9


Lease Maturity Schedule, by % of NTM Rent

 

 

The following table presents the lease expirations by year, including the number of tenants and properties with leases expiring, the square footage covered by the leases expiring, the NTM Rent, and the percentage of NTM Rent for the leases expiring. Late payments, non-payments or other unscheduled payments are not considered in the NTM Rent amounts. NTM Rent includes the impact of contractual rent escalations. Amounts are in thousands, except the number of tenants and properties.

 

Year

 

Number of

Tenants

 

 

Number of

Properties

 

 

Square

Footage

 

 

NTM Rent

 

 

Percentage

of NTM Rent

 

2018

 

 

1

 

 

 

1

 

 

 

2

 

 

$

106

 

 

 

0.1

%

2019

 

 

2

 

 

 

2

 

 

 

8

 

 

 

280

 

 

 

0.1

%

2020

 

 

3

 

 

 

3

 

 

 

95

 

 

 

1,099

 

 

 

0.6

%

2021

 

 

2

 

 

 

4

 

 

 

9

 

 

 

578

 

 

 

0.3

%

2022

 

 

4

 

 

 

3

 

 

 

87

 

 

 

2,442

 

 

 

1.3

%

2023

 

 

9

 

 

 

13

 

 

 

724

 

 

 

6,836

 

 

 

3.6

%

2024

 

 

12

 

 

 

15

 

 

 

1,741

 

 

 

14,023

 

 

 

7.3

%

2025

 

 

2

 

 

 

8

 

 

 

28

 

 

 

1,038

 

 

 

0.5

%

2026

 

 

18

 

 

 

28

 

 

 

801

 

 

 

11,970

 

 

 

6.2

%

2027

 

 

19

 

 

 

35

 

 

 

1,726

 

 

 

18,596

 

 

 

9.7

%

2028

 

 

15

 

 

 

29

 

 

 

1,169

 

 

 

13,563

 

 

 

7.1

%

2029

 

 

15

 

 

 

62

 

 

 

2,664

 

 

 

17,901

 

 

 

9.3

%

2030 and thereafter

 

 

73

 

 

 

325

 

 

 

6,874

 

 

 

103,945

 

 

 

53.9

%

 

10


Our top tenants and brands at December 31, 2017, are listed in the tables below. The percentages are calculated based on our NTM Rent on a per property type basis divided by total NTM Rent. Late payments, non-payments or other unscheduled payments are not considered in the calculation. NTM Rent includes the impact of contractual rent escalations.

Top Ten Tenants, by % of NTM Rent

 

Tenant

 

Property Type

 

% NTM Rent

 

 

Properties

 

Red Lobster Hospitality LLC & Red Lobster

   Restaurants LLC

 

Retail

 

 

3.8

%

 

 

25

 

Art Van Furniture, LLC

 

Retail

 

 

3.4

%

 

 

9

 

Jack’s Family Restaurants LP

 

Retail

 

 

3.0

%

 

 

36

 

Outback Steakhouse of Florida, LLC (1)

 

Retail

 

 

2.8

%

 

 

24

 

Big Tex Trailer Manufacturing Inc.

 

Industrial/Retail/Office

 

 

2.4

%

 

 

17

 

Siemens Medical Solutions USA, Inc. & Siemens

   Corporation

 

Industrial

 

 

2.3

%

 

 

2

 

Nestle' Dreyer's Ice Cream Company

 

Industrial

 

 

2.2

%

 

 

1

 

Nationwide Mutual Insurance Company

 

Office

 

 

2.1

%

 

 

2

 

Arkansas Surgical Hospital LLC

 

Healthcare

 

 

2.1

%

 

 

1

 

Bob Evans Restaurants, LLC

 

Retail

 

 

1.9

%

 

 

25

 

Total

 

 

 

 

26.0

%

 

 

142

 

All Other

 

 

 

 

74.0

%

 

 

386

 

 

(1)

Tenant’s properties include 22 Outback Steakhouse restaurants and two Carrabba’s Italian Grill restaurants.

Top Ten Brands, by % of NTM Rent

 

Brand

 

Property Type

 

% NTM Rent

 

 

Properties

 

Bob Evans Farms (1)

 

Industrial/Retail

 

 

3.8

%

 

 

27

 

Red Lobster

 

Retail

 

 

3.8

%

 

 

25

 

Art Van Furniture

 

Retail

 

 

3.4

%

 

 

9

 

Jack's Family Restaurants

 

Retail

 

 

3.0

%

 

 

36

 

Taco Bell

 

Retail

 

 

2.7

%

 

 

41

 

Wendy's

 

Retail

 

 

2.6

%

 

 

35

 

Outback Steakhouse

 

Retail

 

 

2.4

%

 

 

22

 

Big Tex Trailers

 

Industrial/Retail/Office

 

 

2.4

%

 

 

17

 

Siemens

 

Industrial

 

 

2.3

%

 

 

2

 

Nestle'

 

Industrial

 

 

2.2

%

 

 

1

 

Total

 

 

 

 

28.6

%

 

 

215

 

All Other

 

 

 

 

71.4

%

 

 

313

 

 

(1)

Brand includes two BEF Foods, Inc. properties and 25 Bob Evans Restaurants, LLC restaurants.

11


Our Investment Policy generally requires us to seek diversification of our investments. The Independent Directors Committee approved certain updates to our Investment Policy following the regular annual review of the policy at the November 2017 meeting of our board of directors. Based on the NTM rent of the properties in the portfolio, determined as of the date of the prior quarter end, new investments may not cause us to exceed:

 

5% in any single property;

 

8% leased to any single tenant or brand;

 

10% located in any single metropolitan statistical area; or

 

20% located in any single state.

We may exceed these diversification targets from time to time with the approval of the Independent Directors Committee. To avoid undue risk concentrations in any single asset class or category, long-term asset allocation will be set with the following target percentages and within the following ranges, although these ranges may be temporarily waived by the Independent Directors Committee:

 

Asset Category

 

Target

 

 

Range

Retail

 

 

30

%

 

15-45%

Healthcare

 

 

20

%

 

15-45%

Industrial

 

 

25

%

 

15-45%

Office

 

 

15

%

 

10-20%

Other

 

 

10

%

 

5-15%

 

While the Independent Directors Committee establishes diversification thresholds to manage risk, the management team does not review discrete financial information at this level. Refer to our discussion regarding segment reporting under the caption Segment Reporting in Note 2, “Summary of Significant Accounting Policies” within the Notes to the Consolidated Financial Statements within Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.

We do not currently engage in the development of real estate, but may do so in the future. Our Investment Policy provides the Asset Manager with the authority to make, on our behalf, any acquisition or sale of any property or group of related properties involving up to $50 million for any single or portfolio transaction, $75 million per cumulative tenant concentration, or $100 million per cumulative brand concentration, without approval of the Independent Directors Committee, provided that the transaction otherwise meets our Investment Policy and Property Selection Criteria, and any financing related to any such acquisition does not violate our Leverage Policy (as defined below), as established by the Independent Directors Committee from time to time. Our Investment Policy permits investments in properties that do not otherwise meet our Investment Policy or Property Selection Criteria with the approval of the Independent Directors Committee.

Underwriting Criteria

When evaluating a property acquisition, our underwriting guidelines require that we consider the condition of the property, the creditworthiness of the tenant, the strength of any personal or corporate guarantees, the tenant’s historic performance at the property or similar properties, the location of the property, the overall economic condition of the community in which the property is located, and the property’s potential for appreciation. We apply our credit underwriting guidelines prior to acquiring a property, periodically throughout the lease term, and when we are re-leasing properties in our portfolio. While we seek creditworthy tenants, we do not require them to be investment grade credit-rated. Our credit review process includes analyzing a tenant’s financial statements and other available information. When we obtain guarantees on our leases, we also analyze the creditworthiness of the guarantors. Depending on the circumstances, our process will include discussions with the tenant’s management team surrounding their business plan and strategy.

12


We evaluate the creditworthiness of our existing tenants on an ongoing basis through the use of regularly scheduled real estate portfolio reviews, reviewing updated tenant financial statements on a quarterly or annual basis, depending on the terms of the lease, analysis of updated tenant credit ratings, and our ongoing analysis of the economy and trends in the industries in which our tenants operate. Our portfolio review committee, which includes members of our senior management and our Manager’s portfolio management team, perform an in-depth review of each property in our portfolio at least once every 18 months. The review includes an analysis of the tenant’s recent financial statements, including key metrics such as rent coverage and leverage levels, among other applicable credit metrics, credit ratings, and economic considerations relevant to the tenant. The Manager’s asset management team also periodically reviews tenant financial statements and relevant credit performance metrics. Our credit monitoring procedures also include regular communications with tenants, who are required to communicate certain events to us under the terms of our leases, such as events of default and property damage. We believe our ongoing credit monitoring will enable us to identify material changes to a tenant’s credit quality in a timely basis and preserve our financial position. We have not identified any material changes to the credit quality of the tenants in our real estate portfolio as of December 31, 2017.

Leverage Policy

In March of 2016, Moody’s Investors Service (“Moody’s”) assigned the Operating Company an investment grade credit rating of Baa3 with a stable outlook. Moody’s re-affirmed the investment grade credit rating in March of 2017. The investment grade credit rating allowed us to take advantage of preferential borrowing margins on our outstanding debt, including the credit facility we entered into on June 23, 2017. The investment grade credit rating will also allow us more attractive access to the debt private placement markets. The rating is based on a number of factors, including an assessment of our financial strength, portfolio size and diversification, credit and operating metrics, corporate governance policies, and sustainability of cash flow and earnings. We are strongly committed to maintaining modest leverage, commensurate with our investment grade rating. While Moody’s utilizes other factors outside of our leverage ratio, our leverage policy (“Leverage Policy”) is to maintain a leverage ratio in the 35% to 45% range based on the market value of assets, recognizing that the actual leverage ratio will vary over time and there may be opportunistic reasons to exceed a 45% leverage ratio; provided, however, that we cannot exceed a 50% leverage ratio without the approval of the Independent Directors Committee.

We primarily utilize unsecured term and revolving debt to finance acquisitions, while obtaining mortgage loans and notes payable to a lesser degree. The mix of financing sources may change over time based on market conditions. The unsecured loans generally contain affirmative and negative covenants which are tested against our financial performance.

When utilized, mortgage loans and notes payable (“mortgage financing”) typically cover a single property or a group of related properties acquired from a single seller. The loans may be further secured by guarantees from us or the Operating Company, provided that we attempt to limit the use of guarantees to the extent possible. The Operating Company may assume debt when conducting a transaction or it may mortgage existing properties. As of December 31, 2017, 11 of our 528 properties were secured by mortgage financing, and the aggregate outstanding principal balance of mortgage loans and notes payable was approximately $68.5 million.

To reduce its exposure to variable-rate debt, the Operating Company enters into interest rate swap agreements to fix the rate of interest as a hedge against interest rate fluctuations. These interest rate hedges have staggered maturities to reduce the exposure to interest rate fluctuations in any one year, and generally extend up to 10 years. The interest rate swaps are applied against a pool of debt, which offers flexibility in maintaining our hedge designation concurrent with our ongoing capital markets activity. We attempt to limit our total exposure to floating-rate debt to be within a target of no more than 5% of the market value of total assets, measured at quarter end.

To reduce counterparty concentration risk with respect to our interest rate hedges, we diversify the institutions that serve as swap counterparties, and no more than 30% of the nominal value of our total hedged debt may be with any one institution, to be measured at the time we enter into an interest rate swap transaction and at quarter end.

13


During the year ended December 31, 2017, we added $150.0 million of unsecured, interest-only Senior Notes to our capital structure. The Senior Notes bear interest at a fixed rate of 4.84% per annum, with a 10-year maturity. We strategically use this channel of long-term, fixed-rate debt capital to help mitigate interest rate risk, lengthen our maturity profile, and diversify our sources of debt capital.  

The Independent Directors Committee reviews our Leverage Policy at least annually; however, depending on market conditions and other factors, they may change our Leverage Policy from time to time.

As of December 31, 2017, our total outstanding indebtedness was $1,181.5 million and the ratio of our total indebtedness to the market value of our assets was approximately 41.6%.

Corporate Governance

We operate under the direction of our board of directors, which is responsible for the management and control of our affairs. Our board of directors has retained the Manager and the Asset Manager to manage our day-to-day affairs, to implement our investment strategy, and to provide certain property management services for our properties, with both subject to our board of directors’ direction, oversight, and approval. All of our officers are employees of the Manager.

Our board of directors is currently comprised of nine directors, six of whom are independent directors and serve on the Independent Directors Committee. The Independent Directors Committee reviews our relationship with, and the performance of, the Manager and the Asset Manager, and approves the terms of any affiliate transactions. In addition, the Independent Directors Committee is responsible for, among other things, approving our property and portfolio valuation policy, setting the Determined Share Value for our ongoing private offering, approving and setting our Investment Policy, Property Selection Criteria, and Leverage Policy, and approving acquisitions above certain thresholds or outside of the criteria set forth in our Investment Policy.

Management and Our Structure

Pursuant to the terms of the asset management agreement among us, the Operating Company, and the Asset Manager (as amended, the “Asset Management Agreement”), the Asset Manager is responsible for, among other things, managing our day-to-day operations, establishing and monitoring acquisition and disposition strategies, overseeing all marketing communications and services related to our ongoing private offering, arranging mortgage and other financing, overseeing the acquisition of properties and their initial lease-up if they are not already subject to a net lease upon acquisition, providing support for the good faith valuation of our property portfolio and the setting of the Determined Share Value by the Independent Directors Committee, overseeing investor closings and transfers, arranging our annual stockholder meetings, and servicing and communicating with investors, including providing investment projections and reports. The Asset Manager also has the power pursuant to the Asset Management Agreement to designate two of the nine directors who serve on our board of directors. The Manager owns and controls the Asset Manager.

Pursuant to the property management agreement among us, the Operating Company, and the Manager (as amended, the “Property Management Agreement”), the Manager provides property management services to our properties, including management, rent collection, and re-leasing services. In June 2015, Trident BRE, LLC, an affiliate of Stone Point Capital LLC (“Trident BRE”), acquired through an equity investment an approximate 45.6% equity ownership interest in the Manager. As of December 31, 2017, the Manager is owned, on a fully diluted basis, (i) approximately 44.44% by Trident BRE, (ii) approximately 44.44% by Amy L. Tait, our Executive Chairman of the board of directors and Chief Investment Officer, Tait family trusts, and an investment entity for the families of Ms. Tait and the late Norman Leenhouts, one of our founders, and (iii) approximately 11.12% by employees of the Manager. The Manager is controlled by a four-person board of managers, two of whom are appointed by Trident BRE. In June 2015, in connection with Trident BRE’s investment in the Manager, (i) we acquired 100,000 convertible preferred interests in the Manager (the “Convertible Preferred BRE Units”), for $100 per Convertible Preferred BRE Unit, in exchange for the issuance to the Manager of 138,889 shares of our common stock, then valued at $72.00 per share, and (ii) the Manager purchased 510,416 shares of our common stock, for $72.00 per share. The Manager currently owns 375,000, or approximately 2.0%, of the issued and outstanding shares of our common stock. The Independent Directors Committee approved our investment in the Convertible Preferred BRE Units.

14


As of December 31, 2017, the Manager employed approximately 24 individuals fully-dedicated to our business and operations. Additionally, the Manager employed approximately 38 additional individuals who dedicate a significant portion of their time to our business and operations, in addition to various other tasks and responsibilities on behalf of the Manager and its affiliates.

For more information regarding the relationships among our company, Trident BRE, the Manager, and the Asset Manager and the fees we pay to the Manager and the Asset Manager pursuant to the Property Management Agreement and the Asset Management Agreement, see Item 13. “Certain Relationships and Related Transactions, and Director Independence” of this Form 10-K.

The chart below illustrates the relationships among our company, the Operating Company, the Manager, and the Asset Manager as of December 31, 2017.

 

 

Regulation

Our investments are subject to various federal, state, and local laws, ordinances, and regulations, including, among other things, zoning regulations, land use controls, and environmental controls relating to air and water quality, noise pollution, and indirect environmental impacts. We believe that we have all permits and approvals necessary under current law to operate our investments.

15


Emerging Growth Company Status

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”), and as such we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. A number of these exemptions are not currently relevant to us due to our external management structure, and in any event, we do not currently intend to take advantage of any of these exemptions.

In addition, Section 107 of the JOBS Act provides that an emerging growth company can use the extended transition period provided in Section 13(a) of the Exchange Act for complying with new or revised accounting standards. This permits an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to take advantage of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.

We will remain an emerging growth company until the earliest to occur of (1) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (2) the date on which we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period, and (4) the end of the year in which the five-year anniversary of our initial public offering of our common stock occurs.

Competition

The commercial real estate market is highly competitive. We compete for tenants to occupy our properties in all of our markets with other owners and operators of commercial real estate. We compete based on a number of factors that include location, rental rates, security, suitability of the property’s design to prospective tenants’ needs, and the manner in which the property is operated and marketed. The number of competing properties in a particular market could have a material effect on our occupancy levels, rental rates and the operating expenses of certain of our properties.

In addition, we compete with other entities engaged in real estate investment activities to locate suitable properties to acquire and purchasers to buy our properties. These competitors include other REITs, specialty finance companies, savings and loan associations, sovereign wealth funds, banks, mortgage bankers, insurance companies, institutional investors, investment banking firms, lenders, governmental bodies, and other entities. Some of these competitors, including larger REITs, have substantially greater marketing and financial resources than we have. The relative size of their portfolios may allow them to absorb properties with lower returns and allow them to accept more risk on a given property than we can prudently manage, including risks with respect to the creditworthiness of tenants. In addition, these same entities may seek financing through similar channels to us. Competition from these REITs and other third party real estate investors may limit the number of suitable investment opportunities available to us. It also may result in higher prices, lower yields, and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms.

Seasonality

Our investments are not materially impacted by seasonality.

Employees

We have no employees. Our officers are employees of our Manager or its affiliates and are not compensated by us for their service as our officers. The employees of our Manager and its affiliates manage our day-to-day operations and provide management, acquisition, advisory, and certain administrative services for us.

16


Income Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code and have operated as such commencing with the taxable year ended December 31, 2008. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our annual REIT taxable income to our stockholders, which is computed without regard to the dividends paid deduction and excluding net capital gain and does not necessarily equal net income as calculated in accordance with GAAP. As a REIT, we generally will not be subject to federal income tax to the extent we distribute qualifying dividends to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions.

Financial Information about Industry Segments

We currently operate in a single reportable segment, which includes the acquisition, leasing, and ownership of net leased properties. Refer to the caption Segment Reporting in Note 2, “Summary of Significant Accounting Policies” within the Notes to the Consolidated Financial Statements within Item 8. “Financial Statements and Supplementary Data” of this Form 10-K.

Company Information

Our principal executive offices are located at 800 Clinton Square, Rochester, New York, 14604, and our telephone number is (585) 287-6500.

Our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as our proxy statements, are accessible free of charge at http://investors.bnl.broadstone.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, or you may access them through the EDGAR database at the SEC’s website at http://www.sec.gov.

We have adopted our Code of Ethics to ensure that our business is conducted in accordance with the highest moral, legal, and ethical standards by our officers and directors as well as the Manager, the Asset Manager, and the Manager’s employees. The Code of Ethics is available on our website, http://investors.bnl.broadstone.com, together with the charters of the Board’s Independent Directors Committee, Audit Committee, and Nominating and Corporate Governance Committee. Amendments to, and waivers granted to our directors and executive officers under our codes of ethics, if any, will be posted in this area of our website. Copies of these materials are available in print to any stockholder who requests them. Stockholders should direct such requests in writing to Investor Relations Department, Broadstone Net Lease, Inc., 800 Clinton Square, Rochester, New York 14604. Stockholders may also call 1-585-287-6500.

The information about our website and its content is for your convenience only. The content of our website is not deemed to be incorporated by reference in this report or filed with the SEC.

 

17


Item 1A.

Risk Factors.

The following are some of the risks and uncertainties that could cause our actual results to differ materially from those presented in our forward-looking statements. You should consider carefully the risks described below and the other information in this Form 10-K, including our consolidated financial statements and the related notes. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

General Investment Risks

We may not be able to make distributions to our stockholders at the times or in the amounts we expect, or at all.

We may not be able to continue to generate sufficient cash flow from our properties and from possible distributions on our Convertible Preferred BRE Units, if declared and paid, to permit us to make the distributions we expect. If we pay distributions from the proceeds of our securities offering or from borrowings, the amount of capital we ultimately invest may be reduced, which may reduce the value of an investment in us.

There is no public trading market for our common stock and we are not required to effectuate a liquidity event by a certain date or at all, and transfers of shares of our common stock are subject to a number of restrictions. As a result, it will be difficult for our stockholders to sell shares of our common stock and, if they are able to sell their shares, they are likely to sell them at a discount.

There is no current public market for our common stock, we do not expect that any such public market will develop in the future, and we have no obligation to list our shares on any public securities market or provide any other type of liquidity to our stockholders by a particular date, or at all. The shares of our common stock are not registered under the Securities Act or state securities laws and therefore cannot be resold unless they are subsequently registered under such laws or unless an exemption from registration is available. Although we have adopted our share redemption program pursuant to which our stockholders may request that we redeem shares of our common stock, it is subject to a number of restrictions. Accordingly, our investors should not expect to be able to sell their shares or otherwise liquidate their investment promptly, if at all, and there can be no assurance that the sales price of any shares which are sold would equal or exceed the price originally paid for the shares. Our investors must be prepared to bear the economic risk of holding their shares of our common stock for an indefinite period of time.

Our stockholders are limited in their ability to sell shares of our common stock pursuant to our share redemption program. Our stockholders may not be able to sell any of their shares of our common stock back to us, and if they do sell their shares, they may not receive the price they paid.

We have adopted a share redemption program to provide an opportunity for our stockholders to have shares of our common stock repurchased at a price equal to or at a discount from the current Determined Share Value in effect as of the date the shares are tendered for redemption, subject to a number of restrictions and limitations. No shares may be repurchased under our share redemption program until after the first anniversary of the date of purchase of such shares without approval from our Independent Directors Committee. Further, we are not obligated to repurchase shares of our common stock under the share redemption program. Notwithstanding the procedures outlined in the share redemption program, our board of directors or Independent Directors Committee may, in its sole discretion, reject any share redemption request made by any stockholder at any time. In addition, the share redemption program limits the number of shares that may be redeemed in any quarter. The total number of shares redeemed in any quarter pursuant to the share redemption program may not exceed (i) 1% of the total number of shares outstanding at the beginning of the applicable calendar year, plus (ii) 50% of the total number of any additional shares of our common stock issued during the prior calendar quarter pursuant to our DRIP; provided, however, that the total number of shares redeemed during any calendar year may not exceed 5% of the number of shares outstanding as of the first day of such calendar year. There is no fee in connection with a repurchase of shares pursuant to our share redemption program. Finally, our board of directors reserves the right to amend, suspend, or terminate the share redemption program at any time upon 30 days’ notice to our stockholders. As a result of the foregoing, a stockholder may not be able to sell any of its shares of our common stock back to us pursuant to our share redemption program. Moreover, if a stockholder does sell its shares of our common stock back to us pursuant to the share redemption program, the stockholder may not receive the same price it paid for any shares of our common stock being redeemed.

18


The Independent Directors Committee establishes the Determined Share Value on a quarterly basis. The Determined Share Value is not directly derived from any independent valuation, nor from the value of the existing property portfolio. Investors should use caution in using the Determined Share Value as the current value of shares of our common stock.

On a quarterly basis, the Independent Directors Committee establishes a Determined Share Value per share of our common stock, based on the net asset value of the portfolio, input from management and third-party consultants, and such other factors as the Independent Directors Committee may, in its sole discretion, determine, which we refer to as the Determined Share Value. See the caption Determined Share Value in Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” within this Form 10-K for a complete discussion of the policies, procedures, and parties involved in calculating and reviewing the net asset value of the portfolio and setting the Determined Share Value. Shares of our common stock are offered in our ongoing private offering at a price per share equal to the current Determined Share Value and cash distributions can be reinvested in additional shares of our common stock pursuant to our distribution reinvestment plan at a price per share equal to 98% of the current Determined Share Value. In addition, shares of our common stock are redeemed by us pursuant to the terms of our share redemption program at a per share price equal to or at a discount to the current Determined Share Value. The Independent Directors Committee may, and currently does, engage consultants, appraisers, and other real estate or investment professionals to assist in their establishment of the Determined Share Value, but the Independent Directors Committee is not required to do so. As a result, the price of the shares of our common stock may not necessarily bear a direct relationship to our book or asset values or to any other established criteria for valuing issued or outstanding common stock and the actual value of an investor’s investment in shares of our common stock could be substantially less than what the stockholder may have paid to purchase the shares.

As with any valuation method, the methods used to determine the Determined Share Value are based upon a number of assumptions, estimates and judgments that may not be accurate or complete. Our assets are valued based upon appraisal standards and the values of our assets using these methods are not required to be a reflection of market value and will not necessarily result in a reflection of fair value under GAAP. Further, different parties using different property-specific and general real estate and capital market assumptions, estimates, judgments, and standards could derive different Determined Share Values, which could be significantly different from the Determined Share Values determined by the Independent Directors Committee. The Determined Share Value established as of any given time is not a direct representation or indication that, among other things, (i) a stockholder would be able to realize the full Determined Share Value if he or she attempts to sell their shares, (ii) a stockholder would ultimately realize distributions per share equal to the Determined Share Value upon liquidation of our assets and settlement of our liabilities or upon a sale of our company, (iii) shares of our common stock would trade at the Determined Share Value on a national securities exchange, (iv) a third party would offer the Determined Share Value in an arms-length transaction to purchase all or substantially all of our shares of common stock, or (v) the methodologies used to estimate the Determined Share Value would be acceptable to the requirements of any regulatory agency.

In order to qualify as a REIT, we retain the right to prohibit certain acquisitions and transfers of shares of our common stock, which limits our investors’ ability to purchase or sell shares.

We cannot maintain our qualification as a REIT if, among other requirements: (i) more than 50% of the value of our outstanding common stock is owned, directly or indirectly, by five or fewer stockholders during the last half of each taxable year, or (ii) fewer than 100 persons own our outstanding common stock during at least 335 days of a 12-month taxable year. In order to assist us in meeting certain REIT qualification requirements, our Articles of Incorporation restrict the direct or indirect ownership by one person or entity to no more than 9.8% of the value of our then outstanding shares of capital stock (which includes common stock and any preferred stock we may issue) and no more than 9.8% of the value or number of shares, whichever is more restrictive, of our then outstanding common stock unless exempted by our board of directors. We may, therefore, prohibit certain acquisitions and transfers of shares in an attempt to ensure our continued qualification as a REIT. These prohibitions may prevent our existing stockholders from acquiring additional shares, redeeming their shares, or selling their shares to others who may be deemed to, directly or indirectly, beneficially own our common stock.

19


Risks Related to Our Business

Our success is dependent on the performance of our Manager and Asset Manager and any adverse change in their financial health could cause our operations to suffer.

Our ability to achieve our investment objectives and to pay distributions is dependent upon the performance of our Manager and Asset Manager and any adverse change in their financial health could cause our operations to suffer. Our Manager and Asset Manager are sensitive to trends in the general economy, as well as the commercial real estate and related markets. An economic downturn could result in reductions in overall transaction volume and size of sales and leasing activities, and would put downward pressure on our Manager’s and Asset Manager’s revenues and operating results. To the extent that any decline in revenues and operating results impacts the performance of our Manager or Asset Manager, our operating results could suffer.

Loss of key personnel of the Manager could delay or hinder our investment strategy, which could limit our ability to make distributions and decrease the value of an investment in us.

We are dependent upon the contributions of key personnel of the Manager. Our overall success and the achievement of our investment objectives depends upon the performance of our senior leadership team, each of whom is an employee of the Manager. We rely on our senior leadership team to, among other things, identify and consummate acquisitions, design and implement our financing strategies, manage our investments, and conduct our day-to-day operations. Members of our senior leadership team could choose to leave employment with the Manager for any number of reasons. We rely on the experience, efforts, and abilities of these individuals, each of whom would be difficult to replace. The loss of services of one or more members of our senior leadership team, or the Manager’s inability to attract and retain highly qualified personnel, could adversely affect our business, diminish our investment opportunities, and weaken our relationships with lenders, business partners, existing and prospective tenants, and industry participants, all of which could materially and adversely affect us.

In particular, Amy L. Tait and Christopher J. Czarnecki, our Executive Chairman of the board of directors and Chief Investment Officer and our Chief Executive Officer, respectively, and employees of the Manager, have significant real estate experience which would be difficult to replace. Each of Ms. Tait and Mr. Czarnecki has an employment agreement with the Manager which includes non-competition and non-solicitation covenants; however, these agreements could be amended by the Manager from time to time. Although the Manager has “key employee” life and disability insurance on each of Ms. Tait and Mr. Czarnecki, the proceeds of that insurance will be used as determined by the board of managers of the Manager, which consists of two appointees of the Manager’s management and two appointees of Trident BRE, and may be diverted to uses other than replacing the deceased or incapacitated executive. We may suffer direct, reputational, and other costs in the event of the loss of the services of either Ms. Tait or Mr. Czarnecki.

The Restated Management Contracts (as defined under the caption Asset Management Agreement in Item 13. “Certain Relationships and Related Transactions, and Director Independence” of this Form 10-K) include the concept of a Key Person Event (as defined below). Upon a Key Person Event, the Manager will have a period of 60 days to present to the Independent Directors Committee two individuals to serve as Chairman and Chief Executive Officer (or comparable executive positions with substantially the same responsibilities) of the Manager (such individuals, “Replacement Nominees”). Upon receipt of the Replacement Nominees, the Independent Directors Committee will have a period of up to six months (the “Review Period”) to consider the Replacement Nominees and to reasonably request additional information regarding the Replacement Nominees. If, prior to the expiration of the Review Period, (i) the Independent Directors Committee elects not to approve the Replacement Nominees and (ii) the Manager and the Independent Directors Committee have been unable, despite mutual good faith efforts, to agree upon suitable alternative individuals to appoint as the Chairman and Chief Executive Officer of the Manager, the Independent Directors Committee will have the right to terminate the Restated Management Contracts upon written notice to the Manager on or prior to the last day of the Review Period, with such termination effective 12 months from the date of such notice. The Restated Management Contracts define a “Key Person Event” as any event or circumstance which results in both of Ms. Tait and Mr. Czarnecki (or their respective successors and replacements, as approved by the Independent Directors Committee) no longer continuing to serve as the Chairman and Chief Executive Officer (or comparable executive positions), respectively, of the Manager for a continuous period of 60 days.

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We pay substantial fees to our Manager and Asset Manager. These fees were not negotiated at arm’s length, may be higher than fees payable to unaffiliated third parties and may reduce cash available for investment.

We pay substantial fees to our Manager and Asset Manager. These fees were originally agreed to prior to the company accepting outside capital from investors other than our sponsors and were not negotiated at arm’s length, although the fees have since been reaffirmed by the Independent Directors Committee in connection with the approval of the Restated Management Agreements in December 2017. The fees could be in excess of amounts that we would otherwise pay to third parties for such services. In addition, the full offering price paid by our investors in our private offering will not be invested in properties. The proceeds are primarily used to acquire and operate our properties, but may also be used by us for general corporate purposes and to pay fees due to the Manager and the Asset Manager. As a result, stockholders will only receive a full return of their invested capital if: (1) we sell our assets or our company for a sufficient amount in excess of the original purchase price of our assets; (2) the market value of our company after we list our shares of common stock on a national securities exchange is substantially in excess of the original purchase price of our assets; or (3) they recoup their invested capital through the cash distributions we pay over the time they hold an investment in shares of our common stock.

We may not receive our expected cumulative preferred return on our investment in the Convertible Preferred BRE Units and, if we do not timely convert the Convertible Preferred BRE Units into common membership units of the Manager, we will not be entitled to a return in excess of our original investment in the Convertible Preferred BRE Units and cumulative preferred return.

The Convertible Preferred BRE Units we hold are entitled to distributions from the Manager equal to a cumulative 7.0% annual preferred return, payable prior to distributions paid to the holders of common membership units of the Manager, which preferred return increases annually by 0.25%. However, there can be no assurance that the board of managers of the Manager will declare and pay such distributions. The Convertible Preferred BRE Units are convertible, in whole and not in part, into common membership units of the Manager during the period from January 1, 2018 to December 31, 2019 (“conversion period”). If we do not elect to convert the Convertible Preferred BRE Units into common membership units of the Manager during the conversion period, we will be limited to a return of our original investment in the Convertible Preferred BRE Units and any unpaid cumulative preferred return payable on the Convertible Preferred BRE Units in the event of a liquidation of the Manager or if the Manager exercises its option to redeem the Convertible Preferred BRE Units after the conversion period.

As holder of the Convertible Preferred BRE Units, we have limited rights to approve or disapprove actions of the Manager.

We have limited rights to participate in the management of or control the Manager. The Convertible Preferred BRE Units have no voting rights, except for the limited right to approve, voting as a class, any amendment to the limited liability company agreement of the Manager which would materially and adversely affect the rights of the Convertible Preferred BRE Units or would create a series or type of membership interests senior to or on a parity with the Convertible Preferred BRE Units. As holder of the Convertible Preferred BRE Units, we do have the right to appoint one individual to attend, in an observer capacity, any meeting of the board of managers of the Manager and receive information provided to the managers of the Manager; however, such individual has no power to participate in the voting of the board of managers of the Manager or otherwise control the Manager.

A cybersecurity incident and other technology disruptions could negatively impact our business.

We, the Manager, and the Asset Manager, use technology in substantially all aspects of our business operations. Mobile devices, outside vendors, and other online activities are used to connect with our tenants, vendors, and employees of our affiliates. Our, the Manager’s, and the Asset Manager’s information technology (“IT”) networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations. Our business involves the storage and transmission of numerous classes of sensitive and confidential information and intellectual property, including tenants’ information, private information about our stockholders and the Manager’s employees, and financial and strategic information about us. We face risks associated with security breaches, through cyber-attacks or cyber-intrusions over the internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber-intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions

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from around the world have increased. If we, the Manager, or the Asset Manager, fail to assess and identify cybersecurity risks associated with our operations, we may become increasingly vulnerable to such risks. Additionally, the measures we, the Manager, or the Asset Manager have implemented to prevent security breaches and cyber incidents may not be effective. The theft, destruction, loss, misappropriation, or release of sensitive or confidential information or intellectual property, or interference with or significant disruptions of our IT networks and related systems, or the technology systems of third parties on which we rely, could result in business disruption, negative publicity, brand damage, violation of privacy laws, loss of tenants, potential liability, and competitive disadvantage, any of which could result in a material adverse effect on our financial condition or results of operations.

A failure to maintain effective internal controls could have a material adverse effect on our business, financial condition, and results of operations.

Effective internal controls over financial reporting, disclosures, and operations are necessary for us to provide reliable financial reports and public disclosures, effectively prevent fraud, and operate successfully. If we cannot provide reliable financial reports and public disclosures or prevent fraud, our reputation and operating results would be harmed. Our internal controls over financial reporting and our operating internal controls may not prevent or detect financial misstatements or loss of assets because of inherent limitations, including the possibility of human error, management override of controls, or fraud. Effective internal controls can provide only reasonable assurance with respect to financial statement accuracy, public disclosures, and safeguarding of assets. Any failure of these internal controls, including any failure to implement required new or improved controls as a result of changes to our business or otherwise, or if we experience difficulties in their implementation, could result in decreased investor confidence in the accuracy and completeness of our financial reports and public disclosures, civil litigation, or investigations by the SEC or other regulatory authorities, which may adversely impact our business, financial condition, and results of operations and we could fail to meet our reporting obligations.

If we internalize our management functions, we could incur other significant costs associated with being self-managed.

Our board of directors may decide in the future to internalize our management functions. If we do so, we may elect to negotiate to acquire the Manager’s and the Asset Manager’s assets and hire the Manager’s personnel, each as related to the operation and management of our businesses. While we would no longer bear the costs of the various fees and expenses we expect to pay to the Manager and the Asset Manager under the Restated Management Contracts, our direct expenses would include additional general and administrative costs that are currently paid by the Manager and Asset Manager. In addition, we could be required to pay certain costs and contract termination fees in connection with our current management agreements with the Manager and the Asset Manager. For additional information regarding these termination fees, please see the caption titled Termination in Item 13. “Certain Relationships and Related Transactions, and Director Independence” of this Form 10-K. We would also be required to employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes, and other employee-related liabilities and grievances as well as incur the compensation and benefits costs of our officers and other employees and consultants that are paid by the Manager and the Asset Manager. We cannot reasonably estimate the amount of fees to the Manager and the Asset Manager we would save or the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to the Manager and the Asset Manager, our funds from operations would be lower as a result of the internalization than they otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders.

Disruptions in the financial markets and deteriorating economic conditions could adversely impact our ability to implement our investment strategy and achieve our investment objectives.

The United States and global financial markets have experienced extreme volatility and disruption within the past decade. There was a widespread tightening in overall credit markets, devaluation of the assets underlying certain financial contracts, and increased borrowing by governmental entities. The turmoil in the capital markets resulted in constrained equity and debt capital available for investment in the real estate market, resulting in fewer buyers seeking to acquire properties, increases in capitalization rates, and lower property values. Recently, capital has been more available, and the overall economy has improved. However, the failure of a sustained economic

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recovery or future disruptions in the financial markets and deteriorating economic conditions could impact the value of our investments in properties. In addition, if potential purchasers of properties have difficulty obtaining capital to finance property acquisitions, capitalization rates could increase, and property values could decrease. Current economic conditions greatly increase the risks of our investments. See Risks Related to Investments in Real Estate below.

We report FFO and AFFO, each of which is a non-GAAP financial measure.

We report FFO and AFFO, each of which is a non-GAAP financial measure, which we believe to be appropriate supplemental measures to reflect our operating performance.

Not all REITs necessarily calculate FFO and AFFO and other similar measures in the same way, and therefore comparisons of our disclosures of such measures with that of other REITs may not be meaningful. FFO and AFFO should not be considered as an alternative to net income as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs, including our ability to make distributions to our stockholders. FFO and AFFO should be reviewed in conjunction with GAAP measurements as an indication of our performance. We have provided a reconciliation of these measures to net income, which we believe to be the most comparable GAAP measure, in the caption Net Income and Non-GAAP Measures (FFO and AFFO) in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.

Neither the SEC nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO and AFFO. In the future, the SEC or another regulatory body may decide to standardize the allowable adjustments across the REIT industry and in response to such standardization we may have to adjust our calculation and characterization of FFO and AFFO accordingly.

Risks Related to Our Organizational Structure

Maryland law and our organizational documents limit the rights of our stockholders to bring claims against our officers and directors.

Maryland law provides that a director of a Maryland corporation will not have any liability in that capacity if he or she performs his or her duties in accordance with the applicable standard of conduct. In addition, our Articles of Incorporation provide that, subject to the applicable limitations set forth therein or under Maryland law, no director or officer will be liable to us or our stockholders for monetary damages. Our Articles of Incorporation also provide that we will generally indemnify and advance expenses to our directors, our officers, and our Asset Manager and its affiliates for losses they may incur by reason of their service in those capacities subject to any limitations under Maryland law or in our Articles of Incorporation. Moreover, we have entered into separate indemnification agreements with each of our directors and executive officers. As a result, we and our stockholders may have more limited rights against these persons than might otherwise exist under common law, which could reduce our stockholders’ and our recovery against such persons. In addition, we may be obligated to fund the defense costs incurred by these persons in some cases, which would reduce the cash available for distributions. We have purchased insurance under a policy that insures both us and our officers and directors against exposure and liability normally insured against under such policies, including exposure on the indemnities described above.

The limit on the number of shares of our common stock a person may own may discourage a takeover or business combination that could otherwise result in a premium price to our stockholders.

Our Articles of Incorporation authorize our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Our Articles of Incorporation restrict the direct or indirect ownership by one person or entity to no more than 9.8% of the value of our then outstanding shares of capital stock (which includes common stock and any preferred stock we may issue) and no more than 9.8% of the value or number of shares, whichever is more restrictive, of our then outstanding common stock unless exempted by our board of directors. This restriction may discourage a change of control of us and may deter individuals or entities from making tender offers for shares of our common stock on terms that might be financially attractive to stockholders or which may cause a change in our management. In addition to deterring potential transactions that may be favorable to our stockholders, these provisions may also decrease our stockholders’ ability to sell their shares of our common stock.

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We may issue preferred stock or separate classes or series of common stock, the issuance of which could adversely affect the holders of our common stock.

Our Articles of Incorporation authorize us to issue up to 100,000,000 shares of stock, and our board of directors, without any action by our stockholders, may amend our Articles of Incorporation from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series of stock that we have authority to issue. Holders of shares of our common stock do not have preemptive rights to acquire any shares issued by us in the future.

In addition, our board of directors may classify or reclassify any unissued shares of our common stock or preferred stock and establish the preferences, rights and powers of any such stock. As a result, our board of directors could authorize the issuance of preferred stock or separate classes or series of common stock with terms and conditions that could have priority, with respect to distributions and amounts payable upon our liquidation, over the rights of our common stock. The issuance of shares of such preferred or separate classes or series of common stock could dilute the value of an investment in shares of our common stock. The issuance of shares of preferred stock or a separate class or series of common stock could also have the effect of delaying, discouraging, or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock.

The Independent Directors Committee may change our investment policies without stockholder approval, which could alter the nature of an investment in us.

The methods of implementing our investment policies and strategy may vary as new real estate development trends emerge, new investment techniques are developed, and market conditions evolve. Our investment policies, the methods for their implementation, and our other objectives, policies, and procedures may be altered by the Independent Directors Committee without the approval of our stockholders. As a result, the nature of an investment in us could change without the consent of our stockholders.

Our UPREIT structure may result in potential conflicts of interest with members in the Operating Company whose interests may not be aligned with those of our stockholders.

We use an UPREIT structure because a contribution of property directly to us, rather than the Operating Company, is generally a taxable transaction to the contributing property owner. In the UPREIT structure, a contributor of a property may transfer the property to the Operating Company in exchange for membership units and defer taxation of a gain until the contributor later disposes of or exchanges its membership units for shares of our common stock. We believe that using an UPREIT structure gives us an advantage in acquiring desired properties from persons who may not otherwise sell their properties because of unfavorable tax results.

We may issue membership units of the Operating Company in connection with certain transactions. Members in the Operating Company have the right to vote on certain amendments to the limited liability company agreement of the Operating Company, as well as on certain other matters. Persons holding such voting rights may exercise them in a manner that conflicts with the interests of our stockholders. As the managing member of the Operating Company, we are obligated to act in a manner that is in the best interest of all members of the Operating Company. Circumstances may arise in the future when the interests of members in the Operating Company may conflict with the interests of our stockholders. These conflicts may be resolved in a manner stockholders do not believe is in their best interest.

The value of an investment in our common stock may be reduced if we are required to register as an investment company under the Investment Company Act, and if we are subject to registration under the Investment Company Act, we will not be able to continue our business.

Neither we, the Operating Company, nor any of our subsidiaries intend to register as an investment company under the Investment Company Act. The Operating Company’s and subsidiaries’ investments in real estate will represent the substantial majority of our total asset mix. In order for us not to be subject to regulation under the Investment Company Act, we engage, through the Operating Company and our wholly and majority-owned subsidiaries, primarily in the business of buying real estate.

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If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act that impose, among other things:

 

limitations on capital structure;

 

restrictions on specified investments;

 

prohibitions on transactions with affiliates; and

 

compliance with reporting, record keeping, voting, proxy disclosure, and other rules and regulations that would significantly change our operations and significantly increase our operating expenses.

Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities. Section 3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.

We expect that most of our assets will be held through wholly or majority-owned subsidiaries of the Operating Company. We believe that we, the Operating Company, and most of the subsidiaries of the Operating Company will not fall within either definition of investment company under Section 3(a)(1) of the Investment Company Act as we intend to invest primarily in real property, through our wholly or majority-owned subsidiaries, which we expect to have at least 60% of their assets in real property. As these subsidiaries would be investing either solely or primarily in real property, they would be outside of the definition of “investment company” under Section 3(a)(1) of the Investment Company Act. We are organized as a holding company that conducts its businesses primarily through the Operating Company, which in turn is a holding company conducting its business through its subsidiaries. Both we and the Operating Company intend to conduct our operations so that they comply with the 40% test. We will monitor our holdings to ensure continuing and ongoing compliance with this test. In addition, we believe that neither we nor the Operating Company will be considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because neither we nor the Operating Company will engage primarily or hold itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through the Operating Company’s wholly owned or majority-owned subsidiaries, we and the Operating Company will be primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring real property.

To ensure that neither we nor any of our subsidiaries, including the Operating Company, are required to register as an investment company, each entity may be unable to sell assets that it would otherwise want to sell and may need to sell assets that it would otherwise wish to retain. In addition, we, the Operating Company or our subsidiaries may be required to acquire additional income- or loss-generating assets that we might not otherwise acquire or forego opportunities to acquire interests in companies that we would otherwise want to acquire. Although we, the Operating Company and our subsidiaries intend to monitor our portfolio periodically and prior to each acquisition and disposition, any of these entities may not be able to remain outside the definition of investment company or maintain an exclusion from the definition of investment company. If we, the Operating Company or our subsidiaries are required to register as an investment company but fail to do so, the unregistered entity would be prohibited from engaging in our business, and criminal and civil actions could be brought against such entity. In addition, the contracts of such entity would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of the entity and liquidate its business.

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Risks Related To Conflicts of Interest

The officers and employees of the Manager and its affiliates face competing demands relating to their time, which may cause our operating results to suffer.

The officers and employees of the Manager and the Asset Manager are not prohibited from raising money for, or managing, other investment entities, or from engaging in business activities and investments unrelated to us. As a result, these persons may have competing demands on their time and resources and they may face conflicts of interest in allocating their time between our business and these other activities. During times of intense activity in other programs and ventures, they may devote less time and fewer resources to our business than is necessary or appropriate. If this occurs, the returns on an investment in our company may suffer.

The Manager and Asset Manager currently sponsor and provide services to (a) Broadtree Residential, Inc., a private multifamily apartment REIT with approximately $145 million in investments in a portfolio of income-producing multifamily apartment communities as of December 31, 2017, and (b) Broadstone Real Estate Access Fund, Inc., a continuously offered, non-diversified, closed-end management investment company that is operated as an interval fund with approximately $31 million in investments as of December 31, 2017. As of December 31, 2017, the Manager employed approximately 38 individuals who dedicate time to Broadstone Net Lease, Inc., Broadtree Residential, Inc., and Broadstone Real Estate Access Fund, Inc. The Manager and Asset Manager may sponsor and provide services to additional entities in the future.

Our officers and certain of our directors face conflicts of interest related to the positions they hold with affiliated entities, which could hinder our ability to successfully implement our business strategy and to generate returns for our investors.

Our executive officers and affiliated directors are also officers and managers of, and in some cases equity investors in, our Manager and other affiliated entities. Most significantly, Amy L. Tait, our Executive Chairman of the board of directors and Chief Investment Officer, serves as an executive officer of the Manager, is a member of the Manager’s board of managers, and as of December 31, 2017, owns, together with Tait family trusts and an investment entity for the families of Ms. Tait and the late Norman Leenhouts, an approximately 44.44% equity ownership interest in the Manager; and Christopher J. Czarnecki, our Chief Executive Officer and a member of our board of directors, is an executive officer of the Manager and a member of the Manager’s board of managers. Mr. Czarnecki and our other executive officers also own membership interests in the Manager. All of our executive officers are officers of the Manager and, in certain circumstances, other affiliated entities.

As a result, these individuals owe fiduciary duties to the Manager and other affiliated entities, which may conflict with the duties that they owe to us and our stockholders. Their responsibilities to these other entities could result in actions or inactions that are detrimental to our business, which could harm the implementation of our business strategy and our investment and leasing opportunities. If we do not successfully implement our business strategy, we may be unable to generate cash needed to make distributions to our stockholders and to maintain or increase the value of our assets.

The Manager and the Asset Manager and their respective affiliates, including some of our directors and officers, face conflicts of interest relating to our compensation arrangements with the Manager and the Asset Manager, which could result in actions that are not in the best interests of our stockholders.

Pursuant to the Restated Management Contracts, the Asset Manager and the Manager receive substantial fees from us in return for their services. These compensation arrangements could influence the advice and services provided to us by the Asset Manager and the Manager and present potential conflicts of interest for the officers, employees, and equity owners of the Manager and Asset Manager who also serve as our directors and officers.

Pursuant to the Asset Management Agreement, the Asset Manager is entitled to receive substantial compensation regardless of our performance or the quality of the services provided to us. As a result, the Asset Manager’s interests may not be wholly aligned with those of our stockholders. Our Asset Manager could be motivated to raise equity above and beyond our ability to prudently deploy such capital into accretive investments in order to generate higher annual asset management fees. Further, the acquisition fees and disposition fees payable by us to the Asset Manager may incentivize the Asset Manager to recommend or pursue property acquisitions or dispositions that it would otherwise not recommend or pursue, or upon different terms than it would otherwise find acceptable, if it was not entitled to such fees.

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Pursuant to the Property Management Agreement, the Manager is entitled to receive a property management fee based on the gross rentals payable by the tenants in our properties regardless of the properties’ quality, our overall financial performance, or the quality of the services provided to us by the Manager. As a result, our Manager’s interests may not be wholly aligned with those of our stockholders. The management fees paid to the Manager could also incentivize the Asset Manager to recommend or pursue property acquisitions that it would otherwise not recommend or pursue, or upon different terms than it would otherwise find acceptable, if the Manager was not entitled to such fees.

For additional information regarding these compensation arrangements, see Item 13. “Certain Relationships and Related Transactions, and Director Independence” of this Form 10-K.

The Asset Manager and Manager are entitled to significant termination fees in the event that we terminate the Asset Management Agreement or Property Management Agreement.

Pursuant to the Restated Management Contracts, in the event that we terminate the Asset Management Agreement or the Property Management Agreement other than for “cause” (as defined in the Asset Management Agreement and the Property Management Agreement), we are required to pay the Asset Manager or the Manager, as applicable, a significant termination fee. The termination fee payable pursuant to the Asset Management Agreement is equal to three times the asset management fee to which the Asset Manager was entitled during the 12-month period immediately preceding the date of the termination. The termination fee payable pursuant to the Property Management Agreement is equal to three times the property management fee to which the Manager was entitled during the 12-month period immediately preceding the date of the termination. In addition, the Asset Management Agreement provides that the Asset Manager is entitled to receive a disposition event fee equal to 1.0% of the aggregate consideration (as defined in the Asset Management Agreement) received in connection with the sale of our company. The existence of these fees may create conflicts of interest with respect to the termination of the Asset Management Agreement and the Property Management Agreement, or a sale of our company.

Trident BRE holds a significant ownership interest in the Manager, has the power to appoint two members of the board of managers of the Manager, and employs one of the non-independent members of our board of directors. Trident BRE’s interests may not be fully aligned with those of our other stockholders.

As of December 31, 2017, Trident BRE holds an approximate 44.44% equity ownership interest in the Manager, and has the power to appoint two of the four members of the board of managers of the Manager. In addition, Agha Khan, one of the two non-independent members of our board of directors designated by the Asset Manager, is an employee of Stone Point Capital LLC, an affiliate of Trident BRE. The other member of the board of managers of the Manager appointed by Trident BRE and Mr. Khan owe duties to Stone Point Capital LLC and Trident BRE and their affiliates in addition to their duties to the Manager and us, and may face conflicts of interests as a result. Trident BRE may influence the manner in which our Asset Manager (a wholly owned subsidiary of the Manager) seeks to acquire or dispose of properties or otherwise performs its duties under the Asset Management Agreement or cause the Manager or its affiliates to take on new activities unrelated to our business.

Risks Related to Investments in Real Estate

Our operating results are affected by economic and regulatory changes that impact the real estate market in general.

Our investments in real properties are subject to risks generally attributable to the ownership of real property, including:

 

changes in global, national, regional, or local economic, demographic, or real estate market conditions;

 

changes in supply of or demand for similar properties in an area;

 

increased competition for real property investments targeted by our investment strategy;

 

bankruptcies, financial difficulties, or lease defaults by tenants;

 

changes in interest rates and availability of financing;

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changes in the terms of available financing, including more conservative loan-to-value requirements and shorter debt maturities;

 

competition from other properties;

 

the inability or unwillingness of tenants to pay rent increases;

 

changes in government rules, regulations, and fiscal policies, including changes in tax, real estate, environmental, and zoning laws;

 

changes in the prices of fuel and energy consumption, cost of labor and material, and water and environmental restrictions, which may affect the businesses of tenants and their ability to meet their lease payments;

 

inability to lease properties upon termination of existing leases and renewal of leases at lower rental rates;

 

uninsured property liability and property damage or casualty losses;

 

unexpected expenditures for capital improvements, including requirements to bring properties into compliance with applicable federal, state and local laws;

 

physical or weather-related damage to properties;

 

the potential risk of functional obsolescence of properties over time;

 

acts of terrorism and war; and

 

acts of God and other factors beyond our control.

All of these factors are beyond our control. Any negative changes in these factors could affect our ability to meet our obligations and make distributions to stockholders.

We are unable to predict future changes in global, national, regional, or local economic, demographic, or real estate market conditions. For example, a recession or rise in interest rates could make it more difficult for us to lease or dispose of properties and could make alternative interest-bearing and other investments more attractive and therefore potentially lower the relative value of the real estate assets we acquire. These conditions, or others we cannot predict, may adversely affect our results of operations and returns to our stockholders. In addition, the value of the properties we acquire may decrease following the date we acquire such properties due to the risks described above or any other unforeseen changes in market conditions. If the value of our properties decreases, we may be forced to dispose of our properties at a price lower than the price we paid to acquire our properties, which could adversely impact the results of our operations and our ability to make distributions and return capital to our investors.

We face competition for the purchase and financing of properties from entities with substantially more capital at their disposal that may cause us to have difficulty finding or maintaining properties that generate favorable returns.

We compete with many other entities engaged in real estate investment activities, including other REITs, specialty finance companies, savings and loan associations, sovereign wealth funds, banks, mortgage bankers, insurance companies, institutional investors, investment banking firms, lenders, governmental bodies, and other entities, many of which have greater resources than we do. Larger REITs may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. Further, the rental rates that we are able to receive on the properties we purchase depend substantially upon the presence of competition from these other property purchasers and, to a certain extent, upon the availability of mortgage financing at similar rates that would allow a tenant to own its property. The availability of these alternative purchasers or sources of financing at lower rates has periodically caused competition for attractive properties and caused reduction in market rental rates, both of which could diminish returns to our investors.

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A concentration of our investments in a certain state or geographic regions may leave our profitability vulnerable to a downturn or slowdown in state or region.

Our current Investment Policy provides that we may not invest more than 10% of the aggregate cost of our portfolio in properties located in any single metropolitan statistical area or more than 20% of the aggregate cost of our portfolio in properties located in any single state. However, if our Investment Policy was amended or for some other reason our investments became concentrated in a particular state or geographic region, and such state or geographic region experiences economic difficulty disproportionate to the nation as a whole, then the potential effects on our revenues, and as a result, our cash available for distribution to our stockholders, could be more pronounced than if we had more fully diversified our investments geographically.

A significant portion of our property portfolio’s annual base rent is concentrated in specific industry classifications, tenants and geographic locations.

As of December 31, 2017, approximately 22.8% of the NTM Rent from our property portfolio was generated by tenants in the healthcare industry and approximately 34.2% of the NTM Rent was generated by tenants in the retail industry, of which 22.5% was in the restaurant industry. In recent years a number of companies in the restaurant industry have declared bankruptcy, have gone out of business or have significantly reduced the number of their locations. In particular, we have experienced, and expect to continue to experience, challenges with some of our restaurant tenants, and have recorded immaterial asset impairments on certain assets as a result of increased credit losses.

The ongoing impacts of the disruption in the retail industry, particularly adverse changes in consumer spending and consumer preferences for particular goods, services, or store-based retailing could severely impact retail tenants’ ability to pay rent. Shifts from in-store to online shopping could increase due to changing consumer shopping patterns as well as the increase in consumer adoption and use of mobile electronic devices. This expansion of e-commerce could have an adverse impact on our retail tenants' ongoing viability.

Any economic difficulties or downturns which disproportionately impact such industries could negatively affect market rents, thereby reducing rents payable to us, and they may lead to increased vacancy rates at our properties and diminish our ability to attract and retain tenants. This in turn could have an adverse effect on our results of operations and ability to pay distributions.

We are dependent on our tenants for substantially all of our revenue and our success is materially dependent on the financial stability of our tenants.

Each of our existing properties is occupied by only one master tenant, and as a result our success is dependent on the financial stability of these tenants in the aggregate. Our tenants encounter significant macroeconomic, governmental, and competitive forces. Adverse changes in consumer spending or consumer preferences for particular goods, services, or store-based retailing could severely impact the ability of certain of our tenants to pay rent. The default or financial distress of a tenant on its lease payments may cause us to lose some of the anticipated revenue from the property. Vacancies in properties reduce our revenues, increase property expenses, and could decrease the value of each such vacant property. In the event of a material default under a lease, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and possibly re-letting the property. If a lease is terminated, we cannot assure our investors that the property could be leased for the same amount of rent previously received or that we could sell the property without incurring a loss.

In addition, our ability to increase our revenues and operating income may depend on steady growth of demand for the products and services offered by our tenants. A significant decrease in demand for our tenants’ products and services for any reason could result in a reduction in tenant performance and consequently, adversely affect us.

If a tenant files for bankruptcy, we may be precluded from collecting all sums due to us.

If a tenant, or the guarantor of a lease of a tenant, commences, or has commenced against it, any legal or equitable proceeding under any bankruptcy, insolvency, receivership, or other debtor’s relief statute or law (collectively, a “bankruptcy proceeding”), we may be unable to collect all sums due to us under that tenant’s lease. Any or all of the lease obligations of our tenants, or any guarantor of our tenants, could be subject to a bankruptcy proceeding which may bar our efforts to collect pre-bankruptcy debts from these entities or their properties, unless

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we are able to obtain an enabling order from the bankruptcy court. If our lease is rejected by a tenant in bankruptcy, we may only have a general unsecured claim against the tenant and may not be entitled to any further payments under the lease. A bankruptcy proceeding could hinder or delay our efforts to collect past due balances and ultimately preclude collection of these sums, resulting in a decrease or cessation of rental payments and reducing returns to our investors.

If we are delayed or unable to find suitable investments, we may not be able to achieve our investment objectives and our investors’ returns may be reduced.

We may experience difficulty in finding attractive properties resulting in a delay of investment of the proceeds from our ongoing offering in real estate and reducing our ability to make distributions and, thus, the returns to our investors. Our investors’ returns may be reduced to the extent we are delayed in our selection and acquisition of real estate properties. The proceeds of our ongoing private offering will generally be used to pay down existing advances under the Operating Company’s line of credit or invested at money market rates until such time as it is used to acquire a real estate property. Any proceeds from our ongoing private offering that are ultimately invested by the Operating Company at money market rates will likely produce less income than if such proceeds were immediately invested in real estate properties. As a result, our investors’ returns may be reduced to the extent we are delayed in our selection and acquisition of real estate properties.

Some properties may be suitable for only one use and may be costly to refurbish if a lease is terminated.

The properties we purchase may be designed for a particular type of tenant or tenant use. If a tenant of such property does not renew its occupancy or defaults on its lease, the property might not be marketable without substantial capital improvements. The cost of such improvements may reduce the amount of cash available for distributions to our investors. An attempt to lease or sell the property without such improvements could also result in a lower rent or selling price and may also reduce the amount of cash available for distributions to our investors.

Our real estate investments are illiquid.

Because real estate investments are relatively illiquid, our ability to adjust our portfolio promptly in response to economic or other conditions may be limited. Certain significant expenditures generally do not change in response to economic or other conditions, including: (i) debt service (if any), (ii) real estate taxes, and (iii) operating and maintenance costs. This combination of variable revenue and relatively fixed expenditures may result, under certain market conditions, in reduced earnings and could have an adverse effect on our financial condition.

We may experience difficulty in the sale of a property and could be forced to sell a property at a price that reduces the return to our investors.

The real estate market is affected by many factors that are out of our control, including the availability of financing, interest rates, and other factors, as well as supply and demand for real estate investments. As a result, we cannot predict whether we will be able to sell a property or whether such sale could be made at a favorable price or on terms acceptable to us. We also cannot predict the length of time which will be needed to identify a purchaser or to complete the sale of any property.

We can reinvest proceeds from sales of our properties in replacement properties without our investors’ approval.

We may, from time to time, sell a property and reinvest the proceeds in a replacement property rather than make a distribution to our investors. Our investors will not have a right to the cash received by the Operating Company from the sale of a property and must rely upon the ability of the Asset Manager to find replacement properties in which to reinvest the proceeds.

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Long-term leases may not result in fair market lease rates over time; therefore, our income and our distributions to our stockholders could be lower than if we did not enter into long-term leases.

We generally lease our properties pursuant to long-term leases with terms of 10 or more years, often with extension options. Our long-term leases generally provide for rents to increase over time, due to fixed rent increases or increases based upon increases in the Consumer Price Index or financial metrics related to the tenant. However, if we do not accurately judge the potential for increases in market rental rates, we may set the terms of these long-term leases at levels such that even after contractual rental increases the rent under our long-term leases is less than then-current market rental rates. Further, we may have a limited ability to terminate those leases or to adjust the rent to then-prevailing market rates.

Certain provisions of our leases or loan agreements may be unenforceable.

Our rights and obligations with respect to the leases at our properties, mortgage loans, or other loans are governed by written agreements. A court could determine that one or more provisions of such an agreement are unenforceable, such as a particular remedy, a master lease covenant, a loan prepayment provision, or a provision governing our security interest in the underlying collateral of a borrower or lessee. We could be adversely impacted if this were to happen with respect to an asset or group of assets.

Our costs of compliance with governmental laws and regulations may reduce the investment return of our stockholders.

All real property and the operations conducted on real property are subject to numerous federal, state and local laws and regulations. We cannot predict what laws or regulations will be enacted in the future, how future laws or regulations will be administered or interpreted, or how future laws or regulations will affect us or our properties, including, but not limited to, environmental laws and regulations and the Americans with Disabilities Act of 1990. Compliance with new laws or regulations, or stricter interpretation of existing laws, may require us or our tenants to incur significant expenditures, impose significant liability, restrict or prohibit business activities, and could cause a material adverse effect on our results of operations.

Further, as a reporting company under the Exchange Act, we are required to comply with various reporting requirements, as well as additional laws, rules and regulations, including the Dodd-Frank Act and the Sarbanes-Oxley Act of 2002.  Our efforts to comply with applicable laws and regulations are expected to involve significant, and potentially increasing, costs. In addition, these laws, rules, and regulations create new legal bases for administrative, civil, and criminal proceedings against us in case of non-compliance, thereby increasing our risk of liability and potential sanctions.

We may be subject to known or unknown environmental liabilities and hazardous materials on our properties.

There may be known or unknown environmental liabilities associated with properties we own or acquire in the future. Certain uses of some properties may also have a heightened risk of environmental liability because of the hazardous materials used in performing services on those properties, such as convenience stores with underground petroleum storage tanks or auto parts and auto service businesses using petroleum products, paint, machine solvents, and other hazardous materials. Some properties may contain asbestos or asbestos-containing materials, or may contain or may develop mold or other bio-contaminants. Asbestos-containing materials must be handled, managed, and removed in accordance with applicable governmental laws, rules and regulations. Mold and other bio-contaminants can produce airborne toxins, may cause a variety of health issues in individuals and must be remediated in accordance with applicable governmental laws, rules, and regulations.

The Asset Manager undertakes customary environmental diligence prior to our acquisition of any property. As a current or previous owner of a real estate property, however, we may be required to remove or remediate hazardous or toxic substances on, under, or in such property under various federal, state, and local environmental laws, ordinances, and regulations. These laws may impose liability whether or not the Operating Company knew of, or was responsible for, the presence of such hazardous or toxic substances. Our use and operation of a property may also be restricted by environmental laws or require certain expenditures. Failure to comply with environmental laws may result in sanctions by governmental agencies or liability to third parties. The cost of compliance or defense against claims from a contaminated property will likely affect our results of operations and ability to make distributions.

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Although our leases generally require our tenants to operate in compliance with all applicable federal, state, and local environmental laws, ordinances, and regulations, and to indemnify us against any environmental liabilities arising from the tenants’ activities on the property, we could nevertheless be subject to liability, including strict liability, by virtue of our ownership interest. There also can be no assurance that our tenants, or the guarantor of a lease, could or would satisfy their indemnification obligations under their leases.

Natural disasters and other events beyond our control could impact our properties and operations and the insurance purchased for our properties might not be adequate to cover losses we incur.

Natural disasters or other catastrophic events (e.g., hurricanes, floods, earthquakes, or other types of natural disasters or wars or other acts of violence) may cause damage or disruption to our operations and damage to our properties.  We own properties in regions that have historically been impacted by such natural disasters and it is probable such regions will continue to be impacted by such events.  Although the Manager arranges for, or will require tenants to maintain, comprehensive insurance coverage on our properties, some catastrophic types of losses from such events may be either uninsurable or not economically insurable. If a disaster occurs, we could suffer a complete loss of capital invested in, and any profits expected from, the affected properties.  If uninsured damages to a property occur or a loss exceeds policy limits and we do not have adequate cash to fund repairs, we may be forced to sell the property at a loss or to borrow capital to fund the repairs.

Risks Related to Debt Financing

Our business strategy relies on external financing and, as a result, we may be negatively affected by restrictions on additional borrowings and are subject to the risks associated with leverage, including our debt service obligations.

We use leverage so that we may make more investments than would otherwise be possible in order to maximize potential returns to stockholders. We have been gradually reducing our overall leverage over the past few years, particularly in light of the Operating Company’s receiving an investment grade credit rating, but we still maintain a significant amount of debt, and may increase our debt going forward. Our ability to achieve our investment objectives will be affected by our ability to borrow money in sufficient amounts and on favorable terms. In addition, we may be unable to obtain the degree of leverage we believe to be optimal, which may cause us to have less cash for distribution to stockholders than we would have with an optimal amount of leverage.

We have incurred, and intend to incur in the future, unsecured borrowings and mortgage indebtedness, which may increase our business risks, could hinder our ability to make distributions, and could decrease the value of an investment in our shares.

We have incurred, and plan to incur in the future, financing through unsecured borrowings under term loans and our revolving line of credit and mortgage loans secured by some or all of our real properties. In some cases, the mortgage loans we incur are guaranteed by us, the Operating Company, or both. We may also borrow funds if necessary to satisfy the requirement that we distribute to stockholders as dividends at least 90% of our annual REIT taxable income, or otherwise as is necessary or advisable to assure that we maintain our qualification as a REIT for federal income tax purposes. Our current Leverage Policy targets a leverage ratio equal to 35% to 45% of the approximate market value of our assets. The actual leverage ratio will vary over time but may not exceed 50% without the approval of the Independent Directors Committee. Depending on market conditions and other factors, the Independent Directors Committee may change our Leverage Policy from time to time in its discretion.

We may incur mortgage debt on a particular property, especially if we believe the property’s projected cash flow is sufficient to service the mortgage debt. If there is a shortfall in cash flow, however, then the amount available for distributions to our stockholders may be affected. In addition, incurring mortgage debt may increase the risk of loss since defaults on indebtedness secured by a property may result in foreclosure actions initiated by lenders and our loss of the property securing the loan that is in default. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure but would not receive any of the proceeds. We may give full or partial guarantees to lenders to the Operating Company or its affiliates. If we give a guaranty on behalf of the Operating Company, we will be responsible to the lender for satisfaction of the debt if it is not paid by the Operating Company. If any mortgages contain cross-collateralization or cross-default provisions, there is a risk that more than one of our real properties may be affected by a default. If any of our properties are foreclosed upon due to a default, our results of operations and ability to pay distributions to our stockholders may be adversely affected.

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Our line of credit and term loan agreements contain various covenants which, if not complied with, could accelerate our repayment obligations, thereby materially and adversely affecting our liquidity, financial condition, results of operations, and ability to pay distributions to stockholders.

We are subject to various financial and operational covenants and financial reporting requirements pursuant to the agreements we have entered into governing our line of credit, term loans and Senior Notes. These covenants require us to, among other things, maintain certain financial ratios, including leverage, fixed charge coverage, and debt service coverage, among others. As of December 31, 2017, we were in compliance with all of our loan covenants. Our continued compliance, however, with these covenants depends on many factors, and could be impacted by current or future economic conditions, and thus there are no assurances that we will continue to comply with these covenants. Failure to comply with these covenants would result in a default which, if we were unable to obtain a waiver from the lenders, could accelerate our repayment obligations and thereby have a material adverse impact on our liquidity, financial condition, results of operations and ability to pay distributions to stockholders.

Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make distributions to our stockholders.

We have a significant amount of debt. Although we believe we have effectively hedged the risk of interest rate increases through swaps and the issuance of fixed-rate debt, we will need to refinance our debt in the future. Accordingly, increases in interest rates would increase our interest costs, which could have a material adverse effect on our operating cash flow and ability to pay distributions. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our properties at times which may not permit realization of the maximum or anticipated return on such investments.

An inability to refinance existing mortgage debt as it matures could impact distributions to our stockholders.

Since the mortgage loans secured by certain of our properties amortize over a period longer than their maturity, we will owe substantial amounts of principal on the maturity of such loans. If we cannot refinance these loans on favorable terms, more of our cash from operations may be required to service the loans, properties may have to be sold to fund principal repayments, or properties may be lost to foreclosure. This could adversely affect our results of operations and reduce cash available for distributions.

Failure to maintain our current credit rating could adversely affect our cost of capital, liquidity, and access to capital markets.

In March of 2016, Moody’s assigned the Operating Company an investment grade credit rating of Baa3 with a stable outlook, which was re-affirmed in March of 2017. As a result of receiving the investment grade credit rating, effective April 1, 2016, the interest rate pricing grids utilized to determine the spread we pay over LIBOR for our unsecured credit facilities changed from being dependent upon our leverage ratio, to being dependent upon our credit rating. The rating is based on a number of factors, including an assessment of our financial strength, portfolio size and diversification, credit and operating metrics, and sustainability of cash flow and earnings. If we are unable to maintain our current credit rating it could adversely affect our cost of capital, liquidity, and access to capital markets. Factors that could negatively impact our credit rating include, but are not limited to: a significant increase in our leverage on a sustained basis; a significant increase in secured debt levels; a significant decline in our unencumbered asset base; and a significant decline in our portfolio diversification.

Disruptions in the financial markets or deteriorating economic conditions could adversely affect our ability to obtain debt financing on attractive terms and impact our acquisitions and dispositions.

In periods when the capital and credit markets experience significant volatility, the amounts, sources, and cost of capital available to us may be adversely affected. We use external financing to refinance indebtedness as it matures and to partially fund our acquisitions. If sufficient sources of external financing are not available to us on cost effective terms, we could be forced to limit our planned business activities or take other actions to fund our business activities and repayment of debt such as selling assets or reducing our cash distributions. To the extent that we are able to, or choose to, access capital at a higher cost than we have experienced in recent years, our earnings and cash flows could be adversely affected. Uncertainty in the credit markets also could negatively impact our ability to make acquisitions, make it more difficult or impossible for us to sell properties, or may adversely affect the price we receive for properties that we do sell, as prospective buyers may experience increased costs of debt financing or difficulties in obtaining debt financing.

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Federal Income Tax Risks

Failure to qualify as a REIT would reduce our net income and the investment return of our stockholders would be adversely affected.

If we fail to qualify as a REIT for any taxable year, we will be subject to federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT status. A loss of our REIT status would reduce distributions to our stockholders due to our additional tax liability. In addition, distributions to our stockholders would no longer qualify for the dividends-paid deduction, and we would no longer be required to make distributions. If this occurs, we may need to borrow funds or liquidate some of our properties in order to pay the applicable taxes.

Legislative, regulatory or administrative changes could adversely affect us or our stockholders.

Legislative, regulatory or administrative changes could be enacted or promulgated at any time, either prospectively or with retroactive effect, and may adversely affect us or our stockholders.

On December 22, 2017, the tax legislation commonly referred to as the Tax Cuts and Jobs Act was signed into law, generally applying in taxable years beginning after December 31, 2017. The Tax Cuts and Jobs Act makes significant changes to the U.S. federal income tax rules for taxation of individuals and corporations. In the case of individuals, the income tax brackets are adjusted, the top federal income rate is reduced to 37%, special rules reduce taxation of certain income earned through pass-through entities and reduce the top effective rate applicable to ordinary dividends from REITs to 29.6% (through a 20% deduction for ordinary REIT dividends received in combination with the 37% top rate) and various deductions are eliminated or limited, including limiting the deduction for state and local taxes to $10,000 per year. Most of the changes applicable to individuals are temporary and apply only to taxable years beginning after December 31, 2017, and before January 1, 2026. The corporate income tax rate is reduced to 21%. There are only minor changes to the REIT rules (other than the 20% deduction applicable to individuals for ordinary REIT dividends received).

While the changes in the Tax Cuts and Jobs Act generally appear to be favorable with respect to REITs, the extensive changes to non-REIT provisions in the Code may have unanticipated effects on us, our stockholders, or our tenants. Moreover, Congressional leaders have recognized that the process of adopting extensive tax legislation in a short amount of time without hearings and substantial time for review is likely to have led to drafting errors, issues needing clarification and unintended consequences that will have to be revisited in subsequent tax legislation. At this point, it is not clear if or when Congress will address these issues or when the IRS will issue administrative guidance on the changes made in the Tax Cuts and Jobs Act.

Our stockholders and prospective investors are urged to consult with their own tax advisors with respect to the Tax Cuts and Jobs Act and the status of other legislative, regulatory, or administrative developments and proposals and their potential effect on an investment in shares of our common stock.

Recharacterization of sale-leaseback transactions may cause us to lose our REIT status, which would reduce the investment return of our stockholders.

We may purchase properties and lease them back to the sellers of such properties. If the IRS were to challenge our characterization of such transaction as a “true-lease” and recharacterize the transaction as a financing transaction or loan for federal income tax purposes, deductions for depreciation and cost recovery relating to such property would be disallowed. If a sale-leaseback transaction is recharacterized, we may fail to satisfy the REIT qualification asset tests or income tests and, consequently, lose our REIT status. Alternatively, the amount of our REIT taxable income could be recalculated, which might also cause us to fail to meet the distribution requirements for a taxable year.

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Our stockholders may have current tax liability on distributions based on an election to reinvest in our common stock.

A stockholder who participates in our distribution reinvestment plan will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. As a result, unless a stockholder is a tax-exempt entity, the investor may have to use funds from other sources to pay the investor’s tax liability on the value of the shares of common stock received.

Even if we qualify as a REIT for federal income tax purposes, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to our stockholders.

Even if we remain qualified as a REIT for federal income tax purposes, we may still be subject to federal, state, and local taxes on our income or property. For example:

 

In order to qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income to our stockholders (which is determined without regard to the dividends-paid deduction and excludes net capital gain), and to the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on the undistributed income.

 

We will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income, and 100% of our undistributed income from prior years.

 

If we have net income from the sale of foreclosure property that we hold or acquire primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, we must pay a tax on that income at the highest corporate income tax rate.

 

If we sell a property, other than foreclosure property, that we hold or acquire primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax.

 

We may perform additional, non-customary services for tenants of our buildings through a taxable REIT subsidiary, including real estate or non-real estate related services; however, any earnings that exceed allowable limits related to such services are subject to federal and state income taxes.

To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions to make distributions to our stockholders, which could increase our operating costs and decrease the value of our stockholders’ investment.

To qualify as a REIT, we must distribute to our stockholders each year 90% of our REIT taxable income (which is determined without regard to the dividends-paid deduction and excludes net capital gain). At times, we may not have sufficient funds to satisfy these distribution requirements and may need to borrow funds to maintain our REIT status and avoid the payment of income and excise taxes. These borrowing needs could result from (i) differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes; (ii) the effect of non-deductible capital expenditures; (iii) the creation of reserves; or (iv) required debt or amortization payments. We may need to borrow funds at times when market conditions are unfavorable. Such borrowings could increase our costs and reduce the value of our common stock.

To maintain our REIT status, we may be forced to forego otherwise attractive opportunities, which could delay or hinder our ability to meet our investment objectives and lower the return on an investment in us.

To qualify as a REIT, we must satisfy tests on an ongoing basis concerning, among other things, the sources of our income, nature of our assets, and the amounts we distribute to our stockholders. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.

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In certain circumstances, we may be liable for certain tax obligations of certain of the members of the Operating Company.

In certain circumstances, we may be liable for tax obligations of certain of the members of the Operating Company. In connection with certain UPREIT transactions, we have entered into tax protection agreements under which we have agreed to minimize the tax consequences to members of the Operating Company resulting from the sale or other disposition of our assets in taxable transactions, with specific exceptions and limitations. Pursuant to the tax protection agreements we have also agreed to ensure that such members of the Operating Company are allocated minimum amounts of the Operating Company’s indebtedness. If we fail to meet our obligations under the tax protection agreements, we may be required to reimburse those members of the Operating Company for the amount of the tax liabilities they incur, subject to certain limitations. We may enter into additional tax protection agreements in the future in connection with other UPREIT transactions. In order to limit our exposure to a tax obligation, our use of proceeds from any sales or dispositions of certain properties will be limited. In addition, the indemnification obligations may be significant.

New partnership audit rules could increase the tax liability borne by us in the event of a U.S. federal income tax audit of a subsidiary partnership.

New partnership audit rules apply to partnership taxable years beginning after December 31, 2017, and may alter who bears the liability in the event any subsidiary partnership is audited and an adjustment is assessed. Under the new rules, the partnership itself may be liable for a hypothetical increase in partner-level taxes (including interest and penalties) resulting from an adjustment of partnership tax items on audit, regardless of changes in the composition of the partners (or their relative ownership of the partnership) between the year under audit and the year of the adjustment. The new rules also include an elective alternative method under which the additional taxes resulting from the adjustment are assessed from the affected partners, subject to a higher rate of interest than otherwise would apply. Many questions remain as to how the new rules will apply, in particular with respect to partners that are REITs, and it is not clear at this time what effect these new rules will have on us. However, these rules could increase the U.S. federal income taxes, interest and penalties otherwise borne by us in the event of a U.S. federal income tax audit of a subsidiary partnership.

Item 1B.

Unresolved Staff Comments.

There are no unresolved staff comments.

Item 2.

Properties.

Please refer to Item 1. “Business” of this Form 10-K for information concerning our properties.

Item 3.

Legal Proceedings.

We are subject to various legal proceedings and claims that arise in the ordinary course of our business. These matters are generally covered by insurance or are subject to our right to be indemnified by our tenants that we include in our leases. Management is not aware of any material pending legal proceedings to which we or any of our subsidiaries are a party or to which any of our property is subject, nor are we aware of any such legal proceedings contemplated by government agencies.

Item 4.

Mine Safety Disclosures.

None

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Part II.

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

There is no established public trading market for our shares of common stock and we do not expect a public trading market to develop. There are no issued or outstanding options or warrants to purchase our common stock. Each outstanding membership unit of the Operating Company is convertible into one share of our common stock, subject to certain conditions and limitations. As of March 1, 2018, there were 19,377,844 shares of our common stock issued and outstanding and 1,551,458 non-controlling membership units in the Operating Company issued and outstanding. We have not agreed to register for sale under the Securities Act any shares of our common stock. No shares of our common stock have been or are currently expected to be publicly offered by us.

Stockholders

As of March 1, 2018, there were 2,717 holders of shares of our common stock.

Determined Share Value

Our shares of common stock are sold by us in our ongoing private offering at a price equal to the Determined Share Value, which is established quarterly by the Independent Directors Committee based on the NAV of our portfolio, input from management and third-party consultants, and such other factors as the Independent Directors Committee may determine. The Independent Directors Committee bears sole responsibility for establishing the Determined Share Value. Our determination of NAV applies valuation definitions and methodologies prescribed by Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, in order to fair value our net assets. Our net assets are primarily comprised of our investment in rental property and debt. Other assets and liabilities included in our net asset valuation include cash, interest rate swaps, and accounts payable, among others, and excludes intangible assets and liabilities. Members of our senior executive, portfolio management, accounting, and finance teams are responsible for performing the valuation process and computing the NAV. The Independent Directors Committee is responsible for overseeing the valuation process for the purpose of maintaining independence from conflicts of interest with the management group that determines NAV and who are employed by the Manager. To assist in assessing management’s calculation of the NAV and the valuation of the investment in rental property in the determination of the Determined Share Value by the Independent Directors Committee, we engage a third-party valuation specialist to provide: (i) a high-level/negative assurance review of management’s quarterly portfolio valuation and estimated NAV calculation, which currently occurs as of the end of each of the first, second, and fourth quarters of each calendar year, (ii) a review of individual property appraisals, which are completed for each property on a rolling two-year basis, and (iii) a full positive assurance valuation and review of the portfolio, which currently occurs during the third quarter of each calendar year. The third-party valuation specialist is not responsible for determining the NAV. The positive and negative assurance provided by the third-party valuation specialist has generally found that the NAVs used to establish the Determined Share Values by the Independent Directors Committee have been reasonable and within market parameters.

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The Determined Share Value is reviewed and determined on a quarterly basis by the Independent Directors Committee. The Determined Share Value at any given point in time will be based on the NAV as of a historical balance sheet date. The following table presents our Determined Share Value for each of the past two years, together with the corresponding NAV as of the preceding quarter-end:

 

Period

 

NAV as of

 

Determined

Share Value

 

 

NAV per

share

 

February 1, 2018 – April 30, 2018

 

December 31, 2017

 

$

81.00

 

 

$

81.40

 

November 1, 2017 – January 31, 2018

 

September 30, 2017

 

$

81.00

 

 

$

80.55

 

August 1, 2017 – October 31, 2017

 

June 30, 2017

 

$

80.00

 

 

$

79.90

 

May 1, 2017 – July 31, 2017

 

March 31, 2017

 

$

80.00

 

 

$

79.90

 

February 1, 2017 – April 30, 2017

 

December 31, 2016

 

$

79.00

 

 

$

79.28

 

November 1, 2016 – January 31, 2017

 

September 30, 2016

 

$

77.00

 

 

$

77.40

 

August 1, 2016 – October 31, 2016

 

June 30, 2016

 

$

77.00

 

 

$

76.52

 

May 1, 2016 – July 31, 2016

 

March 31, 2016

 

$

74.00

 

 

$

73.30

 

February 1, 2016 – April 30, 2016

 

December 31, 2015

 

$

74.00

 

 

$

74.09

 

 

The Determined Share Value is applied to outstanding shares prospectively, and is used for purchases, distribution reinvestment, and redemptions. Adjustments to the NAV in arriving at the Determined Share Value are typically the result of the Independent Directors Committee’s understanding of current market conditions and review of assumptions used to value net assets by management in arriving at the NAV. The adjustments do not follow a systematic methodology, but instead allow the Independent Directors Committee to use judgment in determining whether temporary market fluctuations are indicative of changes in core real estate values.

The adjustments to NAV per share in arriving at the Determined Share Value for the periods presented above account for the inherent imprecision in the valuation estimates. In May of 2018, the Independent Directors Committee will review the NAV calculations as of March 31, 2018, and will assess whether adjustments to the current Determined Share Value of $81.00 are appropriate.

The fair value of our investment in rental property is performed using the market approach, whereby we assign an implied market capitalization rate to derive the property valuations. Individual property valuations are calculated by dividing the contractual rental payments over the next 12 months by the implied market capitalization rate. The market capitalization rate assumption reflects our analysis of what a market participant would be willing to pay for a property given the contractual monthly rental payments, third-party appraisals, and an analysis of a tenant’s creditworthiness, among other factors. We deem this methodology to be appropriate based on the triple-net nature of our leases, whereby the tenants are responsible for the maintenance, insurance, and property taxes associated with the properties they lease from us. The triple-net leases provide predictable cash flows, which we then apply against the market capitalization rates. This methodology is consistent with the valuation techniques used to determine the aggregate purchase price of acquisitions. As our acquisition targets are fully-occupied, single-tenant, net leased properties, we do not anticipate paying for material capital expenditures, and therefore, exclude such expenditures from our valuations.

The following table provides a breakdown of the major components of our estimated NAV and NAV per share amounts as of December 31, 2017, and 2016 (in thousands, except per share amounts):

 

NAV as of:

 

December 31,

2017

 

 

December 31,

2016

 

Investment in rental property

 

$

2,840,941

 

 

$

2,166,888

 

Debt

 

 

(1,173,219

)

 

 

(872,969

)

Other assets and liabilities, net

 

 

(2,256

)

 

 

20,945

 

NAV

 

$

1,665,466

 

 

$

1,314,864

 

Number of outstanding shares, including

   noncontrolling interests

 

 

20,461

 

 

 

16,586

 

NAV per share

 

$

81.40

 

 

$

79.28

 

38


The following table details the implied market capitalization rates (shown on a weighted average basis) used to value the investment in rental property, by property type, as of December 31, 2017 and 2016, supporting the Determined Share Value in effect for the periods of February 1, 2018 through April 30, 2018, and February 1, 2017 through April 30, 2017, respectively:

 

Market capitalization rates, as of:

 

Retail

 

 

Industrial

 

 

Healthcare

 

 

Office

 

 

Other

 

 

Portfolio

Total

 

December 31, 2017

 

 

6.38

%

 

 

6.97

%

 

 

6.94

%

 

 

7.08

%

 

 

7.26

%

 

 

6.77

%

December 31, 2016

 

 

6.23

%

 

 

6.97

%

 

 

6.83

%

 

 

6.88

%

 

 

7.48

%

 

 

6.68

%

 

While we believe our assumptions are reasonable, a change in these assumptions would impact the calculation of the value of our real estate investments. For example, assuming all other factors remain unchanged, an increase in the weighted average implied market capitalization rate used as of December 31, 2017, of 0.25% would result in a decrease in the fair value of our investment in rental property of 3.6%, and our NAV per share would have been $76.45. Conversely, a decrease in the weighted average implied capitalization rate used as of December 31, 2017, of 0.25% would result in an increase in the fair value of our investment in rental property of 3.8%, and our NAV per share would have been $86.73. Assuming all other factors remain unchanged, an increase in the weighted average implied market capitalization rate used as of December 31, 2016, of 0.25% would result in a decrease in the fair value of our investment in rental property of 3.8%, and our NAV per share would have been $74.55. Conversely, a decrease in the weighted average implied capitalization rate used as of December 31, 2016, of 0.25% would result in an increase in the fair value of our investment in rental property of 3.9%, and our NAV per share would have been $84.38.

Our methodology is based upon a number of estimates and assumptions that may not be accurate or complete. Different parties with different assumptions and estimates could derive a different Determined Share Value. Accordingly, we have disclosed the following risk factors relative to our Determined Share Value:

 

There is no public trading market for our common stock and we are not required to effectuate a liquidity event by a certain date or at all, and transfers of shares of our common stock are subject to a number of restrictions. As a result, it will be difficult for our stockholders to sell shares of our common stock and, if they are able to sell their shares, they are likely to sell them at a discount and may not be able to realize the Determined Share Value upon such a sale.

 

Our stockholders are limited in their ability to sell shares of our common stock pursuant to our share redemption program. Our stockholders may not be able to sell any of their shares of our common stock back to us, and if they do sell their shares, they may not receive the price they paid.

 

The Independent Directors Committee establishes the Determined Share Value on a quarterly basis. The Determined Share Value is not directly derived from any independent valuation, nor from the value of the existing property portfolio. Investors should not assume that (i) an investor will ultimately realize distributions per share equal to the Determined Share Value upon liquidation of our assets or if our company were sold, (ii) shares of our common stock would trade at the Determined Share Value on a national securities exchange, or (iii) a third party would offer the Determined Share Value in an arms-length transaction to purchase all or substantially all of the shares of our common stock.

Unregistered Sales of Equity Securities and Use of Proceeds

Sales of Common Stock and Issuance of Membership Units

We commenced our ongoing private offering of shares of our common stock in 2007. The first closing of our private offering occurred on December 31, 2007, and we have conducted additional closings at least once every calendar quarter since then. Currently, we close sales of additional shares of our common stock monthly. In November 2017, we instituted a monthly cap of $15.0 million on new and additional investments in our common stock. The cap does not apply to investments made pursuant to our distribution reinvestment plan, or to equity capital received in connection with UPREIT transactions. The cap was initially effective for the months of November 2017, December 2017, and January 2018. The same cap will be in place for the months of February 2018, March 2018, and April 2018. Shares of our common stock are currently being offered in our private offering at

39


$81.00 per share, provided that the per share offering price may be adjusted quarterly by our Independent Directors Committee based on the Determined Share Value, which is based on input from management and third-party consultants, and such other factors as our Independent Directors Committee may consider. We intend to use substantially all of the net proceeds from our private offering, supplemented with additional borrowings, to continue to invest in additional net leased properties. As of December 31, 2017, there were 18,909,257 shares of our common stock issued and outstanding, and 1,551,457 membership units in the Operating Company issued and outstanding. Each outstanding membership unit in the Operating Company is convertible on a one-for-one basis into shares of our common stock, subject to certain limitations.

The following table provides information regarding the sale of shares of our common stock pursuant to our ongoing private offering during the quarter ended December 31, 2017 (in thousands, except year and Determined Share Value amounts).

 

Month

 

Year

 

Common

Shares

Sold

 

 

Determined

Share

Value –

Common

Shares(1)

 

 

Total

Proceeds –

Common

Shares Sold

 

 

Common

Shares

DRIP

 

 

Determined

Share

Value –

DRIP(2)

 

 

Total

Proceeds –

Common

Share

DRIP(3)

 

 

Total

Proceeds

 

October

 

2017

 

 

186

 

 

$

80

 

 

$

14,826

 

 

 

46

 

 

 

78

 

 

$

3,618

 

 

$

18,444

 

November

 

2017

 

 

185

 

 

 

81

 

 

 

15,000

 

 

 

47

 

 

 

78

 

 

 

3,717

 

 

 

18,717

 

December

 

2017

 

 

158

 

 

 

81

 

 

 

12,715

 

 

 

48

 

 

 

79

 

 

 

3,787

 

 

 

16,502

 

TOTAL

 

 

 

 

529

 

 

 

 

 

 

$

42,541

 

 

 

141

 

 

 

 

 

 

$

11,122

 

 

$

53,663

 

 

(1)

Shares of our common stock are sold in our ongoing private offering at a price per share equal to the then-applicable Determined Share Value.

(2)

DRIP shares are purchased at a discounted price of 98% of the Determined Share Value.

(3)

For common shares reinvested under our DRIP there is no corresponding cash flow from the transaction. Refer to Note 14, “Equity” to the consolidated financial statements included in Item 8. “Financial Statements and Supplementary Data” of this Form 10-K for further discussion.

None of the shares of our common stock set forth in the table above were registered under the Securities Act in reliance upon the exemption from registration under the Securities Act provided by Rule 506(c) under Regulation D promulgated under the Securities Act. All of the shares of our common stock set forth in the table above were sold to persons who represented to us in writing that they qualified as an “accredited investor” as such term is defined by Regulation D promulgated under the Securities Act, and provided us with additional documentation to assist us in verifying such person’s status as accredited investors.

In connection with property acquisitions that are structured as UPREIT transactions, the owner of a property will transfer its interest in the property to the Operating Company in exchange for membership units in the Operating Company. During October 2017, we issued 57,940 membership units in the Operating Company valued at $4.6 million in exchange for property valued at $10.0 million. In conjunction with this transaction, we assumed a mortgage with a principal balance of $5.2 million. There were no other membership unit issuances during the quarter ended December 31, 2017.

None of the membership units in the Operating Company were registered under the Securities Act in reliance upon the exemptions from registration under the Securities Act provided by Rule 506(c) under Regulation D promulgated under the Securities Act and Section 4(a)(2) of the Securities Act. All of the membership units in the Operating Company were sold to persons who represented to us in writing that they qualified as an “accredited investor,” as such term is defined by Regulation D promulgated under the Securities Act, and provided us with additional documentation to assist us in verifying such person’s status as accredited investors, including third-party verification as permitted under Regulation D.

40


Senior Notes

In January 2017, we commenced a private offering of unsecured, fixed-rate, interest-only Senior Notes. The initial offering was for up to $100.0 million in Senior Notes, however, based on oversubscriptions and market demand, we elected to increase the offering and received commitments to purchase an aggregate principal amount of $150.0 million of the Senior Notes. In connection with the offering of the Senior Notes, on March 16, 2017, we and the Operating Company entered into a Note and Guaranty Agreement with each of the purchasers of the Senior Notes. The closing of the issuance of the Senior Notes occurred on April 18, 2017. The Senior Notes were issued by the Operating Company and were guaranteed by us and each of the Operating Company’s subsidiaries that guarantee our bank credit facility and term notes. The Senior Notes were issued at par, bear interest at a rate of 4.84% per annum (priced at 240 basis points above the 10-year U.S. Treasury yield at the time of pricing), and have a 10-year maturity, maturing on April 18, 2027.

The Senior Notes were not registered under the Securities Act in reliance upon the exemptions from registration provided by Section 4(a)(2) of the Securities Act. All of the Senior Notes were sold to persons who represented to us in writing that they qualified as an “accredited investor,” as such term is defined by Regulation D promulgated under the Securities Act.

Except as set forth above, we have not sold any securities which were not registered under the Securities Act during the previous three years.

Distribution and Distribution Reinvestment

Distributions are paid when and as declared by our board of directors. We commenced paying quarterly distributions in May 2008. We commenced paying monthly distributions in June 2014. Distribution payments are expected to be made approximately 15 days after the end of each month to stockholders of record on the record date, which is generally the next-to-the-last business day of the prior month. Subscribers making an investment at an end of month closing will begin to accrue dividends in the subsequent month and, if they are stockholders of record at the end of such month, they will receive initial distributions approximately 15 days after the subsequent month is complete.

We intend to make distributions sufficient to satisfy the requirements for qualification as a REIT for tax purposes. Generally, income distributed as dividends will not be taxable to us under the Internal Revenue Code if we distribute at least 90% of our REIT taxable income. Dividends will be declared at the discretion of our board of directors, but will be guided, in substantial part, by a desire to cause us to comply with the REIT qualification requirements.

At its February 9, 2018, meeting, our board of directors declared monthly distributions of $0.43 per share of our common stock and unit of membership interest in the Operating Company to be paid by us to our stockholders and members of the Operating Company (other than us) of record prior to the end of February, March, and April 2018:

 

Dividend Per

Share/Unit

 

 

Record Date

 

Payment Date

(on or before)

$

0.43

 

 

February 27, 2018

 

March 15, 2018

$

0.43

 

 

March 28, 2018

 

April 13, 2018

$

0.43

 

 

April 27, 2018

 

May 15, 2018

 

Investors may purchase additional shares of our common stock by electing to reinvest their distributions through our distribution reinvestment plan. Pursuant to our distribution reinvestment plan, our stockholders and holders of membership units in the Operating Company (other than us), may elect to have cash distributions reinvested in additional shares of our common stock. Shares of our common stock acquired through our distribution reinvestment plan have the same rights and are subject to the same restrictions on transferability as all other shares of our common stock and are eligible for redemption pursuant to our share redemption program. Our distribution reinvestment plan is administered by the Asset Manager.

All of our stockholders and holders of membership units in the Operating Company that are accredited investors are eligible to participate in our distribution reinvestment plan. We may elect to deny an investor

41


participation in the distribution reinvestment plan if the investor resides in a jurisdiction or foreign country where, in our judgment, the burden or expense of compliance with applicable securities laws makes the investor’s participation impracticable or inadvisable. A stockholder or holder of membership units of the Operating Company may be required to cease participation in our distribution reinvestment plan if the investor no longer meets the suitability standards or cannot make the other investor representations set forth in the then-current subscription agreement with respect to our shares of common stock. Participants in the distribution reinvestment plan must agree to notify us promptly when they no longer meet these standards.

A stockholder or holder of membership units in the Operating Company may elect to participate in our distribution reinvestment plan by completing the appropriate portion of the subscription agreement or other approved enrollment form available from time to time from the Asset Manager. An investor’s participation in the distribution reinvestment plan will begin with the next distribution made after receipt of the investor’s enrollment form. Participants in our distribution reinvestment plan generally are required to have the full amount of their cash distributions with respect to all securities owned by them reinvested pursuant to our distribution reinvestment plan. However, the Asset Manager has the discretion, upon the request of a participant, to accommodate a participant’s request for less than all of the participant’s securities to be subject to participation in our distribution reinvestment plan. An investor may also change the number of shares participating in the dividend reinvestment at any time if the investor completes a new enrollment form or other form provided for that purpose.

Cash distributions will be reinvested in additional shares of common stock pursuant to our distribution reinvestment plan at a per share price equal to 98% of the Determined Share Value as of the applicable distribution date. Fractional shares may be issued pursuant to our distribution reinvestment plan.

If an investor elects to participate in our distribution reinvestment plan and is subject to federal income taxation, the investor will incur a tax liability on an amount equal to the fair value on the relevant distribution date of the shares of our common stock purchased with reinvested distributions, even though the investor has elected not to receive the distributions used to purchase those shares of common stock in cash. We will withhold estimated taxes on the amount of distributions or distributions paid if the investor fails to furnish a valid taxpayer identification number, fails to properly report distributions or fails to certify that the investor is not subject to withholding. Notwithstanding the foregoing, the tax consequences of participating in our distribution reinvestment plan will vary depending upon each participant’s particular circumstances, and all participants are urged to consult their own tax advisor regarding the specific tax consequences of participation.

Participation in our distribution reinvestment plan may be terminated by an investor at any time by providing us with written notice. For an investor’s termination to be effective for a particular distribution, we must have received a notice of termination at least 10 business days prior to the record date of the distribution period to which the distribution relates. Any transfer of an investor’s shares will effect a termination of the participation of those shares in the distribution reinvestment plan. We will terminate an investor’s participation to the extent that a reinvestment of an investor’s distributions in our shares would cause the investor to exceed the ownership limitations contained in our Articles of Incorporation.

We may amend our distribution reinvestment plan at any time upon written notice to each participant at least 10 days prior to the effective date of the amendment. We may terminate the distribution reinvestment plan upon written notice to each participant at least 30 days prior to the effective date of the termination.

42


The following table summarizes distributions paid in cash and pursuant to our DRIP for the years ended December 31, 2016, and 2017 (in thousands).

 

 Month

 

Year

 

Cash

Distribution -

Common

Stockholders

 

 

Cash

Distribution -

Membership

Units

 

 

Distribution

Paid

Pursuant to

DRIP on

Common Stock (1)

 

 

Distribution

Paid

Pursuant to

DRIP on

Membership

Units (1)

 

 

Total

Amount of

Distribution

 

January

 

2016

 

$

2,621

 

 

$

439

 

 

$

1,930

 

 

$

100

 

 

$

5,090

 

February

 

2016

 

 

2,672

 

 

 

442

 

 

 

1,990

 

 

 

96

 

 

 

5,200

 

March

 

2016

 

 

2,761

 

 

 

487

 

 

 

2,087

 

 

 

98

 

 

 

5,433

 

April

 

2016

 

 

2,832

 

 

 

487

 

 

 

2,134

 

 

 

98

 

 

 

5,551

 

May

 

2016

 

 

2,892

 

 

 

487

 

 

 

2,194

 

 

 

98

 

 

 

5,671

 

June

 

2016

 

 

2,975

 

 

 

487

 

 

 

2,280

 

 

 

98

 

 

 

5,840

 

July

 

2016

 

 

3,064

 

 

 

487

 

 

 

2,318

 

 

 

98

 

 

 

5,967

 

August

 

2016

 

 

3,092

 

 

 

487

 

 

 

2,377

 

 

 

98

 

 

 

6,054

 

September

 

2016

 

 

3,148

 

 

 

487

 

 

 

2,471

 

 

 

98

 

 

 

6,204

 

October

 

2016

 

 

3,184

 

 

 

487

 

 

 

2,534

 

 

 

98

 

 

 

6,303

 

November

 

2016

 

 

3,220

 

 

 

487

 

 

 

2,618

 

 

 

98

 

 

 

6,423

 

December

 

2016

 

 

3,274

 

 

 

487

 

 

 

2,683

 

 

 

98

 

 

 

6,542

 

January

 

2017

 

 

3,319

 

 

 

488

 

 

 

2,738

 

 

 

98

 

 

 

6,643

 

February

 

2017

 

 

3,394

 

 

 

488