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Section 1: 10-Q (10-Q)

sret_10Q_March 31, 2020

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 


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

 

For the Quarterly Period Ended March 31, 2020

 

Or

 

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

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

 


Commission File Number: 000-54295

 

Sterling Real Estate Trust

d/b/a Sterling Multifamily Trust

(Exact name of registrant as specified in its charter)

 

North Dakota

90-0115411

(State or other jurisdiction of incorporation or organization)

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

 

 

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

58103

(Address of principal executive offices)

(Zip Code)

 

(701) 353-2720

(Registrant’s telephone number, including area code)

 

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

 

Securities registered pursuant to Section 12(b) of the Act

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

Common Shares, par value $0.01 per share

 

N/A

 

N/A

 

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 every Interactive Data File required to be submitted 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 such files).  Yes ☒    No ☐

 

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

 

 

 

 

 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

 

 

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

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

 

 

 

 

Class

 

Outstanding at May 6, 2020

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

 

9,614,311

 

 

 

 

 

 

 

 

Table of Contents

STERLING REAL ESTATE TRUST

 

INDEX

 

Page

 

No.

 

 

PART I.  FINANCIAL INFORMATION 

 

 

 

Item 1.  Financial Statements (unaudited):

3

Consolidated Balance Sheets – as of March 31, 2020 and December 31, 2019 (audited)        

3

Consolidated Statements of Operations and Other Comprehensive Income – Three months ended March 31, 2020 and 2019   

4

Consolidated Statements of Shareholders’ Equity – Three months ended March 31, 2020 and 2019  

5

Consolidated Statements of Cash Flows –  Three months ended March 31, 2020 and 2019  

6

Notes to Consolidated Financial Statements 

8

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

34

Item 3.  Quantitative and Qualitative Disclosures About Market Risk 

44

Item 4.  Controls and Procedures 

44

 

 

PART II.  OTHER INFORMATION 

 

 

 

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

45

Item 6.  Exhibits 

46

Signatures 

47

 

 

 

Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

as of March 31, 2020 (UNAUDITED) and December 31, 2019 (audited)

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

    

2020

    

2019

 

 

(in thousands)

ASSETS

 

 

 

 

 

 

Real estate investments

 

 

 

 

 

 

Land and land improvements

 

$

116,102

 

$

114,666

Building and improvements

 

 

686,188

 

 

676,228

Construction in progress

 

 

17,017

 

 

11,134

Real estate investments

 

 

819,307

 

 

802,028

Less accumulated depreciation

 

 

(150,822)

 

 

(146,316)

Real estate investments, net

 

 

668,485

 

 

655,712

Cash and cash equivalents

 

 

4,295

 

 

9,002

Restricted deposits

 

 

11,398

 

 

8,380

Investment in unconsolidated affiliates

 

 

7,848

 

 

7,915

Note receivable

 

 

1,300

 

 

1,300

Lease intangible assets, less accumulated amortization of $15,429 in 2020 and $15,558 in 2019

 

 

8,395

 

 

9,133

Other assets, net

 

 

6,218

 

 

8,244

 

 

 

 

 

 

 

Total Assets

 

$

707,939

 

$

699,686

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

Mortgage notes payable, net

 

$

395,074

 

$

393,164

Dividends payable

 

 

7,358

 

 

7,118

Tenant security deposits payable

 

 

4,648

 

 

4,439

Lease intangible liabilities, less accumulated amortization of $1,916 in 2020 and $1,881 in 2019

 

 

1,151

 

 

1,207

Accrued expenses and other liabilities

 

 

13,697

 

 

14,711

Total Liabilities

 

 

421,928

 

 

420,639

 

 

 

 

 

 

 

COMMITMENTS and CONTINGENCIES - Note 14

 

 

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS' EQUITY

 

 

 

 

 

 

Beneficial interest

 

 

103,750

 

 

102,373

Noncontrolling interest

 

 

 

 

 

 

Operating partnership

 

 

181,299

 

 

174,221

Partially owned properties

 

 

2,411

 

 

2,416

Accumulated other comprehensive loss

 

 

(1,449)

 

 

37

Total Shareholders' Equity

 

 

286,011

 

 

279,047

 

 

 

 

 

 

 

 

 

$

707,939

 

$

699,686

 

See Notes to Consolidated Financial Statements

 

 

 

 

 

 

3

Table of Contents

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED March 31, 2020 and 2019 (UNAUDITED)

 

 

 

 

 

 

 

 

Three Months Ended

 

March 31,

 

2020

    

2019

 

(in thousands, except per share data)

Income from rental operations

 

Real estate rental income

$

29,906

 

$

29,831

Expenses

 

 

 

 

 

Expenses from rental operations

 

 

 

 

 

Operating expenses, excluding real estate taxes

 

12,535

 

 

12,179

Real estate taxes

 

3,164

 

 

3,029

Depreciation and amortization

 

5,252

 

 

5,538

Interest

 

4,350

 

 

4,715

 

 

25,301

 

 

25,461

Administration of REIT

 

1,162

 

 

1,111

Total expenses

 

26,463

 

 

26,572

Income from operations

 

3,443

 

 

3,259

 

 

 

 

 

 

Other income

 

 

 

 

 

Equity in income of unconsolidated affiliates

 

158

 

 

132

Other income

 

119

 

 

70

Gain on sale of real estate and non-real estate investments

 

1,455

 

 

 —

Gain on involuntary conversion

 

52

 

 

329

 

 

1,784

 

 

531

Net income

$

5,227

 

$

3,790

Net income (loss) attributable to noncontrolling interest:

 

 

 

 

 

Operating Partnership

 

3,419

 

 

2,532

Partially owned properties

 

(5)

 

 

(30)

Net income attributable to Sterling Real Estate Trust

$

1,813

 

$

1,288

 

 

 

 

 

 

Net income per common share, basic and diluted

$

0.19

 

$

0.14

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

Net income

$

5,227

 

$

3,790

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

 

(1,486)

 

 

 4

Comprehensive income

 

3,741

 

 

3,794

Comprehensive income attributable to noncontrolling interest

 

2,442

 

 

2,505

Comprehensive income attributable to Sterling Real Estate Trust

$

1,299

 

$

1,289

 

 

 

 

 

 

Weighted average Common Shares outstanding

 

9,562

 

 

9,091

 

 

See Notes to Consolidated Financial Statements

 

4

Table of Contents

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY 

FOR THE THREE MONTHS ENDED March 31, 2020 and 2019 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

Noncontrolling

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions

 

Total

 

Interest

 

Accumulated

 

 

 

 

 

Common

 

Paid-in

 

in Excess of

 

Beneficial

 

Operating

 

Partially Owned

 

Comprehensive

 

 

 

 

Shares

 

Capital

 

Earnings

 

Interest

 

Partnership

 

Properties

 

Income (Loss)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

BALANCE AT DECEMBER 31, 2018

                    8,967

 

$ 122,624

 

$ (24,741)

 

$ 97,883

 

$ 183,360

 

$ 2,538

 

$ (30)

 

$ 283,751

Shares/units redeemed

 

(11)

 

(197)

 

 -

 

(197)

 

(629)

 

 -

 

 -

 

(826)

Dividends declared

 

 -

 

 -

 

(2,374)

 

(2,374)

 

(4,661)

 

 -

 

 -

 

(7,035)

Dividends reinvested - stock dividend

 

82

 

1,479

 

 -

 

1,479

 

 -

 

 -

 

 -

 

1,479

Issuance of shares under optional purchase plan

 

49

 

929

 

 -

 

929

 

 -

 

 -

 

 -

 

929

Change in fair value of interest rate swaps

 

 -

 

 -

 

 -

 

 -

 

 -

 

 -

 

 4

 

 4

Net income

 

 -

 

 -

 

1,288

 

1,288

 

2,532

 

(30)

 

 -

 

3,790

BALANCE AT MARCH 31, 2019

 

9,087

 

$ 124,835

 

$ (25,827)

 

$ 99,008

 

$ 180,602

 

$ 2,508

 

$ (26)

 

$ 282,092

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

Noncontrolling

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions

 

Total

 

Interest

 

Accumulated

 

 

 

 

 

Common

 

Paid-in

 

in Excess of

 

Beneficial

 

Operating

 

Partially Owned

 

Comprehensive

 

 

 

 

Shares

 

Capital

 

Earnings

 

Interest

 

Partnership

 

Properties

 

Income (Loss)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

BALANCE AT DECEMBER 31, 2019

 

9,436

 

$ 131,261

 

$ (28,888)

 

$ 102,373

 

$ 174,221

 

$ 2,416

 

$ 37

 

$ 279,047

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

 

 -

 

 -

 

 -

 

 -

 

9,031

 

 -

 

 -

 

9,031

Shares/units redeemed

 

(38)

 

(696)

 

 -

 

(696)

 

(541)

 

 -

 

 -

 

(1,237)

Dividends declared

 

 -

 

 -

 

(2,527)

 

(2,527)

 

(4,831)

 

 -

 

 -

 

(7,358)

Dividends reinvested - stock dividend

 

87

 

1,584

 

 -

 

1,584

 

 -

 

 -

 

 -

 

1,584

Issuance of shares under optional purchase plan

 

62

 

1,203

 

 -

 

1,203

 

 -

 

 -

 

 -

 

1,203

Change in fair value of interest rate swaps

 

 -

 

 -

 

 -

 

 -

 

 -

 

 -

 

(1,486)

 

(1,486)

Net income

 

 -

 

 -

 

1,813

 

1,813

 

3,419

 

(5)

 

 -

 

5,227

BALANCE AT MARCH 31, 2020

 

9,547

 

$ 133,352

 

$ (29,602)

 

$ 103,750

 

$ 181,299

 

$ 2,411

 

$ (1,449)

 

$ 286,011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See Notes to Consolidated Financial Statements

 

 

5

Table of Contents

 

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED March 31, 2020 and 2019 (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

    

2020

    

2019

 

 

(in thousands)

OPERATING ACTIVITIES

 

 

 

 

 

 

Net income

 

$

5,227

 

$

3,790

Adjustments to reconcile net income to net cash from operating activities

 

 

 

 

 

 

Gain on sale of real estate investments

 

 

(1,455)

 

 

 —

Gain on involuntary conversion

 

 

(52)

 

 

(329)

Equity in income of unconsolidated affiliates

 

 

(158)

 

 

(132)

Distributions of earnings of unconsolidated affiliates

 

 

158

 

 

132

Allowance for uncollectible accounts receivable

 

 

113

 

 

50

Depreciation

 

 

4,868

 

 

5,012

Amortization

 

 

380

 

 

512

Amortization of debt issuance costs

 

 

140

 

 

155

Effects on operating cash flows due to changes in

 

 

 

 

 

 

Other assets

 

 

1,449

 

 

613

Tenant security deposits payable

 

 

131

 

 

203

Accrued expenses and other liabilities

 

 

(3,617)

 

 

(1,726)

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

 

7,184

 

 

8,280

INVESTING ACTIVITIES

 

 

 

 

 

 

Purchase of real estate investment properties

 

 

(375)

 

 

 —

Capital expenditures and tenant improvements

 

 

(5,058)

 

 

(1,263)

Proceeds from sale of real estate investments and non-real estate investments

 

 

3,494

 

 

 —

Proceeds from involuntary conversion

 

 

259

 

 

294

Investment in unconsolidated affiliates

 

 

(38)

 

 

 —

Distributions in excess of earnings received from unconsolidated affiliates

 

 

105

 

 

121

NET CASH USED IN INVESTING ACTIVITIES

 

 

(1,613)

 

 

(848)

FINANCING ACTIVITIES

 

 

 

 

 

 

Payments for financing, debt issuance and lease costs

 

 

(98)

 

 

 —

Principal payments on special assessments payable

 

 

(253)

 

 

(32)

Proceeds from issuance of mortgage notes payable and subordinated debt

 

 

7,788

 

 

 —

Principal payments on mortgage notes payable

 

 

(9,129)

 

 

(3,150)

Proceeds from issuance of shares under optional purchase plan

 

 

1,203

 

 

929

Shares/units redeemed

 

 

(1,237)

 

 

(826)

Dividends/distributions paid

 

 

(5,534)

 

 

(5,349)

NET CASH USED IN FINANCING ACTIVITIES

 

 

(7,260)

 

 

(8,428)

NET CHANGE IN CASH AND CASH EQUIVALENTS AND RESTRICTED DEPOSITS

 

 

(1,689)

 

 

(996)

CASH AND CASH EQUIVALENTS AND RESTRICTED DEPOSITS AT BEGINNING OF PERIOD

 

 

17,382

 

 

30,065

CASH AND CASH EQUIVALENTS AND RESTRICTED DEPOSITS AT END OF PERIOD

 

$

15,693

 

$

29,069

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AND RESTRICTED DEPOSITS AT END OF PERIOD

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,295

 

$

21,345

Restricted deposits

 

 

11,398

 

 

7,724

TOTAL CASH AND CASH EQUIVALENTS AND RESTRICTED DEPOSITS, END OF PERIOD

 

$

15,693

 

$

29,069

 

See Notes to Consolidated Financial Statements

6

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED March 31, 2020 and 2019 (UNAUDITED) (Continued)

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31,

 

    

2020

    

2019

 

 

(in thousands)

SCHEDULE OF CASH FLOW INFORMATION

 

 

 

 

 

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

 

$

4,203

 

$

4,599

 

 

 

 

 

 

 

SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

 

Dividends reinvested

 

$

1,584

 

$

1,479

Dividends declared and not paid

 

 

2,527

 

 

2,374

UPREIT distributions declared and not paid

 

 

4,831

 

 

4,661

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

 

 

9,031

 

 

 —

Increase in land improvements due to increase in special assessments payable

 

 

65

 

 

213

Unrealized (loss) gain on interest rate swaps

 

 

(1,486)

 

 

 4

Acquisition of assets with new financing

 

 

3,225

 

 

 —

Acquisition of assets through assumption of debt and liabilities

 

 

265

 

 

 —

Capitalized interest and real estate taxes related to construction in progress

 

 

137

 

 

 7

 

See Notes to Consolidated Financial Statements

 

 

7

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

Note 1 - Organization

 

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

 

Sterling previously established an operating partnership (“Sterling Properties, LLLP”) and transferred all of its assets and liabilities to the operating partnership in exchange for general partnership units. As the general partner, Sterling has management responsibility for all activities of the operating partnership. As of March 31, 2020 and December 31, 2019, Sterling owned approximately 34.34% and 34.63%, respectively, of the operating partnership.

 

NOTE 2 – PRINCIPAL ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2019, which have previously been filed with the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from this report on Form 10-Q pursuant to the rules and regulations of the SEC.

 

The results for the interim periods shown in this report are not necessarily indicative of future financial results. The accompanying consolidated balance sheets as of March 31, 2020 and consolidated statements of operations and other comprehensive income, consolidated statements of shareholders’ equity, and consolidated statements of cash flows for the three months ended March 31, 2020 and 2019, as applicable, have not been audited by our independent registered public accounting firm. In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly our consolidated financial statements as of and for the three months ended March 31, 2020 and 2019. These adjustments are of a normal recurring nature.

 

Principles of Consolidation

 

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

 

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

 

 

8

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

Principal Business Activity

 

Sterling currently owns directly and indirectly 178 properties.  The Trust’s 131 residential properties are located in North Dakota, Minnesota, Missouri and Nebraska and are principally multifamily apartment buildings.  The Trust owns 47 commercial properties primarily located in North Dakota with others located in Arkansas, Colorado, Iowa, Louisiana, Michigan, Minnesota, Mississippi, Nebraska, and Wisconsin. The commercial properties include retail, office, industrial, restaurant and medical properties.  Presently, the Trust’s mix of properties is 74.0% residential and 26.0% commercial (based on cost) and total $668,485 in real estate investments at March 31, 2020. Currently Sterling’s acquisition strategy and focus is on multifamily apartment properties.  We currently have no plans to dispose of our non-multifamily apartment properties. We will consider unsolicited offers for purchase of non-multifamily properties on a case by case basis.

 

 

 

 

 

 

 

 

Residential Property

    

Location

    

No. of Properties

    

Units

 

 

North Dakota

 

111

 

6,348

 

 

Minnesota

 

16

 

3,033

 

 

Missouri

 

1

 

164

 

 

Nebraska

 

3

 

495

 

 

 

 

131

 

10,040

 

 

 

 

 

 

 

Commercial Property

    

Location

    

No. of Properties

    

Sq. Ft

 

 

North Dakota

 

20

 

780,000

 

 

Arkansas

 

2

 

28,000

 

 

Colorado

 

1

 

17,000

 

 

Iowa

 

1

 

33,000

 

 

Louisiana

 

1

 

15,000

 

 

Michigan

 

1

 

12,000

 

 

Minnesota

 

14

 

675,000

 

 

Mississippi

 

1

 

15,000

 

 

Nebraska

 

1

 

19,000

 

 

Wisconsin

 

5

 

63,000

 

 

 

 

47

 

1,657,000

 

 

Concentration of Credit Risk

 

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

 

Use of Estimates

 

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

 

Real Estate Investments

 

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

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

The Trust allocates the purchase price of each acquired investment property accounted for as an asset acquisition based upon the estimated acquisition date fair value of the individual assets acquired and liabilities assumed, which generally include (i) land, (ii) building and other improvements, (iii) in-place lease value intangibles, (iv) acquired above and below market lease intangibles, and (v) any assumed financing that is determined to be above or below market, if any. Transaction costs related to acquisitions accounted for as an asset acquisition are capitalized as incurred and included as a cost of the Building in the accompanying consolidated balance sheet.

 

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

 

The portion of the purchase price allocated to acquired in-place lease value intangibles is amortized on a straight-line basis over the life of the related lease as amortization expense. The Trust incurred amortization expense pertaining to acquired in-place lease value intangibles of $341 and $429 for the three months ended March 31, 2020 and 2019, respectively.

 

The portion of the purchase price allocated to acquired above and below market lease intangibles is amortized on a straight-line basis over the life of the related lease as an adjustment to real estate rental income. Amortization pertaining to above market lease intangibles of $52 and $54 for the three months ended March 31, 2020 and 2019, respectively, was recorded as a reduction to real estate rental income. Amortization pertaining to below market lease intangibles of $56 and $67 for the three months ended March 31, 2020 and 2019, respectively, was recorded as an increase to real estate rental income.

 

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

 

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

 

 

 

 

 

Buildings and improvements

    

40 years

Furniture, fixtures and equipment

 

5-9 years

 

Depreciation expense for the three months ended March 31, 2020 and 2019 totaled $4,868 and $5,012, respectively.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

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

 

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

 

·

a substantial decline or continued low occupancy rate;

·

continued difficulty in leasing space;

·

significant financially troubled tenants;

·

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

·

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

·

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

 

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

 

·

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

·

projected capital expenditures and lease origination costs;

·

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

·

comparable selling prices; and

·

property specific discount rates for fair value estimates as necessary.

 

To the extent impairment has occurred, the Company will record an impairment charge calculated as the excess of the carrying value of the asset over its fair value for impairment of investment properties.  Based on evaluation, there were no impairment losses during the three months ended March 31, 2020 and 2019. 

 

Properties Held for Sale

 

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

 

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

 

·

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

·

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

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

·

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

·

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

·

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

·

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

 

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

 

There were no properties classified as held for sale at March 31, 2020 or December 31, 2019.  See Note 15.

 

Construction in Progress

 

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

 

Construction in progress as of March 31, 2020 consists primarily of development and planning costs associated with the Glen Pond development in Eagan, Minnesota and Goldmark Office Park 1715 and 1711 buildings located in Fargo, North Dakota. The Glen Pond development consists of an addition of 114 units to the current multifamily property. Current expectations are that the project will be completed in the second or third quarter of calendar year 2020 and the current project budget approximates $15,598. The Goldmark Office Park consists of three commercial office buildings. Current expectations are that the project which includes building renovations, reconstruction of portions of the Office Park and additional amenities will be completed in phases with the primary phase completed in the second quarter of calendar year 2020. The current project budget is approximately $3,833.

 

Cash and Cash Equivalents and Restricted Deposits

 

We classify highly liquid investments with a maturity of three months or less when purchased as cash equivalents. Restricted deposits include funds escrowed for tenant for tenant security deposits, real estate taxes, insurance and mortgage escrow deposits required by lenders on certain properties to be used for future building renovations or tenant improvements and potential Internal Revenue Code section 1031 tax deferred exchanges (1031 Exchanges).

 

Investment in Unconsolidated Affiliates

 

We account for unconsolidated affiliates using the equity method of accounting per guidance established under ASC 323, Investments – Equity Method and Joint Ventures (“ASC 323”). The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for our share of equity in the affiliates’ earnings and distributions. We evaluate the carrying amount of the investments for impairment in accordance with ASC 323. Unconsolidated affiliates are reviewed for potential impairment if the carrying amount of the investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until the carrying amount is

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

fully recovered. The evaluation of an investment in an affiliate for potential impairment can require our management to exercise significant judgments. No impairment losses were recorded to unconsolidated affiliates for the three months ended March 31, 2020 and 2019.

 

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

 

In determining whether an investment in a limited liability company or tenant in common is a variable interest entity, we consider: the form of our ownership interest and legal structure; the size of our investment; the financing structure of the entity, including the necessity of subordinated debt; estimates of future cash flows; our and our partner’s ability to participate in the decision making related to acquisitions, dispositions, budgeting and financing on the entity; and obligation to absorb losses and preferential returns.  As of March 31, 2020, our tenant in common arrangements do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810.

 

As of March 31, 2020 and December 31, 2019, the unconsolidated affiliates held total assets of $33,451 and $31,261 and mortgage notes payable of $18,169 and $16,690, respectively.

 

The operating partnership is a 50% owner of Grand Forks Marketplace Retail Center as a tenant in common through 100% ownership in a limited liability company.  Grand Forks Marketplace Retail Center has approximately 183,000 square feet of commercial space in Grand Forks, North Dakota. The property is encumbered by a non-recourse first mortgage with a balance at March 31, 2020 and December 31, 2019 of $10,208 and $10,264, respectively. The Company is jointly and severally liable for the full mortgage balance.

 

The operating partnership owns a 66.67% interest as tenant in common in an office building with approximately 75,000 square feet of commercial rental space in Fargo, North Dakota. The property is encumbered by a first mortgage with a balance at March 31, 2020 and December 31, 2019 of $6,379 and $6,426, respectively. The Company is jointly and severally liable for the full mortgage balance.

 

The operating partnership owns a 60% interest in a joint venture (“SE Savage”) that is developing a 190 unit multifamily property. The property is encumbered by a first construction mortgage with a balance at March 31, 2020 of $1,583 and no mortgage balance at December 31, 2019. The operating partnership has contributed $3,305 in cash to SE Savage as of March 31, 2020. The partnership holds total assets of $8,107. The Company is jointly and severally liable for the full mortgage balance.

 

The operating partnership owns a 60% interest in a joint venture (“SE Maple Grove”) that intends to develop a 160 unit multifamily property. The operating partnership has contributed $2,073 in cash to SE Maple Grove as of March 31, 2020. SE Maple Grove holds land located in Maple Grove, Minnesota, total assets of $3,455, and no mortgage payable.

 

Receivables

 

Receivables consist primarily of amounts due for rent and tenant charges. Accounts receivable are carried at original amounts billed. The operating partnership reviews collectability of charges under its tenant operating leases on a quarterly basis. In the event that collection is deemed not probable for any tenant charges, beginning with the adoption of ASC 842

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

as of January 1, 2019, the operating partnership recognizes an adjustment to real estate rental income. Prior to the adoption of ASC 842, the Company recognized a provision for uncollectible amounts or a direct write-off of the specific rent receivable. Receivables are included in other assets in the accompanying consolidated balance sheets.

 

Note receivables are issued periodically and are secured and interest bearing.

 

Financing and Lease Costs

 

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

 

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

 

Debt Issuance Costs

 

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

 

Intangible Assets

 

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

 

The carrying amount of intangible assets is regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset. Based on the review, management determined no impairment charges were necessary at March 31, 2020 and December 31, 2019.

 

Noncontrolling Interest

 

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

 

Operating Partnership: Interests in the operating partnership held by limited partners are represented by operating partnership units.  The operating partnership’s income is allocated to holders of units based upon the ratio of their holdings

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

to the total units outstanding during the period. Capital contributions, distributions, syndication costs, and profits and losses are allocated to noncontrolling interests in accordance with the terms of the operating partnership agreement.

 

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

 

Syndication Costs

 

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

 

Federal Income Taxes

 

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

 

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

 

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

 

We follow ASC Topic 740, Income Taxes, to recognize, measure, present and disclose in our consolidated financial statements uncertain tax positions that we have taken or expect to take on a tax return. As of March 31, 2020 and December 31, 2019, we did not have any liabilities for uncertain tax positions that we believe should be recognized in our consolidated financial statements. We are no longer subject to Federal and State tax examinations by tax authorities for years before 2016.

 

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

 

Revenue Recognition

 

The Trust is the lessor for its residential and commercial leases. Leases are analyzed on an individual basis to determine lease classification. The Trust has determined any lease less than twelve months in length will not be looked at in the classification process and will be presumed an operating lease. As of March 31, 2020, all leases analyzed under the Trust’s

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

lease classification process were determined to be operating leases. As of March 31, 2019, all leases continued to be accounted for as operating leases under the new standard as described under Recent Accounting Pronouncements. 

 

As of March 31, 2020, we derived 79% of our revenues from residential leases that are generally for terms of one year or less. The residential leases may include lease income related items such as parking, storage and non-refundable deposits that we treat as a single lease component because the amenities cannot be leased on their own and the timing and pattern of revenue recognition are the same.  The collection of lease payments at lease commencement is probable and therefore we subsequently recognize lease income over the lease term on a straight-line basis.  Residential leases are renewable upon consent of both parties on an annual or monthly basis.

 

As of March 31, 2020, we derived 21% of our revenues from commercial leases primarily under long-term lease agreements. Substantially all commercial leases contain fixed escalations or, in some instances, changes based on the Consumer Price Index, which occur at specified times during the term of the lease. In certain commercial leases, variable lease income, such as percentage rent, is recognized when rents are earned. We recognize rental income and rental abatements from our commercial leases when earned on a straight-line basis over the lease term. Recognition of rental income commences when control of the leased space has been transferred to the tenant.

 

We recognize variable income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements. When we pay pass-through expenses, subject to reimbursement by the tenant, they are included within Operating expenses, excluding real estate taxes, and reimbursements are included within Real estate rental income along with the associated base rent in the accompanying consolidated financial statements.

 

We record base rents on a straight-line basis. The monthly base rent income according to the terms of our leases is adjusted so that an average monthly rent is recorded for each tenant over the term of its lease. The straight-line rent adjustment decreased revenue by $65 and increased revenue by $103 the three months ended March 31, 2020 and 2019, respectively. The straight-line receivable balance included in other assets on the consolidated balance sheets as of March 31, 2020 and December 31, 2019 was $3,093 and $3,331, respectively. We receive payments for expense reimbursements from substantially all our multi-tenant commercial tenants throughout the year based on estimates. Differences between estimated recoveries and the final billed amounts, which are immaterial, are recognized in the subsequent year.

 

Upon adoption of ASU 2016-02 on January 1, 2019, we elected not to bifurcate lease contracts into lease and non-lease components, since the timing and pattern of revenue is not materially different and the non-lease components is not the primary component of the lease. Accordingly, both lease and non-lease components are presented in “Real estate rental income” in our consolidated financial statements. The adoption of ASU 2016-02 did not result in a material change to our recognition of real estate rental income.

 

Lease income related to the Company’s operating leases is comprised of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  March 31, 2020

 

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

Lease income related to fixed lease payments

 

$

23,203

 

$

4,714

 

$

27,917

Lease income related to variable lease payments

 

 

 —

 

 

1,261

 

 

1,261

Other (a)

 

 

(257)

 

 

(90)

 

 

(347)

 Lease Income (b)

 

$

22,946

 

$

5,885

 

$

28,831

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  March 31, 2019

 

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

Lease income related to fixed lease payments

 

$

22,797

 

$

4,777

 

$

27,574

Lease income related to variable lease payments

 

 

 —

 

 

1,487

 

 

1,487

Other (a)

 

 

(217)

 

 

117

 

 

(100)

 Lease Income (b)

 

$

22,580

 

$

6,381

 

$

28,961

 

(a)

For the three months ended March 31, 2020 and 2019, “Other” is comprised of revenue adjustments related to changes in collectibility and amortization of above and below market lease intangibles and lease inducements.

(b)

Excludes other rental income for the three months ended March 31, 2020 and 2019 of $1,075 and $870, respectively, which is accounted for under the revenue recognition standard.

 

As of March 31, 2020, non-cancelable commercial operating leases provide for future minimum rental income as follows. Apartment leases are not included as the terms are generally for one year or less.

 

 

 

 

 

Years ending December 31,

    

Amount

 

 

(in thousands)

2020 (April 1, 2020 – December 31, 2020)

 

$

 13,288

2021

 

 

14,836

2022

 

 

11,453

2023

 

 

9,479

2024

 

 

9,017

Thereafter

 

 

42,479

 

 

$

100,552

 

Business Interruption Proceeds

 

In the Trust’s normal course of business we periodically receive insurance recoveries for business interruption. The Trust received no insurance recoveries for business interruption during the three months ended March 31, 2020 and 2019. When insurance proceeds are received they are reflected in the statement of operations as real estate rental income.

 

Earnings per Common Share

 

Basic earnings per common share is computed by dividing net income available to common shareholders (the “numerator”) by the weighted average number of common shares outstanding (the “denominator”) during the period. Sterling had no dilutive potential common shares as of March 31, 2020 and 2019, and therefore, basic earnings per common share was equal to diluted earnings per common share for both periods.

 

For the three months ended March 31, 2020 and 2019, Sterling’s denominators for the basic and diluted earnings per common share were approximately 9,562,000 and 9,091,000, respectively.

 

Incurred but Not Reported Insurance Liability

 

The Company maintains a business insurance program with deductible limits, which cover property, business automobile and general liability claims. The Company accrues estimated losses using a reserve for known claims and estimates based on historical loss experience. The calculations used to estimate property claim reserves are based on numerous assumptions, some of which are subjective. The Company will adjust the property claim reserves, if necessary, in the event

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

future loss experience differs from historical loss patterns. As of March 31, 2020 and December 31, 2019, property claim reserves were $510 and $204, respectively, and are included in other liabilities on the consolidated balance sheet.

 

Reclassifications

 

Certain reclassifications considered necessary for a fair presentation have been made to the prior period financial statements in order to conform to the current year presentation.  These reclassifications have not changed the results of operations or equity.

 

Recent Accounting Pronouncements

 

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The standard provides for optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform. On July 27, 2017, the Financial Conduct Authority (FCA), tasked with overseeing the London Interbank Offered Rate (LIBOR) announced the benchmark interest rate will be phased out by the end of 2021. As a result, existing and future contracts indexed to LIBOR will need to be renegotiated to reference another rate.

 

We adopted the standard effective as of January 1, 2020, using the optional transition method to apply the standard as of the effective date. The Trust elected to apply the optional expedients for all of the Trust’s hedging relationships. The Trust will disregard the potential change in the designated hedged risk that may occur due to reference rate reform when the Trust assesses whether the hedged forecasted transaction is probable in accordance with the requirements of Topic 815. The Trust will continue current hedge accounting for our existing cash flow hedges when the hedged risk changes by assuming the reference rate will not be replaced for the remainder of the hedging relationships for our assessment of hedge effectiveness and all subsequent hedge effectiveness assessments.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which superseded FASB ASC Topic 840.  The standard for operating leases as lessor is largely unchanged under ASU 2016-02. However, the standard requires lessees to recognize lease assets and lease liabilities for leases classified as operating and finance leases on the balance sheet. Lessees will recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it will recognize lease expense for such leases generally on a straight-line basis over the lease term.

 

We adopted this standard effective as of January 1, 2019, using the optional transition method to apply the standard as of the effective date. The Company elected to apply the package of practical expedients for the leases as lessor for its residential and commercial leases and these leases will continue to be accounted for as operating leases as of the effective date. Further, the Company elected the practical expedient to combine lease and nonlease components for leases as lessor. Finally, the Company evaluated taxes collected from lessees, lessor costs paid directly by lessees, and initial direct costs and determined that the guidance was consistent with existing practice. Based on these evaluations, the Company determined that for leases as lessor, as of January 1, 2019, there was no impact on lease revenue or related expenses.

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

NOTE 3 – segment reporting

 

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

 

Segment Revenues and Net Operating Income

 

The revenues and net operating income for the reportable segments (residential and commercial) are summarized as follows for the three months ended March 31, 2020 and 2019, along with reconciliations to the consolidated financial statements. Segment assets are also reconciled to Total Assets as reported in the consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  March 31, 2020

 

 

Three months ended  March 31, 2019

 

    

Residential

    

Commercial

    

Total

 

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

 

 

(in thousands)

Income from rental operations

 

$

23,995

 

$

5,911

 

$

29,906

 

 

$

23,434

 

$

6,397

 

$

29,831

Expenses from rental operations

 

 

13,912

 

 

1,787

 

 

15,699

 

 

 

13,389

 

 

1,819

 

 

15,208

Net operating income

 

$

10,083

 

$

4,124

 

$

14,207

 

 

$

10,045

 

$

4,578

 

$

14,623

Depreciation and amortization

 

 

 

 

 

 

 

 

5,252

 

 

 

 

 

 

 

 

 

5,538

Interest

 

 

 

 

 

 

 

 

4,350

 

 

 

 

 

 

 

 

 

4,715

Administration of REIT

 

 

 

 

 

 

 

 

1,162

 

 

 

 

 

 

 

 

 

1,111

Other (income)/expense

 

 

 

 

 

 

 

 

(1,784)

 

 

 

 

 

 

 

 

 

(531)

Net income

 

 

 

 

 

 

 

$

5,227

 

 

 

 

 

 

 

 

$

3,790

 

Segment Assets and Accumulated Depreciation

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2020

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

Real estate investments

 

$

622,753

 

$

196,554

 

$

819,307

Accumulated depreciation

 

 

(107,785)

 

 

(43,037)

 

 

(150,822)

 

 

$

514,968

 

$

153,517

 

 

668,485

Cash and cash equivalents

 

 

 

 

 

 

 

 

4,295

Restricted deposits and funded reserves

 

 

 

 

 

 

 

 

11,398

Investment in unconsolidated affiliates

 

 

 

 

 

 

 

 

7,848

Other assets

 

 

 

 

 

 

 

 

6,218

Note receivable

 

 

 

 

 

 

 

 

1,300

Intangible assets, less accumulated amortization

 

 

 

 

 

 

 

 

8,395

Total Assets

 

 

 

 

 

 

 

$

707,939

 

19

Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 (UNAUDITED)

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

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2019

    

Residential

    

Commercial

    

Total

 

 

(in thousands)

Real estate investments

 

$

605,813

 

$

196,215

 

$

802,028

Accumulated depreciation

 

 

(104,170)

 

 

(42,146)

 

 

(146,316)

 

 

$

501,643

 

$

154,069

 

 

655,712

Cash and cash equivalents

 

 

 

 

 

 

 

 

9,002

Restricted deposits and funded reserves

 

 

 

 

 

 

 

 

8,380

Investment in unconsolidated affiliates

 

 

 

 

 

 

 

 

7,915

Other assets

 

 

 

 

 

 

 

 

8,244

Note receivable

 

 

 

 

 

 

 

 

1,300

Intangible assets, less accumulated amortization

 

 

 

 

 

 

 

 

9,133

Total Assets

 

 

 

 

 

 

 

$

699,686

 

 

 

 

NOTE 4 - Lease intangibles

 

The following table summarizes the net value of other intangible assets and liabilities and the accumulated amortization for each class of intangible:

 

 

 

 

 

 

 

 

 

 

 

 

Lease

 

Accumulated

 

Lease

As of March 31, 2020

    

Intangibles

    

Amortization

    

Intangibles, net

Lease Intangible Assets

 

(in thousands)

In-place leases

 

$