UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-51609
Inland American Real Estate Trust, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
630-218-8000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, $0.001 par value per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
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 x
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 the filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, 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 x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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 x
There is no established market for the registrant’s shares of common stock. The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of June 30, 2011 (the last business day of the registrant’s most recently completed second quarter) was approximately $6,698,005,345, based on the estimated per share value of $8.03, as established by the registrant on September 21, 2010.
As of March 1, 2012, there were 873,737,630 shares of the registrant’s common stock outstanding.
The registrant incorporates by reference portions of its Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, which is expected to be filed no later than April 29, 2012, into Part III of this Form 10-K to the extent stated herein.
INLAND AMERICAN REAL ESTATE TRUST, INC.
TABLE OF CONTENTS
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Consolidated Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
Item 15.
Exhibits and Financial Statement Schedules
Signatures
This Annual Report on Form 10-K includes references to certain trademarks. Courtyard by Marriott®, Marriott®, Marriott Suites®, Residence Inn by Marriott® and SpringHill Suites by Marriott® trademarks are the property of Marriott International, Inc. (“Marriott”) or one of its affiliates. Doubletree®, Embassy Suites®, Hampton Inn®, Hilton Garden Inn®, Hilton Hotels® and Homewood Suites by Hilton® trademarks are the property of Hilton Hotels Corporation (“Hilton”) or one or more of its affiliates. Hyatt Place® trademark is the property of Hyatt Corporation (“Hyatt”). Intercontinental Hotels ® trademark is the property of IHG. Wyndham ® and Baymont Inn & Suites® trademarks are the property of Wyndham Worldwide. Comfort Inn® trademark is the property of Choice Hotels International. Fairmont Hotels and Resorts is a trademark. The Aloft service name is the property of Starwood. For convenience, the applicable trademark or service mark symbol has been omitted but will be deemed to be included wherever the above-referenced terms are used.
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PART I
Item 1. Business
General
Inland American Real Estate Trust, Inc., a Maryland corporation, was incorporated in October 2004. We have elected to be taxed, and currently qualify, as a real estate investment trust (“REIT”) for federal tax purposes. We acquire, own, operate and develop a diversified portfolio of commercial real estate, including retail, multi-family, industrial, lodging, and office properties, located in the United States. In addition, we own assets through joint ventures in which we do not own a controlling interest, as well as properties in development. We also invest in marketable securities and other assets. The following chart depicts the allocation of each type of asset, as of December 31, 2011, based on undepreciated values.
As of December 31, 2011, 86% of our total portfolio was comprised of our “core” assets, which consisted of 964 properties comprised of 49.3 million square feet of retail, office and industrial space, 9,563 multi-family units and 15,597 hotel rooms. We believe that a diversified portfolio balances our risk exposure compared to a portfolio with a single asset class. We believe that a diversified portfolio like ours provides our stockholders with significant benefits, and reduces their risk relative to a portfolio concentrated on one property sector or properties located in one geographical area or region. Because we believe that most real estate markets are cyclical in nature, we believe that our diversified investment strategy allows us to more effectively deploy capital into sectors and locations where the underlying investment fundamentals are relatively strong and away from sectors where the fundamentals are relatively weak. Further, we believe that an investment strategy that combines real property investments with other real estate-related investments, like ours, provides our stockholders with additional diversification benefits. The following chart depicts the allocation of our core assets for each segment, as of December 31, 2011, based on undepreciated assets within our property portfolio.
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Objectives & Strategy
We focus on maximizing stockholder value by utilizing the depth of our expertise to capitalize on opportunities in the real estate industry. We believe our capacity to identify and react to investment opportunities is one of our biggest strengths. Our strategies for reaching this objective are:
Maintaining a reliable and sustainable distribution rate
Disposing of less strategic assets and deploying capital into quality assets in higher performing asset segments to further enhance the value of our segments
Positioning our capital structure to capture near-term acquisition opportunities through a conservative balance sheet and manageable debt maturities
Maximizing revenue from our existing properties by improving occupancy at market rents, controlling both operating and capital expenditures
Maximizing stockholder value through liquidity events on a segment by segment basis
2011 Highlights
Distributions
We have paid a monthly cash distribution to our stockholders which totaled $428.7 million for the year ended December 31, 2011, which was equal to $0.50 per share for 2011. The distributions paid for the year ended December 31, 2011 were funded from cash flow from operations and distributions from unconsolidated joint ventures.
Investing Activities
During 2011, we continued to refine our asset portfolio. We acquired three upper upscale lodging properties consisting of 1,172 rooms for $166.5 million. In addition, we acquired seven high quality multi-tenant retail properties consisting of 1,673,701 square feet for $282.8 million. As part of our strategy to realign our asset segments with higher performing assets, we sold 26 properties for a gross disposition price of $242.3 million, including fourteen retail properties, six midscale lodging properties, four office properties, one industrial property, and one multi-family property.
Financing Activities
We successfully refinanced our 2011 maturities of approximately $540 million and placed debt on new and existing properties. We were able to obtain favorable rates while still maintaining a manageable debt maturity schedule for future years. As of December 31, 2011, we had mortgage debt of approximately $5.8 billion, of which $671 million matures in 2012. Subsequently, we have refinanced or extended approximately $200 million. Our debt increased by $303.9 million from 2010 and have a weighted average interest rate of 5.2% per annum.
Operating Results
We saw significant net operating income increases in our same store lodging and multi-family properties from the year ended December 31, 2010 to 2011, offset by a slight decrease in net operating income in our retail, office and industrial portfolios. In 2012, we expect similar operating results in our lodging and multi-family portfolios due to the growth projected in these segments. We expect to maintain high occupancy in our retail, office, and industrial portfolios, which will result in consistent operating performance in the retail and industrial segments and a slight decrease in our office performance.
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The following table represents our same store net operating results for the years ended December 31, 2011 and 2010.
Retail
Lodging
Office
Industrial
Multi-Family
Segment Data
We have five business segments: Retail, Lodging, Office, Industrial, and Multi-family. We evaluate segment performance primarily based on net property operations. Net property operations of the segments do not include interest expense, depreciation and amortization, general and administrative expenses, or interest and other investment income from corporate investments. The non-segmented assets include our cash and cash equivalents, investment in marketable securities, construction in progress, and investment in unconsolidated entities. Information related to our business segments including a measure of profits or loss and revenues from external customers for each of the last three fiscal years and total assets for each of the last two fiscal years is set forth in Note 14 to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Significant Tenants
For the year ended December 31, 2011, we generated more than 16% of our rental revenue from two tenants, SunTrust Bank and AT&T, Inc. SunTrust Bank leases multiple properties throughout the United States, which collectively generated approximately 9% of our rental revenue for the year ended December 31, 2011. For the year ended December 31, 2011, approximately 7% of our rental revenue was generated by three properties leased to AT&T, Inc.
Tax Status
We have elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code of 1986 as amended (the “Code”) beginning with the tax year ended December 31, 2005. Because we qualify for taxation as a REIT, we generally will not be subject to federal income tax on taxable income that is distributed to stockholders. If we fail to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, we will be subject to federal and state income tax on our taxable income at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income, property or net worth, respectively, and to Federal income and excise taxes on our undistributed income.
Competition
The commercial real estate market is highly competitive. We compete in all of our markets with other owners and operators of commercial properties. We compete based on a number of factors that include location, rental rates, security, suitability of the property’s design to 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 a property’s occupancy levels, rental rates and operating income.
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We compete with many third parties engaged in real estate investment activities including other REITs, including other REITs sponsored by our sponsor, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, hedge funds, governmental bodies and other entities. There are also other REITs with investment objectives similar to ours and others may be organized in the future. In addition, these same entities seek financing through the same channels that we do. Therefore, we compete for funding in a market where funds for real estate investment may decrease, or grow less than the underlying demand.
Employees
As of December 31, 2011, we have 99 full-time individuals employed primarily by our multi-family subsidiaries.
Our executive officers do not receive any compensation from us for their services as such officers. Our executive officers are officers of one or more of The Inland Group, Inc.’s affiliated entities, including our business manager, and are compensated by these entities, in part, for their services rendered to us. For the purposes of reimbursement, our secretary is not considered an “executive officer.”
We have entered into a business management agreement with Inland American Business Manager & Advisor, Inc. to serve as our business manager, with responsibility for overseeing and managing our day-to-day operations. We have also entered into property management agreements with each of our property managers. We pay fees to our business manager and our property managers in consideration for the services they perform for us pursuant to these agreements.
Conflicts of Interest
Our governing documents require a majority of our directors to be independent. Further, any transactions between The Inland Group, Inc. or its affiliates and us must be approved by a majority of our independent directors.
Environmental Matters
Compliance with federal, state and local environmental laws has not had a material adverse effect on our business, assets, or results of operations, financial condition and ability to pay distributions, and we do not believe that our existing portfolio will require us to incur material expenditures to comply with these laws and regulations. However, we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on our properties.
Seasonality
The lodging segment is seasonal in nature, reflecting higher revenue and operating income during the second and third quarters. This seasonality can be expected to cause fluctuations in our net property operations for the lodging segment. None of our other segments are seasonal in nature.
Access to Company Information
We electronically file our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports with the Securities and Exchange Commission (“SEC”). The public may read and copy any of the reports that are filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at (800)-SEC-0330. The SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically.
We make available, free of charge, by responding to requests addressed to our customer relations group, the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all
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amendments to those reports on our website, www.inland-american.com. These reports are available as soon as reasonably practicable after such material is electronically filed or furnished to the SEC.
Certifications
We have filed with the Securities and Exchange Commission the principal executive officer and principal financial officer certifications required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, which are attached as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K.
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Item 1A. Risk Factors
The occurrence of any of the risks discussed below could have a material adverse effect on our business, financial condition, results of operations and ability to pay distributions to our stockholders.
Risks Related to Our Business
Recent disruptions in the financial markets and current economic conditions could adversely affect our ability to refinance or secure additional debt financing at attractive terms and the values of our investments.
The capital and credit markets have been extremely volatile since the fall of 2008. In particular, the real estate debt markets have experienced volatility as a result of certain factors, including the tightening of underwriting standards by lenders and credit rating agencies, therefore making it more costly to refinance our existing debt and to obtain new financing on attractive terms. If overall borrowing costs continue to increase, either by increases in the index rates or by increases in lender spreads, our operations may generate lower returns.
In addition, the disruptions in the financial markets and recent economic conditions have negatively impacted commercial real estate fundamentals, which could have, and in some cases have already had, various negative impacts on the value of our investments, including:
a decrease in the values of our investments in commercial properties, below the amounts paid for such investments; or
a decrease in revenues from our properties, due to lower occupancy and rental rates, which may make it more difficult for us to pay distributions or meet our debt service obligations on debt financing.
Our ongoing strategy depends, in part, upon future acquisitions, and we may not be successful in identifying and consummating these transactions.
Our business strategy involves realigning on assets through disposal of assets and acquisition of higher performing properties. We may not be successful in identifying suitable properties or other assets or in consummating these transactions on satisfactory terms, if at all.
Further, we face significant competition for attractive investment opportunities from an indeterminate number of other real estate investors, including investors with significant capital resources such as domestic and foreign corporations and financial institutions, publicly traded and privately held REITs, private institutional investment funds, investment banking firms, life insurance companies and pension funds. As a result of competition, we may be unable to acquire additional properties as we desire or the purchase price may be significantly elevated.
In light of current market conditions and depressed real estate values, property owners in many markets remain hesitant to sell their properties, resulting in fewer opportunities to acquire properties. Of the limited number of desirable properties that we are seeing come to market, we are either facing significant competition to acquire stabilized properties, or having to accept lease-up risk associated with properties that have lower occupancy. As market conditions and real estate values recover, more properties may become available for acquisition, but we can provide no assurances that these properties will meet our investment objectives or that we will be successful in acquiring these properties. Although conditions in the credit markets have improved over the past year, the ability of buyers to utilize higher levels of leverage to finance property acquisitions has been, and remains, somewhat limited. If we are unable to acquire sufficient debt financing at suitable rates or at all, we may be unable to acquire as many additional properties as we anticipate.
Our ongoing strategy involves the disposition of properties; however, we may be unable to sell a property on acceptable terms and conditions, if at all.
Another one of our strategies is to dispose of certain properties. We believe that in certain instances, it makes economic sense to sell properties in today’s market, such as when we believe the value of the leases in place at a
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property will significantly decline over the remaining lease term, when the property has limited or no equity with a near-term debt maturity, when a property has equity but the projected returns do not justify further investment or when the equity in a property can be redeployed in the portfolio in order to achieve better returns or strategic goals. However, the general economic climate along with property specific issues, such as vacancies and lease terminations, have negatively affected the value of certain of our properties and therefore reduced our ability to sell these properties on acceptable terms. Real estate investments often cannot be sold quickly. As a result of current economic conditions, potential purchasers may be unable to obtain financing on acceptable terms, if at all, thereby delaying our ability to sell our properties. In addition, the capitalization rates at which properties may be sold could have risen since our acquisition of the properties, thereby reducing our potential proceeds from sale. Furthermore, properties that we have owned for a significant period of time or that we acquired in exchange for partnership interests in our operating partnership may have a low tax basis. If we were to dispose of any of these properties in a taxable transaction, we may be required under provisions of the Code applicable to REITs to distribute a significant amount of the taxable gain, if any, to our stockholders and this could, in turn, impact our cash flow. In some cases, tax protection agreements with third parties may prevent us from selling certain properties in a taxable transaction without incurring substantial costs. In addition, purchase options and rights of first refusal held by tenants or partners in joint ventures may also limit our ability to sell certain properties.
If we lose or are unable to obtain key personnel, our ability to implement our investment strategies could be delayed or hindered.
Our success depends to a significant degree upon the contributions of certain of our executive officers and other key personnel of our business manager and property managers. If any of the key personnel of our business manager or property managers were to cease their affiliation with our business manager or property managers, respectively, our operating results could suffer. Further, we do not separately maintain “key person” life insurance that would provide us with proceeds in the event of death or disability of these persons. We believe our future success depends, in part, upon the ability of our business manager and property managers to hire and retain highly skilled managerial, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure you that our business manager or property managers will be successful in attracting and retaining skilled personnel.
If we internalize our management functions, your interest in us could be diluted and we may be unable to retain key personnel.
At some point in the future, we may consider internalizing the functions performed for us by our business manager or property managers. The method by which we could internalize these functions could take many forms, and the method and cost of internalizing cannot be determined or estimated at this time. If we acquired our business manager or property managers as part of an internalization, the amount and form of any consideration that we would pay in this type of transaction could take many forms. For example, we could acquire the business manager or property managers through a merger in which we issue shares of our common stock for all of the outstanding common stock or assets of these entities. Issuing shares of our common stock would reduce the percentage of our outstanding shares owned by stockholders prior to any transaction. Issuing promissory notes could reduce our net income, cash flow from operating activities and our ability to make distributions, particularly if internalizing these functions does not produce cost savings. Further, if we internalize our management functions, certain key employees may not become our employees but may instead remain employees of our business manager and property managers, or their respective affiliates, especially if we internalize our management functions but do not acquire our business manager or property managers. SeeIf we seek to internalize our management functions, other than by acquiring our business manager or property managers, we could incur greater costs and lose key personnel below. An inability to manage an internalization transaction could effectively result in our incurring excess costs and suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. These deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from most effectively managing our investments, which could result in us being sued and incurring litigation-associated costs in connection with the internalization transaction.
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If we pursue the acquisition of our business manager or property managers, there is no assurance that we will reach an agreement with these parties as to the terms of the transaction.
Even if we pursue the acquisition of our business manager and property managers, neither entity is obligated to enter into a transaction with us or to do so at any particular price. If we desire to internalize our management functions by acquiring our business manager and property managers, our independent directors, as a whole, or a committee thereof, will have to negotiate the specific terms and conditions of any agreement or agreements to acquire these entities, including the actual purchase price. There is no assurance that we will be able to enter into an agreement with the business manager and property managers on mutually acceptable terms. Accordingly, we would have to seek alternative courses of actions to internalize our management functions.
If we seek to internalize our management functions, other than by acquiring our business manager or property managers, we could incur greater costs and lose key personnel.
If our board deems an internalization to be in our best interests, it may decided that we should pursue an internalization by hiring our own group of executives and other employees or entering into an agreement with a third party, such as a merger, instead of by acquiring our business manager and property managers. The costs that we would incur in this case are uncertain and may be substantial. In addition, certain key personnel of the business manager and or property managers have employment agreements with those entities, which could restrict our ability to retain such personnel if we do not acquire the business manager and or property managers. Further, we would lose the benefit of the experience of business manager and property managers.
The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.
We have deposited our cash and cash equivalents in several banking institutions in an attempt to minimize exposure to the failure or takeover of any one of these entities. However, the Federal Insurance Deposit Corporation, or “FDIC,” generally only insures limited amounts per depositor per insured bank. At December 31, 2011, we had cash and cash equivalents and restricted cash deposited in interest bearing transaction accounts at certain financial institutions exceeding these federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over the federally insured levels. The loss of our deposits could reduce the amount of cash we have available to distribute or invest.
Risks Related to our Real Estate Assets
There are inherent risks with real estate investments.
Investments in real estate assets are subject to varying degrees of risk. For example, an investment in real estate cannot generally be quickly converted to cash, limiting our ability to promptly vary our portfolio in response to changing economic, financial and investment conditions. Investments in real estate assets also are subject to adverse changes in general economic conditions which, for example, reduce the demand for rental space.
Among the factors that could impact our real estate assets and the value of an investment in us are:
local conditions such as an oversupply of space or reduced demand for real estate assets of the type that we own or seek to acquire, including, with respect to our lodging facilities, quick changes in supply of and demand for rooms that are rented or leased on a day-to-day basis;
inability to collect rent from tenants;
vacancies or inability to rent space on favorable terms;
inflation and other increases in operating costs, including insurance premiums, utilities and real estate taxes;
increases in energy costs or airline fares or terrorist incidents which impact the propensity of people to travel and therefore impact revenues from our lodging facilities, although operating costs cannot be adjusted as quickly;
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adverse changes in the federal, state or local laws and regulations applicable to us, including those affecting rents, zoning, prices of goods, fuel and energy consumption, water and environmental restrictions;
the relative illiquidity of real estate investments;
changing market demographics;
an inability to acquire and finance, or refinance, properties on favorable terms, if at all;
acts of God, such as earthquakes, floods or other uninsured losses; and
changes or increases in interest rates and availability of financing.
In addition, periods of economic slowdown or recession, or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or increased defaults under existing leases.
We depend on tenants for our revenue, and accordingly, lease terminations and tenant defaults could adversely affect the income produced by our properties.
The success of our investments depends on the financial stability of our tenants. The current economic conditions have adversely affected, and may continue to adversely affect, one or more of our tenants. For example, business failures and downsizings have affected the tenants of our office and industrial properties, and reduced consumer demand for retail products and services has affected the tenants of our retail properties. In addition, our retail shopping center properties typically are anchored by large, nationally recognized tenants, any of which may experience a downturn in their business that may weaken significantly their financial condition. Further, mergers or consolidations among large retail establishments could result in the closure of existing stores or duplicate or geographically overlapping store locations, which could include tenants at our retail properties.
As a result of these factors, our tenants may delay lease commencements, decline to extend or renew their leases upon expiration, fail to make rental payments when due, or declare bankruptcy. Any of these actions could result in the termination of the tenants’ leases, the expiration of existing leases without renewal, or the loss of rental income attributable to the terminated or expired leases. In the event of a tenant default or bankruptcy, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment and re-leasing our property. Specifically, a bankruptcy filing by, or relating to, one of our tenants or a lease guarantor would bar efforts by us to collect pre-bankruptcy debts from that tenant or lease guarantor, or its property, unless we receive an order permitting us to do so from the bankruptcy court. In addition, we cannot evict a tenant solely because of bankruptcy. The bankruptcy of a tenant or lease guarantor could delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude collection of these sums. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy balances due under the lease must be paid to us in full. If, however, a lease is rejected by a tenant in bankruptcy, we would have only a general, unsecured claim for damages. An unsecured claim would only be paid to the extent that funds are available and only in the same percentage as is paid to all other holders of general, unsecured claims. Restrictions under the bankruptcy laws further limit the amount of any other claims that we can make if a lease is rejected. As a result, it is likely that we would recover substantially less than the full value of the remaining rent during the term.
Two of our tenants generated a significant portion of our revenue, and rental payment defaults by these significant tenants could adversely affect our results of operations.
For the year ended December 31, 2011, approximately 9% of our rental revenue was generated by over 400 retail banking properties leased to SunTrust Bank. Also, for the year ended December 31, 2011, approximately 7% of our rental revenue was generated by three properties leased to AT&T, Inc. The lease for one of the AT&T
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properties, with approximately 1.7 million square feet, expires in 2016. As a result of the concentration of revenue generated from these properties, if either SunTrust or AT&T were to cease paying rent or fulfilling its other monetary obligations, we could have significantly reduced rental revenues or higher expenses until the defaults were cured or the properties were leased to a new tenant or tenants.
We may suffer adverse consequences due to the financial difficulties, bankruptcy or insolvency of our tenants.
Recent economic conditions have caused, and may continue to cause, our tenants to experience financial difficulties, including bankruptcy, insolvency, or a general downturn in their business. The retail sector in particular has been, and could continue to be, adversely affected by weakness in the national, regional and local economies, the level of consumer spending and consumer confidence, the adverse financial condition of some large retailing companies, the ongoing consolidation in the retail sector, the excess amount of retail space in a number of markets and increasing competition from discount retailers, outlet malls, internet retailers and other online businesses. We cannot provide assurance that any tenant that files for bankruptcy protection will continue to pay us rent. A bankruptcy filing by, or relating to, one of our tenants or a lease guarantor would bar efforts by us to collect pre-bankruptcy debts from that tenant or lease guarantor, or its property, unless we receive an order permitting us to do so from the bankruptcy court. In addition, we cannot evict a tenant solely because of bankruptcy. The bankruptcy of a tenant or lease guarantor could delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude collection of these sums. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy balances due under the lease must be paid to us in full. If, however, a lease is rejected by a tenant in bankruptcy, we would have only a general, unsecured claim for damages. An unsecured claim would only be paid to the extent that funds are available and only in the same percentage as is paid to all other holders of general, unsecured claims. Restrictions under the bankruptcy laws further limit the amount of any other claims that we can make if a lease is rejected. As a result, it is likely that we would recover substantially less than the full value of the remaining rent during the term.
Leases representing approximately 5.4% of the rentable square feet of our retail, office, and industrial portfolio are scheduled to expire in 2012. We may be unable to renew leases or lease vacant space at favorable rates or at all.
As of December 31, 2011, leases representing approximately 5.4% of the 49,267,633 rentable square feet of our retail, office, and industrial portfolio were scheduled to expire in 2012, and an additional 7.0% of the square footage of our retail, office, and industrial portfolio was available for lease. We may be unable to extend or renew any of these leases, or we may be able to lease these spaces only at rental rates equal to or below existing rental rates. In addition, some of our tenants have leases that include early termination provisions that permit the lessee to terminate all or a portion of its lease with us after a specified date or upon the occurrence of certain events with little or no liability to us. We may be required to offer substantial rent abatements, tenant improvements, early termination rights or below-market renewal options to retain these tenants or attract new ones. Portions of our properties may remain vacant for extended periods of time. Further, some of our leases currently provide tenants with options to renew the terms of their leases at rates that are less than the current market rate or to terminate their leases prior to the expiration date thereof. If we are unable to obtain new rental rates that are on average comparable to our asking rents across our portfolio, then our ability to generate cash flow growth will be negatively impacted.
We may be required to make significant capital expenditures to improve our properties in order to retain and attract tenants.
We expect that, upon the expiration of leases at our properties, we may be required to make rent or other concessions to tenants, accommodate requests for renovations, build-to-suit remodeling and other improvements or provide additional services to our tenants. As a result, we may have to pay for significant leasing costs or tenant improvements in order to retain tenants whose leases are expiring and to attract new tenants in sufficient numbers. Additionally, we may need to raise capital to make such expenditures. If we are unable to do so or
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capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in non-renewals by tenants upon expiration of their leases, which would result in declines in revenues from operations.
We face significant competition in the leasing market, which may decrease or prevent increases in the occupancy and rental rates of our properties.
We own properties located throughout the United States. We compete with numerous developers, owners and operators of commercial properties, many of which own properties similar to, and in the same market areas as, our properties. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge in order to attract new tenants and retain existing tenants when their leases expire. Also, if our competitors develop additional properties in locations near our properties, there may be increased competition for creditworthy tenants, which may require us to make capital improvements to properties that we would not have otherwise made.
Geographic concentration of our portfolio may make us particularly susceptible to adverse economic developments in the real estate markets of those areas or natural disasters in those areas.
Because our properties are concentrated in certain geographic areas, our operating results are likely to be impacted by economic changes affecting the real estate markets in those areas. As of December 31, 2011, approximately, 4%, 5%, 7% and 12% of our base rental income of our consolidated portfolio, excluding our lodging facilities, was generated by properties located in the Minneapolis, Dallas, Chicago and Houston metropolitan areas, respectively.
Additionally, at December 31, 2011, 34 of our lodging facilities, or approximately 36% of our lodging portfolio, were located in Washington D.C. and the eight eastern seaboard states ranging from Connecticut to Florida, which includes 11 hotels in North Carolina. Additionally, 19 properties were located in Texas. Adverse events in these areas, such as recessions, hurricanes or other natural disasters, could cause a loss of revenues from these hotels. Further, several of the hotels are located near the water and are exposed to more severe weather than hotels located inland. Elements such as salt water and humidity can increase or accelerate wear on the hotels’ weatherproofing and mechanical, electrical and other systems, and cause mold issues. As a result, we may incur additional operating costs and expenditures for capital improvements at these hotels. Geographic concentration also exposes us to risks of oversupply and competition in these markets. Significant increases in the supply of certain property types, including hotels, without corresponding increases in demand could have a material adverse effect on our financial condition, results of operations and our ability to pay distributions.
To qualify as a REIT, we must rely on third parties to operate our hotels.
To continue qualifying as a REIT, we may not, among other things, operate any hotel, or directly participate in the decisions affecting the daily operations of any hotel. Thus, we have retained third party managers to operate our hotel properties. We do not have the authority to directly control any particular aspect of the daily operations of any hotel, such as setting room rates. Thus, even if we believe our hotels are being operated in an inefficient or sub-optimal manner, we may not be able to require an immediate change to the method of operation. Our only alternative for changing the operation of our hotels may be to replace the third party manager of one or more hotels in situations where the applicable management agreement permits us to terminate the existing manager. Certain of these agreements may not be terminated without cause, which generally requires fraud, misrepresentation and other illegal acts. Even if we terminate or replace any manager, there is no assurance that we will be able to find another manager or that we will be able to enter into new management agreements favorable to us. Any change of hotel management would cause a disruption in operations.
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Conditions of franchise agreements could adversely affect us.
Our lodging properties are operated pursuant to agreements with nationally recognized franchisors including Marriott International, Inc., Hilton Hotels Corporation, Intercontinental Hotels Group PLC, Hyatt Corporation, Wyndham Worldwide Corporation and Choice Hotels International. These agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of a hotel in order to maintain uniformity within the franchisor’s system. These standards are subject to change over time, in some cases at the discretion of the franchisor, and may restrict our ability to make improvements or modifications to a hotel, causing us to incur significant costs, without the consent of the franchisor. Conversely, these standards may require us to make certain improvements or modifications to a hotel, even if we do not believe the capital improvements are necessary or desirable or will result in an acceptable return on our investment.
These agreements also permit the franchisor to terminate the agreement in certain cases such as a failure to pay royalties and fees or to perform under covenants under the franchise agreement, bankruptcy, abandonment of the franchise, commission of a felony, assignment of the franchise without the consent of the franchisor or failure to comply with applicable law or maintain applicable standards in the operation and condition of the relevant hotel. If a franchise license terminates due to our failure to comply with the terms and conditions of the agreement, we may be liable to the franchisor for a termination payment. These payments vary. Also, these franchise agreements do not renew automatically.
Actions of our joint venture partners could negatively impact our performance.
As of December 31, 2011 we had entered into joint venture agreements with 11 entities to fund the investment of office, industrial/distribution, retail, lodging, and mixed use properties. The carrying value of our investment in these joint ventures, which we do not consolidate for financial reporting purposes, was $317 million. For the year ended December 31, 2011, we recorded losses of $13 million and impairments net of gains of $106 million associated with these ventures.
With respect to these investments, we are not in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity. Consequently, our joint venture investments may involve risks not otherwise present with other methods of investing in real estate. For example, our co-member, co-venturer or partner may have economic or business interests or goals which are or which become inconsistent with our business interests or goals or may take action contrary to our instructions or requests or contrary to our policies or objectives. We have experienced these events from time to time with our current venture partners, which in some cases has resulted in litigation with these partners. There can be no assurance that an adverse outcome in any lawsuit will not have a material effect on our results of operations for any particular period. In addition, any litigation increases our expenses and prevents our officers and directors from focusing their time and effort on other aspects of our business. Our relationships with our venture partners are contractual in nature. These agreements may restrict our ability to sell our interest when we desire or on advantageous terms and, on the other hand, may be terminated or dissolved under the terms of the agreements and, in each event, we may not continue to own or operate the interests or assets underlying the relationship or may need to purchase these interests or assets at an above-market price to continue ownership.
Current credit market disruptions and recent economic trends may increase the likelihood of a commercial developer defaulting on its obligations with respect to our development projects, including projects where we have notes receivable, or becoming bankrupt or insolvent.
We have entered into, and may continue to enter into, projects that are in various stages of pre-development and development. Investing in properties under development, and in lodging facilities in particular, which typically must be renovated or otherwise improved on a regular basis, including renovations and improvements required by existing franchise agreements, subjects us to uncertainties such as the ability to achieve desired zoning for
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development, environmental concerns of governmental entities or community groups, ability to control construction costs or to build in conformity with plans, specifications and timetables. The current economic climate has continued to impact real estate developments as well. The current slow-down in consumer spending has negatively impacted the retail environment in particular, and is causing many retailers to reduce new leasing and expansion plans. We believe that our retail developments will experience longer lease-up periods and that actual lease rates will be less than the leasing rates originally underwritten.
In addition, recent economic conditions have caused an increase in developer failures. The developers of the projects in which we have invested are exposed to risks not only with respect to our projects, but also other projects in which they are involved. A default by a developer in respect of one of our development project investments, or the bankruptcy, insolvency or other failure of a developer for one of these projects, may require that we determine whether we want to assume the senior loan, fund monies beyond what we are contractually obligated to fund, take over development of the project, find another developer for the project, or sell our interest in the project. Developer failures could give tenants the right to terminate pre-construction leases, delay efforts to complete or sell the development project and could ultimately preclude us from realizing our anticipated returns. These events could cause a decrease in the value of our assets and compel us to seek additional sources of liquidity, which may or may not be available, in order to hold and complete the development project.
Generally, under bankruptcy law and the bankruptcy guarantees we have required of certain of our joint venture development partners, we may seek recourse from the developer-guarantor to complete our development project with a substitute developer partner. However, in the event of a bankruptcy by the developer-guarantor, we cannot provide assurance that the developer or its trustee will satisfy its obligations. The bankruptcy of any developer or the failure of the developer to satisfy its obligations would likely cause us to have to complete the development or find a replacement developer on our own, which could result in delays and increased costs. We cannot provide assurance that we would be able to complete the development on terms as favorable as when we first entered into the project. If we are not able to, or elect not to, proceed with a development opportunity, the development costs ordinarily would be charged against income for the then-current period if we determine our costs are not recoverable.
Sale leaseback transactions may be recharacterized in a manner unfavorable to us.
From time to time we have entered into a sale leaseback transaction where we purchase a property and then lease the property to the seller. These transactions could, however, be characterized as a financing instead of a sale in the case of the seller’s bankruptcy. In this case, we would not be treated as the owner of the property but rather as a creditor with no interest in the property itself. The seller may have the ability in a bankruptcy proceeding to restructure the financing by imposing new terms and conditions. The transaction also may be recharacterized as a joint venture. In this case, we would be treated as a joint venturer with liability, under some circumstances, for debts incurred by the seller relating to the property.
Our investments in equity and debt securities have materially impacted, and may in the future materially impact, our results.
As of December 31, 2011, we had investments valued at $289 million in real estate related equity and debt securities. Real estate related equity securities are always unsecured and subordinated to other obligations of the issuer. Investments in real estate-related equity securities are subject to numerous risks including: (1) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities; (2) substantial market price volatility resulting from, among other things, changes in prevailing interest rates in the overall market or related to a specific issuer, as well as changing investor perceptions of the market as a whole, REIT or real estate securities in particular or the specific issuer in question; (3) subordination to the liabilities of the issuer; (4) the possibility that earnings of the issuer may be insufficient to meet its debt service obligations or to pay distributions; and (5) with respect to investments in real estate-related preferred equity securities, the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause
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the issuer to redeem the securities. In addition, investments in real estate-related securities involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related securities generally invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed herein. In fact, many of the entities that we have invested in have reduced the dividends paid on their securities. The stock prices for some of these entities have declined since our initial purchase, and in certain cases we have sold these investments at a loss.
Any mortgage loans that we originate or purchase are subject to the risks of delinquency and foreclosure.
We may originate and purchase mortgage loans. These loans are subject to risks of delinquency and foreclosure, and risks of loss. The ability of a borrower to repay a loan secured by an income-producing property depends primarily upon the successful operation of the property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. A property’s net operating income can be affected by the any of the potential issues associated with real estate-related investments as discussed herein. We bear the risks of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to that borrower will be deemed to be collateralized only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure of a mortgage loan can be an expensive and lengthy process that could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. We may also be forced to foreclose on certain properties, be unable to sell these properties and be forced to incur substantial expenses to improve operations at the property.
We may make a mortgage loan to affiliates of, or entities sponsored by, our sponsor.
If we have excess working capital, we may, from time to time, and subject to the conditions in our articles, make a mortgage loan to affiliates of, or entities sponsored by, our sponsor. These loan arrangements will not be negotiated at arm’s length and may contain terms and conditions that are not in our best interest and would not otherwise be applicable if we entered into arrangements with a third-party borrower not affiliated with these entities.
An increase in real estate taxes may decrease our income from properties.
From time to time, the amount we pay for property taxes increases as either property values increase or assessment rates are adjusted. Increases in a property’s value or in the assessment rate result in an increase in the real estate taxes due on that property. If we are unable to pass the increase in taxes through to our tenants, our net operating income for the property decreases.
Uninsured losses or premiums for insurance coverage may adversely affect a stockholder’s returns.
We attempt to adequately insure all of our properties against casualty losses. There are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters that are uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments. Risks associated with potential acts of terrorism could sharply increase the premiums we pay for coverage against property and casualty claims. Additionally, mortgage lenders sometimes require commercial property owners to purchase specific coverage against terrorism as a condition for providing mortgage loans. These policies may not be available at a reasonable cost, if at all, which could inhibit our ability to finance or refinance our properties. In such instances, we may be required to provide
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other financial support, either through financial assurances or self-insurance, to cover potential losses. If we incur any casualty losses not fully covered by insurance, the value of our assets will be reduced by the amount of the uninsured loss. In addition, other than any reserves we may establish, we have no designated source of funding to repair or reconstruct any uninsured damaged property.
Terrorist attacks and other acts of violence or war may affect the markets in which we operate, our operations and our profitability.
We own estate assets located in areas that are susceptible to attack. These attacks may directly impact the value of our assets through damage, destruction, loss or increased security costs. Although we may obtain terrorism insurance, we may not be able to obtain sufficient coverage to fund any losses we may incur. Risks associated with potential acts of terrorism could sharply increase the premiums we pay for coverage against property and casualty claims. Further, certain losses resulting from these types of events are uninsurable or not insurable at reasonable costs.
More generally, any terrorist attack, other act of violence or war, including armed conflicts, could result in increased volatility in, or damage to, the United States and worldwide financial markets and economy. Any terrorist incident may, for example, deter people from traveling, which could affect the ability of our hotels to generate operating income and therefore our ability to pay distributions. Additionally, increased economic volatility could adversely affect our tenants’ ability to pay rent on their leases or our ability to borrow money or issue capital stock at acceptable prices.
The cost of complying with environmental and other governmental laws and regulations may adversely affect us.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations (including those of foreign jurisdictions) relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. We also are required to comply with various local, state and federal fire, health, life-safety and similar regulations. Some of these laws and regulations may impose joint and several liability on tenants or owners for the costs of investigating or remediating contaminated properties. These laws and regulations often impose liability whether or not the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. The cost of removing or remediating could be substantial. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell or rent a property or to use the property as collateral for borrowing.
Environmental laws and regulations also may impose restrictions on the manner in which properties may be used or businesses may be operated, and these restrictions may require substantial expenditures by us. Environmental laws and regulations provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Third parties may seek recovery from owners of real properties for personal injury or property damage associated with exposure to released hazardous substances. Compliance with new or more stringent laws or regulations or stricter interpretations of existing laws may require material expenditures by us. For example, various federal, regional and state laws and regulations have been implemented or are under consideration to mitigate the effects of climate change caused by greenhouse gas emissions. Among other things, “green” building codes may seek to reduce emissions through the imposition of standards for design, construction materials, water and energy usage and efficiency, and waste management. We are not aware of any such existing requirements that we believe will have a material impact on our current operations. However, future requirements could increase the costs of maintaining or improving our existing properties or developing new properties.
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Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.
The presence of mold at any of our properties could require us to undertake a costly program to remediate, contain or remove the mold. Mold growth may occur when moisture accumulates in buildings or on building materials. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing because exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. The presence of mold could expose us to liability from our tenants, their employees and others if property damage or health concerns arise.
We may incur significant costs to comply with the Americans With Disabilities Act.
Our properties generally are subject to the Americans With Disabilities Act of 1990, as amended. Under this act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The act has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services be made accessible and available to people with disabilities. The act’s requirements could require us to remove access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages.
Risks Associated with Debt Financing
Borrowings may reduce the funds available for distribution and increase the risk of loss since defaults may cause us to lose the properties securing the loans.
We have acquired, and may continue to acquire, real estate assets by using either existing financing or borrowing new monies. Our articles generally limit the total amount we may borrow to 300% of our net assets. In addition, we may obtain loans secured by some or all of our properties or other assets to fund additional acquisitions or operations including to satisfy the requirement that we distribute at least 90% of our annual “REIT taxable income” (subject to certain adjustments) to our stockholders, or as is otherwise necessary or advisable to assure that we qualify as a REIT for federal income tax purposes. Payments required on any amounts we borrow reduce the funds available for, among other things, distributions to our stockholders because cash otherwise available for distribution is required to pay principal and interest associated with amounts we borrow.
Defaults on loans secured by a property we own may result in us losing the property or properties securing the loan that is in default as a result of foreclosure actions initiated by a lender. For tax purposes, a foreclosure would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the property. If the outstanding balance of the debt exceeds our tax basis in the property, we would recognize taxable gain on the foreclosure but would not receive any cash proceeds. We also may fully or partially guarantee any monies that subsidiaries borrow to purchase or operate real estate assets. In these cases, we will be responsible to the lender for repaying the loans if the subsidiary is unable to do so. If any mortgage contains cross-collateralization or cross-default provisions, more than one property may be affected by a default.
Lenders may restrict certain aspects of our operations, which could, among other things, limit our ability to make distributions.
The terms and conditions contained in any of our loan documents may require us to maintain cash reserves; limit the aggregate amount we may borrow on a secured and unsecured basis; require us to satisfy restrictive financial covenants; prevent us from entering into certain business transactions, such as a merger, sale of assets or other business combination; restrict our leasing operations; or require us to obtain consent from the lender to complete transactions or make investments that are ordinarily approved only by our board of directors. In addition, secured lenders typically restrict our ability to discontinue insurance coverage on a mortgaged property even though we may believe that the insurance premiums paid to insure against certain losses, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters, are greater than the potential risk of loss.
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Interest-only indebtedness may increase our risk of default.
We have obtained, and continue to incur interest related to, interest-only mortgage indebtedness. During the interest only period, the amount of each scheduled payment is less than that of a traditional amortizing mortgage loan. The principal balance of the mortgage loan is not reduced (except in the case of prepayments) because there are no scheduled monthly payments of principal during this period. After the interest-only period, we are required either to make scheduled payments of amortized principal and interest or to make a lump-sum or “balloon” payment at maturity. These required principal or balloon payments increase the amount of our scheduled payments and may increase our risk of default under the related mortgage loan and reduce the funds available for distribution to our stockholders.
Increases in interest rates could increase the amount of our debt payments.
As of December 31, 2011, approximately $1.5 billion of our indebtedness bore interest at variable rates. Increases in interest rates in variable rate debt that has not otherwise been hedged through the use of swap agreements reduce the funds available for other needs, including distribution to our stockholders. As fixed rate debt matures, we may not be able to secure low fixed rate financing. In addition, if rising interest rates cause us to need additional capital to repay indebtedness, we may be forced to sell one or more of our properties or investments in real estate at times which may not permit us to realize the return on the investments we would have otherwise realized.
To hedge against interest rate fluctuations, we use derivative financial instruments, which may be costly and ineffective.
From time to time, we use derivative financial instruments to hedge exposures to changes in interest rates on certain loans secured by our assets. Our derivative instruments currently consist of interest rate swap contracts but may, in the future, include, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions are determined in light of the facts and circumstances existing at the time of the hedge. There is no assurance that our hedging strategy will achieve our objectives. We may be subject to costs, such as transaction fees or breakage costs, if we terminate these arrangements.
To the extent that we use derivative financial instruments to hedge against interest rate fluctuations, we are exposed to credit risk, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. Finally, legal enforceability risks encompass general contractual risks including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract. A counterparty could fail, shut down, file for bankruptcy or be unable to pay out contracts. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract to cover our risk. We cannot provide assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
Further, the REIT provisions of the Code may limit our ability to hedge the risks inherent to our operations. We may be unable to manage these risks effectively.
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We may be contractually obligated to purchase property even if we are unable to secure financing for the acquisition.
We typically finance a portion of the purchase price for each property that we acquire. However, to ensure that our offers are as competitive as possible, we generally do not enter into contracts to purchase property that include financing contingencies. Thus, we may be contractually obligated to purchase a property even if we are unable to secure financing for the acquisition. In this event, we may choose to close on the property by using cash on hand, which would result in less cash available for our operations and distributions to stockholders. Alternatively, we may choose not to close on the acquisition of the property and default on the purchase contract. If we default on any purchase contract, we could lose our earnest money and become subject to liquidated or other contractual damages and remedies.
Risks Related to Our Common Stock
There is no public market for our shares, and you may not be able to sell your shares, including through our share repurchase program.
There is no public market for our shares and no assurance that one may develop. Our charter does not require our directors to seek stockholder approval to liquidate our assets by a specified date, nor does our charter require our directors to list our shares for trading by a specified date. Further, our amended and restated share repurchase program permits us to repurchase shares only from a beneficiary of a stockholder that has died or from stockholders that have a qualifying disability or that are confined to a long-term care facility.
There is no assurance that we will be able to continue paying cash distributions or that distributions will increase over time.
We intend to continue paying regular monthly cash distributions to our stockholders. However, there are many factors that can affect the availability and timing of cash distributions to stockholders such as our ability to earn positive yields on our real estate assets, the yields on securities of other entities in which we invest, our operating expense levels, as well as many other variables. Actual cash available for distributions may vary substantially from estimates. There is no assurance that we will be able to continue paying distributions at the current level or that the amount of distributions will increase, or not decrease, over time. Even if we are able to continue paying distributions, the actual amount and timing of distributions is determined by our board of directors in its discretion and typically depends on the amount of funds available for distribution, which depends on items such as current and projected cash requirements and tax considerations. As a result, our distribution rate and payment frequency may vary from time to time.
Funding distributions from sources other than cash flow from operating activities may negatively impact our ability to sustain or pay distributions and will result in us having less cash available for other uses.
If our cash flow from operating activities is not sufficient to fully fund the payment of distributions, the level of our distributions may not be sustainable and some or all of our distributions will be paid from other sources. For example, from time to time, our business manager has determined, in its sole discretion, to either forgo or defer a portion of the business management fee, which has had the effect of increasing cash flow from operations for the relevant period because we have not had to use that cash to pay any fee or reimbursement which was foregone or deferred during the relevant period. For the year ended December 31, 2011, we paid a business management fee of $40 million, or approximately 0.35% of our average invested assets on an annual basis, as well as an investment advisory fee of approximately $1.6 million, together which are less than the full 1% fee that the business manager could be paid. However, there is no assurance that our business manager will forgo or defer any portion of its business management fee in the future. Further, we would need to use cash at some point in the future to pay any fee or reimbursement that is deferred. We also may use cash from financing activities, components of which may include borrowings (including borrowings secured by our assets), as well as proceeds from the sales of our properties, to fund distributions. To the extent distributions are paid from financing activities, we will have less money available for other uses, such as cash needed to refinance existing indebtedness.
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Risks Related to Conflicts of Interest
There are conflicts of interest between us and affiliates of our sponsor that may affect our acquisition of properties and financial performance.
During the ten years ended December 31, 2011, our sponsor and Inland Private Capital Corporation (“IPCC”) had sponsored, in the aggregate, three other REITs and 107 real estate exchange private placement limited partnerships and limited liability companies. Two of the REITs, Inland Diversified Real Estate Trust, Inc. and Inland Monthly Income Trust, Inc., are, or in the case of Inland Monthly Income Trust will be, managed by affiliates of our business manager. Two other REITs, Inland Real Estate Corporation and Inland Western Retail Real Estate Trust, Inc., are self-managed, but our sponsor and its affiliates continue to hold a significant investment in these entities. We may be seeking to buy real estate assets at the same time as certain of these other programs. Further, certain programs sponsored by our sponsor or IPCC own and manage the type of properties that we own, and in the same geographical areas in which we own them. Therefore, our properties may compete for tenants with other properties owned and managed by these other programs. Persons performing services for our property managers may face conflicts of interest when evaluating tenant leasing opportunities for our properties and other properties owned and managed by these programs, and these conflicts of interest may have an adverse impact on our ability to attract and retain tenants.
Our sponsor may face a conflict of interest in allocating personnel and resources between its affiliates, our business manager and our property managers.
We rely, to a great extent, on persons performing services for our business manager and property managers and their affiliates to manage our day-to-day operations. Some of these persons also provide services to one or more investment programs previously sponsored by our sponsor. These individuals face competing demands for their time and service and may have conflicts in allocating their time between our business and assets and the business and assets of our sponsor, its affiliates and the other programs formed and organized by our sponsor. In addition, if another investment program sponsored by our sponsor decides to internalize its management functions in the future, it may do so by hiring and retaining certain of the persons currently performing services for our business manager and property managers, and if it did so, would likely not allow these persons to perform services for us.
We do not have arm’s-length agreements with our business manager, our property managers or any other affiliates of our sponsor.
None of the agreements and arrangements with our business manager, our property managers or any other affiliates of our sponsor was negotiated at arm’s-length. These agreements may contain terms and conditions that are not in our best interest and would not otherwise be applicable if we entered into arm’s length agreements with third parties.
Our business manager and its affiliates face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our stockholders.
We pay significant fees to our business manager, property managers and other affiliates of our sponsor for services provided to us. Most significantly, our business manager receives fees based on the aggregate book value, including acquired intangibles, of our invested assets. Further, our property managers receive fees based on the gross income from properties under management. Other parties related to, or affiliated with, our business manager or property managers may also receive fees or cost reimbursements from us. These compensation arrangements may cause these entities to take or not take certain actions. For example, these arrangements may provide an incentive for our Business Manager to borrow more money than prudent to increase the amount we can invest. Ultimately, the interests of these parties in receiving fees may conflict with the interest of our stockholders in earning income on their investment in our common stock.
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We rely on entities affiliated with our sponsor to identify real estate assets.
We rely on Inland Real Estate Acquisitions, Inc. (“IREA”) and other affiliates of our sponsor to identify suitable investment opportunities for us. Other public or private programs sponsored by our sponsor or IPCC also rely on these entities to identify potential investments. These entities have, in some cases, rights of first refusal or other pre-emptive rights to the properties that IREA identifies. Our right to acquire properties identified by IREA is subject to the exercise of any prior rights vested in these entities. We may not, therefore, be presented with opportunities to acquire properties that we otherwise would be interested in acquiring.
Risks Related to Our Organization and Structure
Stockholders have limited control over changes in our policies and operations.
Our board of directors determines our major policies, including those regarding investment policies and strategies, financing, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise certain of these and other policies without a vote of the stockholders.
Stockholders’ interest in us will be diluted if we issue additional shares.
Stockholders do not have preemptive rights to any shares issued by us in the future. Our articles authorize us to issue up to 1.5 billion shares of capital stock, of which 1.46 billion shares are designated as common stock and 40 million are designated as preferred stock. Future issuances of common stock, including issuances through our distribution reinvestment plan (“DRP”), will reduce the percentage of our shares owned by our current stockholders who do not participate in future stock issuances. Stockholders generally will not be entitled to vote on whether or not we issue additional shares. In addition, depending on the terms and pricing of an additional offering of our shares and the value of our properties, our stockholders may experience dilution in both the book value and fair value of their shares. Further, our board could authorize the issuance of stock with terms and conditions that could subordinate the rights of the holders of our current common stock or have the effect of delaying, deferring or preventing a change in control in 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 our stockholders.
Stockholders’ returns may be reduced if we are required to register as an investment company under the Investment Company Act.
We are not registered, and do not intend to register our company or any of our subsidiaries, as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). If we become obligated to register our company or any of our subsidiaries as an investment company, the registered entity would have to comply with a variety of substantive requirements under the Investment Company Act imposing, 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.
We intend to continue conducting our operations, directly and through wholly or majority-owned subsidiaries, so that we and each of our subsidiaries continue to be exempt from registration as an investment company under the Investment Company Act. Under Section 3(a)(1)(A) of the Investment Company Act, a company is not deemed to be an “investment company” if it neither is, nor holds itself out as being, engaged primarily, nor proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of
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the Investment Company Act, a company is not deemed to be an “investment company” if it neither is engaged, nor proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and does not own or propose to acquire “investment securities” having a value exceeding 40% of the value of its total assets on an unconsolidated basis, which we refer to as the “40% test.”
We believe that we and most, if not all, of our wholly and majority-owned subsidiaries are not considered investment companies under either Section 3(a)(1)(A) or Section 3(a)(1)(C) of the Investment Company Act. In the event that the company or any of its wholly or majority-owned subsidiaries would ever inadvertently fall within one of the definitions of “investment company,” we intend to rely on the exception provided by Section 3(c)(5)(C) of the Investment Company Act.
Under Section 3(c)(5)(C), the SEC staff generally requires us to maintain at least 55% of our assets directly in qualifying assets to qualify for this exception. Mortgage-backed securities may or may not constitute qualifying assets, depending on the characteristics of the mortgage-backed securities, including the rights that we have with respect to the underlying loans. Our ownership of mortgage-backed securities, therefore, is limited by provisions of the Investment Company Act and SEC staff interpretations.
The method we use to classify our assets for purposes of the Investment Company Act is based in large measure upon no-action positions taken by the SEC staff in the past. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action positions were issued more than ten years ago. No assurance can be given that the SEC staff will concur with our classification of our assets. In addition, the SEC staff may, in the future, issue further guidance that may require us to re-classify our assets for purposes of qualifying for exemption from regulation under the Investment Company Act. If we are required to re-classify our assets, we may no longer be in compliance with the exclusion from the definition of an “investment company” provided by Section 3(c)(5)(C) of the Investment Company Act.
A change in the value of any of our assets could cause us to fall within the definition of “investment company” and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. To avoid being required to register our company or any of our subsidiaries as an investment company under the Investment Company Act, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire interests in companies that we would otherwise want to acquire and would be important to our investment strategy.
If we were required to register the company as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
Maryland law and our organizational documents limit a stockholder’s right to bring claims against our officers and directors.
Subject to the limitations set forth in our articles, a director will not have any liability for monetary damages under Maryland law so long as he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interest, and with the care that an ordinary prudent person in a like position would use under similar circumstances. In addition, our articles, in the case of our directors, officers, employees and agents, and the business management agreement and the property management agreements, in the case of our business manager and property managers, respectively, require us to indemnify these persons for actions taken by them in good faith and without negligence or misconduct, or, in the case of our independent directors, actions taken in good faith without gross negligence or willful misconduct. As a result, we and our stockholders may
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have more limited rights against these persons than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by these persons in some cases.
Our board of directors may, in the future, adopt certain measures under Maryland law without stockholder approval that may have the effect of making it less likely that stockholders would receive a “control premium” for their shares.
Corporations organized under Maryland law are permitted to protect themselves from unsolicited proposals or offers to acquire the company. Although we are not subject to these provisions, our stockholders could approve an amendment to our articles eliminating this restriction. If we do become subject to these provisions, our board of directors would have the power under Maryland law to, among other things, amend our articles without stockholder approval to:
stagger our board of directors into three classes;
require a two-thirds vote of stockholders to remove directors;
empower only remaining directors to fill any vacancies on the board;
provide that only the board can fix the size of the board;
provide that all vacancies on the board, regardless of how the vacancy was created, may be filled only by the affirmative vote of a majority of the remaining directors in office; and
require that special stockholders meetings be called only by holders of a majority of the voting shares entitled to be cast at the meeting.
These provisions may discourage an extraordinary transaction, such as a merger, tender offer or sale of all or substantially all of our assets, all of which might provide a premium price for a stockholder’s shares.
Further, under the Maryland Business Combination Act, we may not engage in any merger or other business combination with an “interested stockholder” or any affiliate of that interested stockholder for a period of five years after the most recent purchase of stock by the interested stockholder. After the five-year period ends, any merger or other business combination with the interested stockholder must be recommended by our board of directors and approved by the affirmative vote of at least:
80% of all votes entitled to be cast by holders of outstanding shares of our voting stock; and
two-thirds of all of the votes entitled to be cast by holders of outstanding shares of our voting stock other than those shares owned or held by the interested stockholder unless, among other things, our stockholders receive a minimum payment for their common stock equal to the highest price paid by the interested stockholder for its common stock.
Our articles exempt any business combination involving us and The Inland Group or any affiliate of The Inland Group, including our business manager and property managers, from the provisions of this law.
Our articles place limits on the amount of common stock that any person may own without the prior approval of our board of directors.
To qualify as a REIT, no more than 50% of the outstanding shares of our common stock may be beneficially owned, directly or indirectly, by five or fewer individuals at any time during the last half of each taxable year. Our articles prohibit any persons or groups from owning more than 9.8% of our common stock without the prior approval of our board of directors. These provisions may have the effect of delaying, deferring 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 involve a premium price for holders of our common stock. Further, any person or group attempting to purchase shares exceeding these limits could be compelled to sell the additional shares and, as a result, to forfeit the benefits of owning the additional shares.
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Our articles permit our board of directors to issue preferred stock on terms that may subordinate the rights of the holders of our current common stock or discourage a third party from acquiring us.
Our board of directors is permitted, subject to certain restrictions set forth in our articles, to issue up to forty million shares of preferred stock without stockholder approval. Further, subject to certain restrictions set forth in our articles, our board may classify or reclassify any unissued preferred stock and establish the preferences, conversions or other rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms or conditions of redemption of any preferred stock. Thus, our board of directors could authorize us to issue shares of preferred stock with terms and conditions that could subordinate the rights of the holders of our common stock or have the effect of delaying, deferring 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.
Maryland law limits, in some cases, the ability of a third party to vote shares acquired in a “control share acquisition.”
Under the Maryland Control Share Acquisition Act, persons or entities owning “control shares” of a Maryland corporation acquired in a “control share acquisition” have no voting rights with respect to those shares except to the extent approved by a vote of two-thirds of the corporation’s disinterested stockholders. Shares of stock owned by the acquirer or by officers or directors who are employees of the corporation, are not considered disinterested for these purposes. “Control shares” are shares of stock that, taken together with all other shares of stock the acquirer previously acquired, would entitle the acquirer to exercise voting power in electing directors within one of the following ranges of voting power:
one-tenth or more but less than one-third of all voting power;
one-third or more but less than a majority of all voting power; or
a majority or more of all voting power.
Control shares do not include shares of stock the acquiring person is entitled to vote as a result of having previously obtained stockholder approval. A “control share acquisition” means the acquisition of control shares, subject to certain exceptions. The Control Share Acquisition Act does not apply to (1) shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction or (2) acquisitions approved or exempted by our articles or bylaws. Our articles exempt transactions between us and The Inland Group and its affiliates, including our business manager and property managers, from the limits imposed by the Control Share Acquisition Act. This statute could have the effect of discouraging offers from third parties to acquire us and increase the difficulty of successfully completing this type of offer by anyone other than The Inland Group and its affiliates.
Federal Income Tax Risks
If we fail to qualify as a REIT, we will have less cash to distribute to our stockholders.
Our qualification as a REIT depends on our ability to meet requirements regarding our organization and ownership, distributions of our income, the nature and diversification of our income and assets as well as other tests imposed by the Internal Revenue Code of 1986, as amended (the “Code”). We cannot assure you that our actual operations for any one taxable year will satisfy these requirements. Further, new legislation, regulations, administrative interpretations or court decisions could significantly affect our ability to qualify as a REIT and/or the federal income tax consequences of our qualification as a REIT. If we were to fail to qualify as a REIT and did not qualify for certain statutory relief provisions:
we would not be allowed to deduct distributions paid to stockholders when computing our taxable income;
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we would be subject to federal, state and local income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates;
we would be disqualified from being taxed as a REIT for the four taxable years following the year during which we failed to qualify, unless qualify for certain statutory relief provisions;
we would have less cash to pay distributions to stockholders; and
we may be required to borrow additional funds or sell some of our assets in order to pay the corporate tax obligations we may incur as a result of being disqualified.
In addition, if we were to fail to qualify as a REIT, we would not be required to pay distributions to stockholders, and all distributions to stockholders that we did pay would be subject to tax as regular corporate dividends to the extent of our current and accumulated earnings and profits. This means that, under current law, which is subject to change, our U.S. stockholders who are taxed at individual rates would be taxed on our dividends at long-term capital gains rates through 2012 and that our corporate stockholders generally would be entitled to the dividends received deduction with respect to such dividends, subject, in each case, to applicable limitations under the Code.
To maintain REIT status, we may be forced to borrow funds or dispose of assets during unfavorable market conditions to make distributions to our stockholders, which could increase our operating costs and decrease the value of an investment in our company.
To qualify as a REIT, we must distribute 90% of our REIT taxable income (which is determined without regard to the dividends-paid deduction or net capital gain) to our stockholders each year. At times, we may not have sufficient funds to satisfy these distribution requirements and may need to borrow funds or dispose of assets to make these distributions and maintain our REIT status and avoid the payment of income and excise taxes. Our inability to satisfy the distribution requirements with operating cash flow could result from (1) differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes; (2) the effect of non-deductible capital expenditures; (3) the creation of reserves; or (4) required debt amortization payments. We may need to borrow funds at times when market conditions are unfavorable. Further, if we are unable to borrow funds when needed for this purpose, we would have to fund alternative sources of funding or risk losing our status as a REIT.
Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flows.
Even if we qualify for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets. For example:
We will be subject to tax on any 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 plus amounts retained for which federal income tax was paid 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 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 primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transactions” tax.
Our taxable REIT subsidiaries are subject to regular corporate federal, state and local taxes.
We will be subject to a 100% penalty tax on transactions with a taxable REIT subsidiary that are not conducted on an arm’s-length basis.
Any of these taxes would decrease cash available for distributions to our stockholders.
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The prohibited transactions tax may limit our ability to dispose of our properties.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. We may be subject to the prohibited transactions tax equal to 100% of net gain upon a disposition of a property. Although a safe harbor to the characterization of the sale of property by a REIT as a prohibited transaction is available, we cannot assure you that we can comply with the safe harbor or that we will avoid owning property that may be characterized as held primarily for sale to customers in the ordinary course of business. Consequently, we may choose not to engage in certain sales of our properties or may conduct such sales through a taxable REIT subsidiary, which would be subject to federal, state and local income taxation.
We may fail to qualify as a REIT if the Internal Revenue Service (the “IRS”) successfully challenges the valuation of our common stock used for purposes of our DRP.
In order to satisfy the REIT distribution requirements, the dividends we pay must not be “preferential.” A dividend determined to be preferential will not qualify for the dividends paid deduction. To avoid paying preferential dividends, we must treat every stockholder of a class of stock with respect to which we make a distribution the same as every other stockholder of that class, and we must not treat any class of stock other than according to its dividend rights as a class. For example, if certain stockholders receive a distribution that is more or less than the distributions received by other stockholders of the same class, the distribution will be preferential. If any part of a distribution is preferential, none of that distribution will be applied towards satisfying our REIT distribution requirements.
Stockholders participating in our DRP receive distributions in the form of shares of our common stock rather than in cash. Currently, the purchase price per share under our DRP is equal to 100% of the “market price” of a share of our common stock. Because our common stock is not yet listed for trading, for these purposes, “market price” means the fair market value of a share of our common stock, as estimated by us. In the past, our DRP has offered participants the opportunity to acquire newly-issued shares of our common stock at a discount to the “market price.” Pursuant to an IRS ruling, the prohibition on preferential dividends does not prohibit a REIT from offering shares under a distribution reinvestment plan at discounts of up to 5% of fair market value, but a discount in excess of 5% of the fair market value of the shares would be considered a preferential dividend. Any discount we have offered in the past was intended to fall within the safe harbor for such discounts set forth in the ruling published by the IRS. However, the fair market value of our common stock has not been susceptible to a definitive determination. If the purchase price under our DRP is deemed to have been at more than a 5% discount at any time, we would be treated as having paid one or more preferential dividends. Similarly, we would be treated as having paid one or more preferential dividends if the IRS successfully asserted that the value of the common stock distributions paid to stockholders participating in our DRP exceeded on a per-share basis the cash distribution paid to our other stockholders, which could occur if the IRS successfully asserted that the fair market value of our common stock exceeded the “market value” used for purposes of calculating the distributions under our DRP. If we are determined to have paid preferential dividends as a result of our DRP, we would likely fail to qualify as a REIT.
Complying with the REIT requirements may force us to liquidate otherwise attractive investments.
To maintain qualification as a REIT, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets, including shares of stock in other REITs, certain mortgage loans and mortgage-backed securities. The remainder of our investment in securities (other than governmental securities, qualified real estate assets and securities of taxable REIT subsidiaries) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities, qualified real estate assets and securities of taxable REIT subsidiaries) can consist of the securities of any one issuer, and no more than 25% of
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the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within thirty days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments in order to maintain our REIT status.
If our leases are not respected as true leases for federal income tax purposes, we would fail to qualify as a REIT.
To qualify as a REIT, we must satisfy two gross income tests, pursuant to which specified percentages of our gross income must be passive income such as rent. For the rent to we receive under our lease to be treated as qualifying income for purposes of the gross income tests, the leases must be respected as true leases for federal income tax purposes and must not be treated as service contracts, joint ventures or some other type of arrangement. There are no controlling Treasury regulations, published rulings or judicial decisions involving leases with terms substantially the same as our hotel leases that discuss whether such leases constitute true leases for federal income tax purposes. We believe that all of our leases, including our hotel leases, will be respected as true leases for federal income tax purposes. There can be no assurance, however, that the IRS will agree with this characterization. If a significant portion of our leases were not respected as true leases for federal income tax purposes, we would not be able to satisfy either of the two gross income tests and each would likely lose its REIT status.
If MB REIT failed to qualify as a REIT, we would like fail to qualify as a REIT.
We own 100% of the common stock of MB REIT, which owns a significant portion of our properties and has elected to be taxed as a REIT for federal income tax purposes. MB REIT is subject to the various REIT qualification requirements and other limitations that apply to us. We believe that MB REIT has operated and will continue to operate in a manner to permit it to qualify for taxation as a REIT for federal income tax purposes. However, if MB REIT were to fail to qualify as a REIT, then (1) MB REIT would become subject to regular corporation income tax and (2) our ownership of shares MB REIT would cease to be a qualifying real estate asset for purposes of the 75% asset test applicable to REITs and would become subject to the 5% asset test, the 10% vote test, and the 10% value test generally applicable to our ownership in corporations other than REITs, qualified REIT subsidiaries and taxable REIT subsidiaries. If MB REIT were to fail to qualify as a REIT, we would not satisfy the 5% asset test, the 10% value test, or the 10% vote test, in which event we would fail to qualify as a REIT unless we qualified for certain statutory relief provisions.
If our hotel managers do not qualify as “eligible independent contractors,” we would fail to qualify as a REIT.
Rent paid by a lessee that is a “related party tenant” of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. We lease our hotels to our certain of our taxable REIT subsidiaries. A taxable REIT subsidiary will not be treated as a “related party tenant,” and will not be treated as directly operating a lodging facility, which is prohibited, to the extent that hotels that our taxable REIT subsidiaries lease are managed by an “eligible independent contractor.”
We believe that the rent paid by our taxable REIT subsidiaries that lease our hotels is qualifying income for purposes of the REIT gross income tests and that our taxable REIT subsidiaries qualify to be treated as “taxable REIT subsidiaries” for federal income tax purposes, but there can be no assurance that the IRS will not challenge this treatment or that a court would not sustain such a challenge. If the IRS successfully challenged this treatment, we would likely fail to satisfy the asset tests applicable to REITs and a significant portion of our income would fail to qualify for the gross income tests. If we failed to satisfy either the asset or gross income tests, we would likely lose our REIT qualification for federal income tax purposes, unless we qualified for certain statutory relief provisions.
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If our hotel managers do not qualify as “eligible independent contractors,” we may fail to qualify as a REIT. Each of the hotel management companies that enters into a management contract with our taxable REIT subsidiaries that lease our hotels must qualify as an “eligible independent contractor” under the REIT rules in order for the rent paid to us by taxable REIT subsidiaries to be qualifying income for gross income tests. Among other requirements, in order to qualify as an eligible independent contractor, (1) a manager must be actively engaged in the trade or business of operating hotels for third parties at the time the manger enters into a management contract with a taxable REIT subsidiary lessee and (2) the manager must not own more than 35% of our outstanding shares (by value) and no person or group of persons can own more than 35% of our outstanding shares and the ownership interests of the manager. Although we believe that all of our hotel managers qualify as eligible independent contractors, no complete assurance can be provided that the IRS will not successfully challenge that position.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code may limit our ability to hedge the risks inherent to our operations. Under current law, any income that we generate from derivatives or other transactions intended to hedge our interest rate risk with respect to borrowings made to acquire or carry real estate assets generally will not constitute gross income for purposes of the two gross income tests applicable to REITs, so long as we clearly identify any such transactions as hedges for tax purposes before the close of the day on which they are acquired or entered into and we satisfy other identification requirements. In addition, any income from other hedging transactions would generally not constitute gross income for purposes of both the gross income tests. Accordingly, we may have to limit the use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes than we would otherwise incur.
Legislative or regulatory action could adversely affect you.
Changes to the tax laws are likely to occur, and these changes may adversely affect the taxation of our stockholders. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. You are urged to consult with your own tax advisor with respect to the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares.
The maximum tax rate on qualified dividends paid by corporations to stockholders taxed at individual rates is 15% through 2012. REIT dividends, however, generally do not constitute qualified dividends and consequently are not eligible for favorable capital gains tax rates. Therefore, our stockholders will pay federal income tax on our dividends (other than capital gains dividends, dividends designated as qualified dividends (generally, qualified dividend income received by us from a taxable REIT subsidiary or other corporate investment or previously taxable to us in a prior year as undistributed income) or distributions which represent a return of capital or in excess of tax basis for tax purposes) at the applicable “ordinary income” rate, the maximum of which is 35% through 2012. However, as a REIT, we generally would not be subject to federal or state corporate income taxes on that portion of our ordinary income or capital gain that we distribute currently to our stockholders, and we thus expect to avoid the “double taxation” to which other corporations are typically subject.
Future legislation might result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be taxed, for federal income tax purposes, as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a corporation, without the vote of our stockholders. Our board of directors has fiduciary duties to us and our stockholders and could only cause changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.
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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We own interests in retail, office, industrial, multi-family and lodging properties. As of December 31, 2011, we, directly or indirectly, including through joint ventures in which we have a controlling interest, owned an interest in 869 properties, excluding our lodging and development properties, located in 35 states and the District of Columbia. In addition, we, through our wholly-owned subsidiaries, Inland American Winston Hotels, Inc., Inland American Orchard Hotels, Inc., Inland American Urban Hotels, Inc., and Inland American Lodging Corporation, own 95 lodging properties in 26 states and the District of Columbia. (Dollar amounts stated in thousands, except for revenue per available room, average daily rate and average rent per square foot).
The following table sets forth information regarding the 10 individual tenants in descending order based on base rent paid in 2011 but excluding our lodging, multi-family, and development properties. (Dollar amounts stated in thousands.)
Tenant Name
Type
SunTrust Bank
AT&T, Inc.
Citizens Banks
Sanofi-Aventis
United Healthcare Services
C&S Wholesalers
Atlas Cold Storage
Stop N Shop
Cornell Corrections
Lockheed Martin Corporation
The following sections set forth certain summary information about the character of the properties that we owned at December 31, 2011. Certain of the Company’s properties are encumbered by mortgages, totaling $5,770,595, and additional detail about the mortgages can be found on Schedule III – Real Estate and Accumulated Depreciation.
Retail Segment
As of December 31, 2011, our retail segment consisted of 726 properties. Our retail segment is centered on multi-tenant properties with an average of approximately 140,000 square feet of total space, located in stable communities, primarily in the southwest and southeast regions of the country. Our retail tenants are largely necessity-based retailers such as grocery and pharmacy, as well as moderate-fashion shoes and clothing retailers, and services such as banking. We own the following types of retail centers:
The majority of our single tenant retail properties are bank branches operated by SunTrust Bank or Citizens Bank. The bank branches typically offer a wide range of face-to-face or automated banking services to their customers and are often located on corners or out parcels. Typically, these tenants pay rents with contractual increases over time and bear virtually all expenses associated with operating the facility.
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Community or neighborhood centers are generally open air and designed for tenants that offer a larger array of apparel and other soft goods. Typically, these centers contain anchor stores and other national retail tenants. Our neighborhood shopping centers are generally in-line strip centers with a grocery store anchor, a drugstore, and other small retailers. Tenants of these centers typically offer necessity-based products.
Power centers consist of several anchors, such as department stores, off-price stores, warehouse clubs or stores that offer a large selection of merchandise. Typically, the number of specialty tenants is limited.
We have not experienced bankruptcies or receivable write-offs in our retail portfolio that have materially impacted our result of operations in the economy or retail environment. Our retail business is not highly dependent on specific retailers or specific retail industries, which we believe shields the portfolio from significant revenue variances over time.
The following table reflects the types of properties within our retail segment as of December 31, 2011.
Retail Properties
Single Tenant
Community & Neighborhood Center
Power Center
The following table represents lease expirations for the retail segment:
Lease Expiration Year
2012
2013
2014
2015
2016
Thereafter
We have staggered our lease expirations so that we can manage lease rollover. The average percentage of leases expiring over the next five years is less than 10%.
Lodging Segment
Lodging facilities have characteristics different from those found in office, retail, industrial, and multi-family properties. Revenue, operating expenses, and net income of lodging properties are directly tied to the daily hotel sales operation whereas these other asset classes generate revenue from medium to long-term lease contracts. In this way, net operating income for properties in our other asset classes is somewhat more predictable than lodging properties, though we believe that opportunities to increase revenue are, in many cases, limited because of the duration of the existing lease contracts. We believe lodging facilities have the benefit of capturing
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increased revenue opportunities on a daily or weekly basis but are also subject to immediate decreases in lodging revenue as a result of declines in daily rental rates and/or daily occupancy when demand is reduced. Due to seasonality, we expect our lodging revenues to be greater during the second and third quarters with lower revenues in the first and fourth quarters.
We follow two practices common for REITs that own lodging properties: 1) association with national franchise organizations and 2) management of the properties by third-party hotel managers. We have aligned our portfolio with what we believe are the top franchise enterprises in the lodging industry: Marriott, Hilton, Intercontinental, Hyatt, Wyndham, Choice, Fairmont and Starwood Hotels. Our lodging facilities and these franchise enterprises are generally classified in the “upscale” or “upper-upscale” lodging categories. By entering into franchise agreements with these organizations, we believe our lodging operations benefit from enhanced advertising, marketing, and sales programs through the franchisor (in this case, the organization) while the franchisee (in this case, us) pays only a fraction of the overall cost for these programs. We believe effective TV, radio, print, on-line, and other forms of advertisement are necessary to draw customers to our lodging facilities, thus, creating higher occupancy and rental rates, and increased revenue. Additionally, by using the franchise system we are also able to benefit from the frequent traveler rewards programs or “point awards” systems of the franchisor which we believe further bolsters occupancy and overall daily rental rates.
The following table reflects the types of properties within our lodging segment as of December 31, 2011.
Lodging Properties
Marriot
Hilton
Other
Office Segment
Our investments in office properties largely represent assets leased to and occupied by either a diverse group of tenants or to a single tenant that fully occupy the leased space. Examples of our multi-tenant properties include the IDS Center located in the central business district of Minneapolis, Minnesota and Dulles Executive Plaza and Worldgate Plaza, both located in metropolitan Washington D.C., with space leased to high-technology companies and federal government contractors. Examples of our single tenant properties include three buildings leased and occupied by AT&T and located in three distinct US office markets—Chicago, Illinois, St. Louis, Missouri, and Cleveland, Ohio. In addition, our single tenant office portfolio includes bank offices leased on a net basis to SunTrust, with locations in the east and southeast regions of the country.
The following table reflects the types of properties within our office segment as of December 31, 2011.
Office Properties
Single-Tenant
Multi-Tenant
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The following table represents lease expirations for the office segment:
The percentage of leases expiring each year for the next four years is low. During the fifth year, 67% of the lease expiration relates to one property, with approximately 1.7 million square feet, occupied by AT&T in Hoffman Estates, Illinois, which is in the greater metro Chicago market.
Industrial Segment
Our industrial segment is comprised of four types of properties: distribution centers, specialty distribution centers, charter schools, and correctional facilities. Our distribution centers are warehouses or other specialized buildings which stock products to be distributed to retailers, wholesalers or directly to consumers. Some properties are located in what we believe are active and sought-after industrial markets, such as the O’Hare airport market of Chicago, Illinois. The specialty distribution centers consist of refrigeration or air conditioned buildings which supply grocery stores in various locations across the country. The charter schools and correctional facilities consist of ten properties under long-term triple net leases.
The following table reflects the types of properties within our industrial segment as of December 31, 2011.
Industrial Properties
Distribution Center
Specialty Distribution Center
Charter Schools
Correctional Facility
The following table represents lease expirations for the industrial segment:
The percentage of leases expiring each year for the next five years is less than 10%. We believe this is a manageable percentage of lease rollover.
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Multi-Family Segment
Our multi-family portfolio consists of conventional apartments and student housing. Our conventional apartment properties are upscale with resident amenities such as business centers, fitness centers, swimming pools, landscaped grounds and clubhouse facilities. The apartment buildings are typically three-story walk-up buildings offering one, two and three bedroom apartments and are leased on per unit basis. Our student-housing portfolio consists of residential and mixed-use communities close to university campuses and in urban infill locations. Student-housing facilities are leased on a per bed basis rather than per unit. These five student housing properties were constructed between mid-2007 and 2010.
The following table reflects the types of properties within our multi-family segment as of December 31, 2011.
Multi-family Properties
Conventional
Student-Housing
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Not applicable.
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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 public trading market for the common stock. We announced an estimated value per share of our common stock equal to $7.22 as of December 29, 2011. We intend on estimating our value per share on an annual basis.
We published an estimated per share value of our common stock to assist broker-dealers that sold our common stock in our initial and follow-on “best efforts” offerings to comply with the rules published by the Financial Industry Regulatory Authority (“FINRA”) and to assist fiduciaries of retirement plans subject to annual reporting requirements of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), whose clients purchased our common stock. Specifically, FINRA requires registered broker-dealers to disclose in a customer’s account statement an estimated value for a REIT’s securities if the annual report of that REIT discloses a per share estimated value. The FINRA rules presently prohibit broker-dealers from using a per share estimated value developed from data that is more than eighteen months old.
The FINRA rules provide no guidance regarding the methodology a REIT must use to determine its estimated value per share. As with any valuation methodology, the methodology employed by our business manager was based upon a number of estimates and assumptions that may not be reflective of actual results. Further, different parties using different assumptions and estimates could derive a different estimated value per share, which could be significantly different from our estimated value per share. The estimated per share value published by us represents neither the fair value according to U.S. generally accepted accounting principles (or “GAAP”) of our assets less liabilities, nor the amount our shares would trade at on a national securities exchange or the amount a stockholder would obtain if he or she tried to sell his or her shares or if we liquidated our assets and distributed the proceeds after paying all of our expenses and liabilities.
Share Repurchase Program
Our board of directors adopted a share repurchase program, which became effective August 31, 2005 and was suspended as of March 30, 2009. Our board later adopted an Amended and Restated Share Repurchase Program, which was effective from April 11, 2011 through January 31, 2012 (the “First Amended Program”). Our board subsequently adopted a Second Amended and Restated Share Repurchase Program, which became effective as of February 1, 2012 (the “Second Amended Program”).
Under the First Amended Program, we were permitted to repurchase shares of our common stock, on a quarterly basis, upon the death of the beneficial owners of our shares. We were authorized to repurchase shares at a price per share equal to 90% of the most recently disclosed estimated per share value of our common stock, which, on each of the relevant repurchase dates, was equal to $7.23 per share. Our obligation to repurchase any shares under the First Amended Program was conditioned upon our having sufficient funds available to complete the repurchase. Our board had reserved $5.0 million per calendar quarter for this purpose. In addition, notwithstanding anything to the contrary, at no time during any consecutive twelve month period could the aggregate number of shares repurchased under the First Amended Program exceed 5.0% of the aggregate number of issued and outstanding shares of our common stock at the beginning of the twelve month period. If our funds were insufficient to repurchase all of the shares for which repurchase requests have been submitted in a particular quarter, or if the number of shares accepted for repurchase would cause us to exceed the 5.0% limit, we would repurchase the shares in chronological order, based upon the beneficial owner’s date of death.
Under the Second Amended Program, we may repurchase shares of our common stock, on a quarterly basis, from the beneficiary of a stockholder that has died or from stockholders that have a “qualifying disability” or are confined to a “long-term care facility” (together, referred to herein as “hardship repurchases”). We are authorized
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to repurchase shares at a price per share equal to 100% of the most recently disclosed estimated per share value of our common stock, which currently is equal to $7.22 per share. Our obligation to repurchase any shares under the Second Amended Program is conditioned upon our having sufficient funds available to complete the repurchase. Our board has initially reserved $10.0 million per calendar quarter for the purpose of funding repurchases associated with death and $15.0 million per calendar quarter for the purpose of funding hardship repurchases. In addition, notwithstanding anything to the contrary, at no time during any consecutive twelve month period may the aggregate number of shares repurchased under the Second Amended Program exceed 5.0% of the aggregate number of issued and outstanding shares of our common stock at the beginning of the twelve month period. For any calendar quarter, if the number of shares accepted for repurchase would cause us to exceed the 5.0% limit, repurchases for death will take priority over any hardship repurchases, in each case in accordance with the procedures, and subject to the funding limits, described in the Second Amended Program and summarized herein.
If, on the other hand, the funds reserved for either category of repurchase under the Second Amended Program are insufficient to repurchase all of the shares for which repurchase requests have been received for a particular quarter, or if the number of shares accepted for repurchase would cause us to exceed the 5.0% limit, we will repurchase the shares in the following order:
for death repurchases, we will repurchase shares in chronological order, based upon the beneficial owner’s date of death; and
for hardship repurchases, we will repurchase shares on a pro rata basis, up to, but not in excess of, the limits described herein; provided, that in the event that the repurchase would result in a stockholder owning less than 150 shares, we will repurchase all of that stockholder’s shares.
The Second Amended Program will immediately terminate if our shares are approved for listing on any national securities exchange. We may amend or modify any provision of the Second Amended Program, or reject any request for repurchase, at any time in our board’s sole discretion.
The table below outlines the shares of common stock we repurchased pursuant to the First Amended Program during the three months ended December 31, 2011:
Month
October 2011
November 2011
December 2011
Stockholders
As of March 1, 2012, we had 187,276 stockholders of record.
We have been paying monthly cash distributions since October 2005. During the years ended December 31, 2011 and 2010, we declared cash distributions, which are paid monthly in arrears to stockholders, totaling $429.6 million and $417.9 million, respectively, in each case equal to $.50 per share on an annualized basis. For Federal income tax purposes for the years ended December 31, 2011 and 2010, 62% and 66% of the distributions paid constituted a return of capital in the applicable year.
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We intend to continue paying regular monthly cash distributions to our stockholders. However, there are many factors that can affect the amount and timing of cash distributions to stockholders. There is no assurance that we will be able to continue paying distributions at the current level or that the amount of distributions will increase, or not decrease further, over time. Even if we are able to continue paying distributions, the actual amount and timing of distributions is determined by our board of directors in its discretion and typically depends on the amount of funds available for distribution, which depends on items such as current and projected cash requirements and tax considerations. As a result, our distribution rate and payment frequency may vary from time to time.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information regarding our equity compensation plans as of December 31, 2011.
Equity Compensation Plan Information
Plan category
Equity compensation plans approved by security holders:
Independent Director Stock Option Plan
Equity compensation plans not approved by security holders
Total:
We have adopted an Independent Director Stock Option Plan, as amended, which, subject to certain conditions, provides for the grant to each independent director of an option to purchase 3,000 shares following their becoming a director and for the grant of additional options to purchase 500 shares on the date of each annual stockholder’s meeting. The options for the initial 3,000 shares are exercisable as follows: 1,000 shares on the date of grant and 1,000 shares on each of the first and second anniversaries of the date of grant. All other options are exercisable on the second anniversary of the date of grant. The exercise price for all options is equal to the fair value of our shares, as defined in the plan, on the date of each grant.
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Recent Sales of Unregistered Securities
Item 6. Selected Financial Data
The following table shows our consolidated selected financial data relating to our consolidated historical financial condition and results of operations. Such selected data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes appearing elsewhere in this report (dollar amounts are stated in thousands, except per share amounts).
Balance Sheet Data:
Total assets
Mortgages, notes and margins payable
Operating Data:
Total income
Total interest and dividend income
Net income (loss) attributable to Company
Net income (loss) per common share, basic and diluted
Common Stock Distributions:
Distributions declared to common stockholders
Distributions per weighted average common share
Funds from Operations:
Funds from operations (a)
Cash Flow Data:
Cash flows provided by operating activities
Cash flows used in investing activities
Cash flows provided by (used in) financing activities
Other Information:
Weighted average number of common shares outstanding, basic and diluted
In 2011, NAREIT clarified the FFO definition to exclude impairment charges of depreciable real estate assets as well as the gains and or losses related to unconsolidated entities to the extent they are due to the depreciable real estate assets. Consequently, we have restated prior years’ FFO to reflect these changes.
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FFO is neither intended to be an alternative to “net income” nor to “cash flows from operating activities” as determined by GAAP as a measure of our capacity to pay distributions. We believe that FFO is a better measure of our properties’ operating performance because FFO excludes non-cash items from GAAP net income. FFO is calculated as follows (in thousands):
Add:
Less:
Gains from property sales reflected in equity in earnings of unconsolidated entities
Gains from sale of unconsolidated entities
Noncontrolling interest share of depreciation and amortization related to investment properties
Below is additional information related to certain items that significantly impact the comparability of our Funds from Operations and Net Loss or significant non-cash items from the periods presented (in thousands):
Gain on conversion of note receivable to equity interest
Payment from note receivable previously impaired
Provision for goodwill impairment
Impairment of notes receivable
Impairment on securities
(Gain) loss on consolidated investment
Straight-line rental income
Amortization of above/below market leases
Amortization of mark to market debt discounts
Gain on extinguishment of debt
Acquisition Costs
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical, including statements regarding management’s intentions, beliefs, expectations, representations, plans or predictions of the future and are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may,” “will,” “should” and “could.” Similarly, statements that describe or contain information related to matters such as management’s intent, belief or expectation with respect to the Company’s financial performance, investment strategy and portfolio, cash flows, growth prospects, legal proceedings, amount and timing of anticipated future cash distributions, and other matters are forward-looking statements. These forward-looking statements are not historical facts but are the intent, belief or current expectations of the Company’s management based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and stockholders should not place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described under “Risk Factors” in this Annual Report on Form 10-K . These factors include, but are not limited to: market and economic volatility experienced by the U.S. economy or real estate industry as a whole, and the local economic conditions in the markets in which the Company’s properties are located; the Company’s ability to refinance maturing debt or to obtain new financing on attractive terms; the availability of cash flow from operating activities to fund distributions; future increases in interest rates; and actions or failures by the Company’s joint venture partners, including development partners. The Company intends that such forward-looking statements be subject to the safe harbors created by Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. The Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results.
The following discussion and analysis relates to the years ended December 31, 2011, 2010 and 2009 and as of December 31, 2011 and 2010. You should read the following discussion and analysis along with our Consolidated Financial Statements and the related notes included in this report.
Overview
We continue to maintain a sustainable distribution rate funded by our operations. In 2011, we began disposing of assets we determined less strategic and reinvesting the capital in real estate assets that we believe will produce attractive current yields and long-term risk-adjusted returns to our stockholders. To achieve these objectives, our property managers for our non-lodging properties actively seek to lease space at favorable rates, control expenses, and maintain strong tenant relationships. We oversee the management of our lodging facilities through active engagement with our third party managers and franchisors to maximize occupancy and daily rates as well as control expenses.
On a consolidated basis, essentially all of our revenues and cash flows from operations for the year ended December 31, 2011 were generated by collecting rental payments from our tenants, room revenues from lodging properties, distributions from unconsolidated entities and dividend income earned from investments in marketable securities. Our largest cash expense relates to the operation of our properties as well as the interest expense on our mortgages. Our property operating expenses include, but are not limited to, real estate taxes, regular repair and maintenance, management fees, utilities and insurance (some of which are recoverable). Our lodging operating expenses include, but are not limited to, rooms, food and beverage, utility, administrative and marketing, payroll, franchise and management fees and repairs and maintenance expenses.
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In evaluating our financial condition and operating performance, management focuses on the following financial and non-financial indicators, discussed in further detail herein:
Cash flow from operations as determined in accordance with U.S. generally accepted accounting principles (“GAAP”).
Funds from Operations (“FFO”), a supplemental non-GAAP measure to net income determined in accordance with GAAP.
Economic and physical occupancy and rental rates.
Leasing activity and lease rollover.
Managing operating expenses.
Average daily room rate, revenue per available room, and average occupancy to measure our lodging properties.
Debt maturities and leverage ratios.
Liquidity levels.
During 2012, we will continue to execute on our strategy to dispose of less strategic assets and deploy the capital into higher performing asset segments. We believe that our debt maturities over the next five years are manageable and although we believe interest rates will rise in the future, we anticipate low interest rates in 2012. We expect to see increased same store operating performance in our lodging and multi-family segments in 2012. The lodging industry is expected to have positive growth for 2012 and the rental growth is projected to continue for the multi-family properties in 2012. Our retail, office and industrial portfolios are expected to maintain high occupancy and have limited lease rollover in the coming years. We believe the retail and industrial segments same store income will be consistent with 2011 results. We do expect to see lower income in the office segment compared to 2011 results. We believe we will be maintain our cash distribution in 2012 and anticipate distributions to be funded by cash flow from operations as well as distributions from unconsolidated entities and gains on sales of properties.
Results of Operations
Consolidated Results of Operations
This section describes and compares our results of operations for the years ended December 31, 2011, 2010 and 2009. We generate most of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the operating performance of all properties from period to period and properties we have owned and operated for the same period during each year. Investment properties owned for the entire years ended December 31, 2011 and 2010 and December 31, 2010 and 2009, respectively, are referred to herein as “same store” properties. Unless otherwise noted, all dollar amounts are stated in thousands (except per share amounts, per square foot amounts, revenue per available room and average daily rate).
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Comparison of the years ended December 31, 2011, 2010 and 2009
Operating Income and Expenses:
Income:
Rental income
Tenant recovery income
Other property income
Lodging income
Operating Expenses:
Lodging operating expenses
Property operating expenses
Real estate taxes
Provision for asset impairment
General and administrative expenses
Business manager management fee
Property Income and Operating Expenses
Rental income for non-lodging properties consists of basic monthly rent, straight-line rent adjustments, amortization of acquired above and below market leases, fee income, and percentage rental income recorded pursuant to tenant leases. Tenant recovery income consists of reimbursements for real estate taxes, common area maintenance costs, management fees, and insurance costs. Tenant recovery income generally fluctuates correspondingly with property operating expenses and real estate taxes. Other property income for non-lodging properties consists of lease termination fees and other miscellaneous property income. Property operating expenses for non-lodging properties consist of real estate taxes, regular repair and maintenance, management fees, utilities and insurance (some of which are recoverable from the tenant).
The increase in property revenues in the year ended December 31, 2011 was primarily due to a full year of operations reflected in 2011 for properties acquired during 2010 in addition to 2011 acquisition of seven properties. Same store consolidated property revenues amounted to $637,894 in 2011 compared to $639,181 in 2010, which was less than a 1% change. In correlation, same store property operating expenses increased from $114,892 in 2010 to $114,992 in 2011, which was also less than a 1% change. Real estate taxes on a a same store basis decreased less than 2%, from $54,173 in 2010 to $53,168 in 2011.
Similarly, the increase in property revenues in the year ended December 31, 2010 was primarily due to a full year of operations reflected in 2010 for properties acquired during 2009 in addition to 2010 acquisitions of 28 properties. Same store consolidated property revenues amounted to $545,502 in 2010 compared to $550,410 in 2009, which was less than a 1% change. In correlation, same store property operating expenses increased from $97,828 in 2009 to $101,077 in 2010, which was a 3% change. Real estate taxes on a same store basis decreased by 5%, from $50,176 in 2009 to $47,721 in 2010.
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Lodging Income and Operating Expenses
Our lodging properties generate revenue through sales of rooms and associated food and beverage services. Lodging operating expenses include the room maintenance, food and beverage, utilities, administrative and marketing, payroll, franchise and management fees, and repairs and maintenance expenses.
Lodging income increased in the year ended December 31, 2011 primarily due to a full year of operations reflected in 2011 for hotels acquired in 2010 in addition to 2011 acquisition of three hotels. In general, the economy was better in 2011 than in the prior year and businesses held more meetings at hotels, which also resulted in additional income through the sale of food and drinks. As expected, lodging operating expense increased correspondingly to lodging income.
Lodging income increased in the year ended December 31, 2010 primarily due to occupancy increases across the lodging segment. Due to the economic recovery during the latter part of 2010, hotel performances increased which allowed for an increase in the demand for hotel rooms. This in turn increased the occupancy rate and the average daily rate for some areas as corporate business travel and leisure travel improved. Additional hotels purchased in mid-year also contributed to the increase in revenue by adding a better mix of hotels to the total portfolio.
Provision for Asset Impairment
For the year ended December 31, 2011, we identified certain properties which may have a reduction in the expected holding period and reviewed the probability of these assets’ dispositions. As a result, we recorded a provision for asset impairment of $105,795 for continuing operations and $57,846 for discontinued operations, to reduce the book value of certain of our investment properties to their fair values.
For the years ended December 31, 2010 and 2009, we recorded a provision for asset impairment of $3,180 and $1,117, respectively, to reduce the book value of certain of our investment properties to their new fair values. We disposed of many of the properties impaired in 2010 and 2009 by December 31, 2011, and therefore, the related impairment charges of $44,349 and $32,934, respectively, are reflected in discontinued operations.
General Administrative Expenses and Business Management Fee
After our stockholders have received a non-cumulative, non-compounded return of 5% per annum on their “invested capital,” we pay our business manager an annual business management fee of up to 1% of the “average invested assets,” payable quarterly in an amount equal to 0.25% of the average invested assets as of the last day of the immediately preceding quarter. Once we have satisfied the minimum return on invested capital, the amount of the actual fee paid to the business manager is determined by the business manager up to the amount permitted by the agreement.
We incurred a business management fee of $40,000, $36,000 and $39,000, which is equal to 0.35%, 0.32%, and 0.38% of average invested assets, and the business manager waived the remaining fee of $75,155, $78,120, and $64,584 for the years ended December 31, 2011, 2010, and 2009, respectively. There is no assurance that our business manager will continue to forego or defer all or a portion of its business management fee.
The decrease in general and administrative expense from the year ended December 31 2010 to the year ended December 31, 2011 was primarily a result of a decrease in legal and consulting costs. We saw a decrease from the year ended December 31, 2009 to the year ended December 31, 2010 due primarily to the slow down in acquisition activity in 2010 as compared to 2009 activity.
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Non-Operating Income and Expenses:
Non-operating income and expenses:
Other income
Interest expense
Equity in loss of unconsolidated entities
Gain (impairment) of investment in unconsolidated entities, net
Realized gain (loss) and impairment on securities
Income (loss) from discontinued operations
Other Income
The increase in other income in the year ended December 31, 2011 was primarily due to the gain recognized on the conversion of a note receivable to equity of $17,150 in an unconsolidated entity. Other income in the years ended December 31, 2010 and 2009 were minimal compared to the year ended December 31, 2011.
Interest Expense
The increase in interest expense in the year ended December 31, 2011 was primarily due to the principal amount of mortgage debt financings during 2011 which increased by $303,927 from 2010 as well as a $6,362 amortization of a mark to market mortgage discount as a result of two property loans, totaling $43,236 being in default. Similarly, the principal amount of mortgage debt financings during 2010 increased by $452,270 from 2009. Our weighted average interest rate on outstanding debt was 5.2%, 5.1%, and 4.9% per annum for the years ended December 31, 2011, 2010, and 2009 respectively.
Equity in Loss of Unconsolidated Entities
For the year ended December 31, 2011, we recognized our share of a gain on the sales of properties in two unconsolidated entities which total $11,141, offset by impairment charges recognized by two unconsolidated entities of which our portion was $16,739. The decrease in equity in loss of unconsolidated entities for the year ended December 31, 2011 was primarily due to impairments recorded by our joint ventures for the year ended December 31, 2010, of which our portion was $10,710 incurred by our DR Stephens joint venture, with no offset by gain on sales of properties.
The decrease in equity in loss of unconsolidated entities for the year ended December 31, 2010 was primarily due to significant losses incurred and impairments recorded by our Concord debt joint ventures for the year ended December 31, 2009, of which our portion was $75,787.
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Gain (Impairment) of Investment in Unconsolidated Entities, net
For the year ended December 31, 2011, we recorded an impairment of $113,621 on our investment in unconsolidated entities related to the Net Lease Strategic Assets Fund LP joint venture. The impairment reduced our investment in the unconsolidated entity to $26,508. On February 21, 2012, we delivered to our joint venture partner a right of first offer under the partnership agreement. Pursuant to the notice, we have requested the venture sell the assets for a purchase price of $548,706. On February 20 and 21, 2012, our partner delivered notice to us to exercise the buy sell option under the partnership agreement at a purchase price of $213,014. If the right of first offer is not accepted, the partnership agreement allows a third party buyer to be sought. For the year ended December 31, 2011, we valued the equity interest in part based on the fair value of the underlying assets of the investment using a discounted cash flow model, including discount rates and capitalization rates on the expected future cash flows of the properties. These factors resulted in the valuation of our investment in the entity at $26,508 and an impairment charge of $113,621. The impairment is offset by a $7,545 gain on our investment in unconsolidated entities due to the sale of 100% of our equity in the NRF Healthcare LLC.
For the year ended December 31, 2010, we recorded an impairment of $11,239 on our investment in unconsolidated entities related to a retail development center and two lodging developments.
For the year ended December 31, 2009, we recorded an impairment of $7,443 on our investment in unconsolidated entities relate to a retail center and a lodging development venture.
Realized Gain (Loss) and Impairment on Securities
Realized gain (loss) and impairment on securities was a gain in the year ended December 31, 2010 and a loss in the year ended December 31, 2011. In 2011, we took an impairment charge of $24,356 on existing securities which was offset by $6,125 sale of impaired securities which resulted in a gain. In 2010, we sold impaired stock which resulted in a $33,834 gain, which was offset by a $12,475 loss on the impaired bonds. For the year ended December 31, 2009, we recorded an impairment charge of $4,038 offset by realized gains on the sales of securities.
Discontinued Operations
For the year ended December 31, 2011, we recorded loss of $29,608 from discontinued operations, which primarily included a gain on sale of properties of $11,964, a gain on extinguishment of debt of $10,848, a gain on transfer of assets of $4,546, and provision for asset impairment of $57,846.
For the year ended December 31, 2010, we recorded income of $23,254 from discontinued operations, which primarily included a gain on sale of properties of $55,412, a gain on extinguishment of debt of $19,227, and a provision for asset impairment of $44,349.
For the year ended December 31, 2009, we recorded a loss of $39,066 from discontinued operations, which primarily included a provision for asset impairment of $32,934.
Segment Reporting
An analysis of results of operations by segment is below. In order to evaluate our overall portfolio, management analyzes the operating performance of all properties from period to period and properties we have owned and operated for the same period during each year. A total of 910 and 877 of our investment properties satisfied the criteria of being owned for the entire years ended December 31, 2011 and 2010 and December 31, 2010 and 2009, respectively, and are referred to herein as “same store” properties. This same store analysis allows management to monitor the operations of our existing properties for comparable periods to determine the effects of our new acquisitions on net income. The tables contained throughout summarize certain key operating
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performance measures for the years ended December 31, 2011, 2010 and 2009. The base rental rates reflected in retail, office, industrial, and multi-family are exclusive of tenant improvements and lease commissions. For the year ended December 31, 2011, these costs associated with leasing space were not material.
Our retail segment net operating income on a same store basis remained stable for the year ended December 31, 2011 compared to year ended December 31, 2010 with a slight decrease of 1.0%, down $220,592 from $222,908, respectively. This is a result of the strong same store economic occupancy percentage of 94% for both periods and comparable lease rates year to year. We had similar economic occupancy of 93% for the same store properties for the years ended December 31, 2010 and 2009, but saw a decrease in net operating income of 2.5%, to $181,778 from $186,405, respectively, due to less lease termination income in 2010 compared to 2009. During 2009, 2010, and 2011, we acquired fifty-five retail properties totaling approximately 9 million square feet. These acquisitions were well matched with our retail business, which is centered on multi-tenant properties, located in stable communities. The tenants largely consist of necessity-based retailers such as grocery and pharmacy, as well as moderate-fashion shoes and clothing retailers, and services.
Base rental rates have decreased slightly from $15.90 per square foot as of December 31, 2009 to $15.05 per square foot as of December 31, 2010 to $14.96 per square foot as of December 31, 2011. The decrease was offset by increase in economic occupancy over the same period, which resulted in a less than 1% change in base rent income on a same store basis for the comparable periods. For 2012, we expect rental rates to remain consistent with 2011.
Physical occupancy
Economic occupancy
Base rent per square foot
Gross investment in properties
Comparison of Years Ended December 31, 2011 and 2010
The table below represents operating information for the retail segment and for the same store retail segment consisting of properties acquired prior to January 1, 2010. The properties in the same store portfolio were owned for the entire years ended December 31, 2011 and 2010.
Revenues:
Tenant recovery incomes
Total revenues
Expenses:
Total operating expenses
Net operating income
Average occupancy for the period
Number of Properties
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Comparison of Years Ended December 31, 2010 and December 31, 2009
The table below represents operating information for the retail segment and for the same store retail segment consisting of properties acquired prior to January 1, 2009. The properties in the same store portfolio were owned for the entire years ended December 31, 2011 and 2010.
We measure our financial performance for lodging properties by revenue generated per available room known as RevPAR, which is an operational measure commonly used in the lodging industry to evaluate lodging performance. RevPAR represents the product of the average daily room rate charged and the average daily occupancy achieved but excludes other revenue generated by a hotel property, such as food and beverage, parking, telephone and other guest service revenues.
Our lodging portfolio has seen significant increases in net operating income year over year comparing 2009, 2010 and 2011. On a same store basis, net operating income increased 4.1% for the years ended December 31, 2009 to December 31, 2010, from $137,552 to $143,161. The same store properties for the years ended December 31, 2011 and December 31, 2010 also had an increase in net operating income of 10.8%, from $143,161 to $158,567. During 2009, the hotel industry experienced declines in both occupancy levels and rental rates (better known as “Average Daily Rate” or “ADR”). The downturn in performance affected all major segments of the travel industry (e.g. corporate travel, group travel, and leisure travel). Hotel performance has been steadily climbing up from the economic downturn as occupancy started increasing in 2010 followed by increases in average daily rates in the fourth quarter 2010. In 2011, occupancy growth slightly outpaced the ADR growth but US RevPar increased 8.2% and our lodging portfolio increased 7.5%.
We are optimistic our lodging portfolio will continue its strong performance in 2012. Business and leisure travel is forecasted to remain strong in 2012. While occupancy continues to rise, pricing increases will lag behind as both types of travel remain sensitive to price increases. We expect ADR growth in 2012 to be slightly higher than in 2011. RevPar is expected to steadily grow in 2012, specifically in the upscale and above segments. We believe we will have strong increases in our revenue per available room consistent with industry expectations. Our third party managers and asset management are focusing on increasing average daily rates, maintaining and growing occupancy while controlling operating costs to improve cash flow to the owner.
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Revenue per available room
Average daily rate
Occupancy
The table below represents operating information for the lodging segment and for the same store portfolio for properties acquired prior to January 1, 2010. The properties in the same store portfolio were owned for the entire years ended December 31, 2011 and 2010.
Lodging operating income
The table below represents operating information for the lodging segment and for the same store portfolio of properties acquired prior to January 1, 2009. The properties in the same store portfolio were owned for the entire years ended December 31, 2010 and December 31, 2009.
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Our office portfolio has remained consistent on a total segment basis as net operating income slightly decreased from $136,469 to $133,614 and to $132,050 for the years ended December 31, 2009, 2010 and 2011, respectively. On a same store basis, net operating income is down approximately 2.7% comparing the years ended December 31, 2011 to 2010 and 6.3% comparing the years ended December 31, 2010 to 2009. For the same comparative periods, rental income is down 2.2% and 4.3%, respectively. This correlation can be attributed to a decrease in occupancy coupled with releasing at rates lower than expiring lease rental rates.
Although we see market rates continuing to decrease from the current rates, occupancy is stable at 92% with limited lease rollover in the next three to five years.
The table below represents operating information for the office segment and for the same store portfolio consisting of properties acquired prior to January 1, 2010. The properties in the same store portfolio were owned for the years ended December 31, 2011 and 2010.
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The table below represents operating information for the office segment and for the same store portfolio consisting of properties acquired prior to January 1, 2009. The properties in the same store portfolio were owned for the years ended December 31, 2010 and December 31, 2009.
During 2011, our industrial holdings continued to experience high economic occupancy and maintained consistent rental rates, which is reflected in same store net operating income decrease of less than 1% for the year ended December 31, 2010 to December 31, 2011. In early 2010, we acquired charter schools and correctional facilities consisting of nine properties under long-term triple net leases. These acquisitions contributed to total segment net operating income for December 31, 2010 exceeding the prior year by $11,023 or 15.2%. On a same store basis for the year ended December 31, 2010 compared to December 31, 2009, we saw net operating income decrease $3,908, or 5.5%, which was a result of increased lease rates.
Rental rates are expected to remain consistent in 2012 for our specialty distribution centers and slightly increase for our distribution centers constructed in the past ten years as well as our charter school and correctional facilities.
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The table below represents operating information for the industrial segment and for the same store portfolio consisting of properties acquired prior to January 1, 2010. The properties in the same store portfolio were owned for the years ended December 31, 2011 and December 31, 2010.
The table below represents operating information for the industrial segment and for the same store portfolio consisting of properties acquired prior to January 1, 2009. The properties in the same store portfolio were owned for the years ended December 31, 2010 and December 31, 2009.
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Multi-family Segment
Our multi-family portfolio continues to perform remarkably well with net operating income increasing $11,069 or 26.8% on a total segment basis for the year ended December 31, 2011 compared to the year ended December 31, 2010 and $8,457 or 25.7% for the year ended December 31, 2010 compared to the year ended December 31, 2009. The significant increases are a result of increased occupancy coupled with increased rental rates and decrease in concessions, specifically in 2011. On a same store basis, net operating income increased $6,218 or 16.7% for the year ended December 31, 2011 compared to the year ended December 31, 2010 and $861 or 2.9% for the year ended December 31, 2010 compared to the year ended December 31, 2009. The same store increases mirror the total segment increases and are consistent with the conventional multi-family and the student housing portfolios.
During 2010 and 2011, we acquired 3,833 units, placed in service 482 units, and disposed of 1,239 units. As of December 31, 2011, we had five student housing properties. We anticipate placing three additional student housing properties in service; two in the fall of 2012 and one in the fall of 2013. We anticipate placing one additional conventional multi-family property in service in the spring of 2013. We expect to see rates in the student housing and conventional multi-family continue to rise in 2012 and occupancy to remain consistent with 2011.
End of month scheduled base rent per unit per month
The table below represents operating information for the multi-family segment and for the same store portfolio consisting of properties acquired prior to January 1, 2010. The properties in the same store portfolio were owned for the years ended December 31, 2011 and 2010.
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The table below represents operating information for the multi-family segment and for the same store portfolio consisting of properties acquired prior to January 1, 2009. The properties in the same store portfolio were owned for the years ended December 31, 2010 and December 31, 2009.
Multi-family
Developments
We have development projects that are in various stages of pre-development and development which are funded by borrowings secured by the properties. Specifically identifiable direct development and construction costs are capitalized, including, where applicable, salaries and related costs, real estate taxes and interest incurred in developing the property. These developments encompass the retail and multi-family segments.
The properties under development and all amounts set forth below are as of December 31, 2011. (Dollar amounts stated in thousands.)
Name
Woodbridge
Stone Creek
Cityville/Cityplace
UH at UCF
UH at Fullerton
ASU Housing
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As part of our restructure and foreclosure of the Stan Thomas note, we began overseeing as the secured lender certain roadway and utility infrastructure projects that will provide access to the 240 acre Sacramento Railyards property. The Railyards property is located immediately adjacent to, and to the north of, Sacramento’s central business district. The infrastructure projects were planned, approved and funded prior to the foreclosure of the Stan Thomas note. The Railyards property is the subject of a collaborative planning and infrastructure funding effort of various federal, state and local municipalities, and its development is scheduled to be completed in phases during the years 2013-2030. We are currently engaged in efforts both to either sell parcels within the Railyards or to sell the entire property to a master developer. The current book value of the Railyards property is $117.9 million as of December 31, 2011.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. This section discusses those critical accounting policies and estimates. These judgments often result from the need to make estimates about the effect of matters that are inherently uncertain. GAAP requires information in financial statements about accounting principles, methods used and disclosures pertaining to significant estimates. This discussion addresses our judgment pertaining to trends, events or uncertainties known which were taken into consideration upon the application of those policies.
Acquisitions
We allocate the purchase price of each acquired business between tangible and intangible assets at full fair value at the date of the transaction. Such tangible and intangible assets include land, building and improvements, acquired above market and below market leases, in-place lease value, customer relationships (if any), and any assumed financing that is determined to be above or below market terms. Any additional amounts are allocated to goodwill as required, based on the remaining purchase price in excess of the fair value of the tangible and intangible assets acquired and liabilities assumed. The allocation of the purchase price is an area that requires judgment and significant estimates.
We expense acquisition costs of all transactions as incurred. All costs related to finding, analyzing and negotiating a transaction are expensed as incurred as a general and administrative expense, whether or not the acquisition is completed. These expenses would include acquisition fees, if any, paid to an affiliate of our business manager.
Impairment
We assess the carrying values of the respective long-lived assets, whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be fully recoverable, such as a reduction in the expected holding period of the asset. If it is determined that the carrying value is not recoverable because the undiscounted cash flows do not exceed carrying value, we are required to record an impairment loss to the extent that the carrying value exceeds fair value. The valuation and possible subsequent impairment of investment properties is a significant estimate that can and does change based on our continuous process of analyzing each property and reviewing assumptions about uncertain inherent factors, as well as the economic condition of the property at a particular point in time.
We also evaluate our equity method investments for impairment indicators. The valuation analysis considers the investment positions in relation to the underlying business and activities of our investment and identities potential declines in fair value. An impairment loss should be recognized if a decline in value of the investment has occurred that is considered to be other than temporary, without ability to recover or sustain operations that would support the value of the investment.
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Cost Capitalization and Depreciation Policies
Our policy is to review all expenses paid and capitalize any items which are deemed to be an upgrade or a tenant improvement. These costs are capitalized and included in the investment properties classification as an addition to buildings and improvements.
Buildings and improvements are depreciated on a straight-line basis based upon estimated useful lives of 30 years for buildings and improvements, and 5-15 years for site improvements and furniture, fixtures and equipment. Tenant improvements are depreciated on a straight-line basis over the life of the related lease as a component of depreciation and amortization expense. The portion of the purchase price allocated to acquired above market costs and acquired below market costs is amortized on a straight-line basis over the life of the related lease as an adjustment to net rental income. Acquired in-place lease costs, customer relationship value and other leasing costs are amortized on a straight-line basis over the life of the related lease as a component of amortization expense.
Cost capitalization and the estimate of useful lives requires our judgment and includes significant estimates that can and do change based on our process which periodically analyzes each property and on our assumptions about uncertain inherent factors.
Investment in Marketable Securities
We classify our investment in securities in one of three categories: trading, available-for-sale, or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which we have the ability and intent to hold the security until maturity. All securities not included in trading or held-to-maturity are classified as available-for-sale. Investment in securities at December 31, 2011 and 2010 consists of common stock investments and investments in commercial mortgage backed securities that are all classified as available-for-sale securities and are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. When a security is impaired, management considers whether we have the ability and intent to hold the investment for a time sufficient to allow for any anticipated recovery in market value and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period end and forecasted performance of the investee.
Revenue Recognition
We commence revenue recognition on our leases based on a number of factors. In most cases, revenue recognition under a lease begins when the lessee takes possession of or controls the physical use of the leased asset. Generally, this occurs on the lease commencement date. The determination of who is the owner, for accounting purposes, of the tenant improvements determines the nature of the leased asset and when revenue recognition under a lease begins. If we are the owner, for accounting purposes, of the tenant improvements, then the leased asset is the finished space and revenue recognition begins when the lessee takes possession of the finished space, typically when the improvements are substantially complete. If we conclude we are not the owner, for accounting purposes, of the tenant improvements (the lessee is the owner), then the leased asset is the unimproved space and any tenant improvement allowances funded under the lease are treated as lease incentives which reduces revenue recognized over the term of the lease. In these circumstances, we begin revenue recognition when the lessee takes possession of the unimproved space for the lessee to construct their own improvements. We consider a number of different factors to evaluate whether it or the lessee is the owner of the tenant improvements for accounting purposes. These factors include:
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whether the lease stipulates how and on what a tenant improvement allowance may be spent;
whether the tenant or landlord retains legal title to the improvements;
the uniqueness of the improvements;
the expected economic life of the tenant improvements relative to the length of the lease; and
who constructs or directs the construction of the improvements.
The determination of who owns the tenant improvements, for accounting purposes, is subject to significant judgment. In making that determination, we consider all of the above factors. No one factor, however, necessarily establishes its determination.
We recognize rental income on a straight-line basis over the term of each lease. The difference between rental income earned on a straight-line basis and the cash rent due under the provisions of the lease agreements is recorded as deferred rent receivable and is included as a component of accounts and rents receivable in the accompanying consolidated balance sheets. Due to the impact of the straight-line basis, rental income generally is greater than the cash collected in the early years and decreases in the later years of a lease. We periodically review the collectability of outstanding receivables. Allowances are taken for those balances that we deem to be uncollectible, including any amounts relating to straight-line rent receivables.
Reimbursements from tenants for recoverable real estate tax and operating expenses are accrued as revenue in the period the applicable expenses are incurred. We make certain assumptions and judgments in estimating the reimbursements at the end of each reporting period. We do not expect the actual results to significantly differ from the estimated reimbursement.
In conjunction with certain acquisitions, we may receive payments under master lease agreements pertaining to certain non-revenue producing spaces either at the time of, or subsequent to the purchase of some of our properties. These master leases may be established at the time of purchase in order to mitigate the potential negative effects of loss of rent and expense reimbursements. Master lease payments are received through a draw of funds escrowed at the time of purchase and may cover a period from six months to three years. These funds may be released to either us or the seller when certain leasing conditions are met. Funds received by third party escrow agents, from sellers, pertaining to master lease agreements are included in restricted cash. We record such escrows as both an asset and a corresponding liability, until certain leasing conditions are met.
We will recognize lease termination income if there is a signed termination letter agreement, all of the conditions of the agreement have been met, collectability is reasonably assured and the tenant is no longer occupying the property. Upon early lease termination, we will provide for losses related to unrecovered intangibles and other assets.
We recognize lodging operating revenue on an accrual basis consistent with operations.
Consolidation
We evaluate our investments in limited liability companies and partnerships to determine whether such entities may be a variable interest entity (“VIE”). If the entity is a VIE, the determination of whether we are the primary beneficiary must be made. We will consolidate a VIE if we are deemed to be the primary beneficiary, as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic on Consolidation. The equity method of accounting is applied to entities in which we are not the primary beneficiary as defined in the Consolidation Topic of the FASB ASC, or the entity is not a VIE and we do not have effective control, but can exercise influence over the entity with respect to its operations and major decisions.
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Income Taxes
We operate in a manner intended to enable each entity to qualify as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. Under those sections, a REIT that distributes at least 90% of its “REIT taxable income” determined without regard to the deduction for dividends paid and by excluding any net capital gain to its stockholders each year and that meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its stockholders. If we fail to distribute the required amount of income to our stockholders, or fail to meet the various REIT requirements, without the benefit of certain relief provisions, we may fail to qualify as a REIT and substantial adverse tax consequences may result. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income, property, or net worth, and to federal income and excise taxes on our undistributed taxable income. In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries is subject to federal, state and local income taxes.
Liquidity and Capital Resources
We continually evaluate the economic and credit environment and its impact on our business. Maintaining significant capital reserves has become a priority for all companies including us. We believe we are appropriately positioned to have significant cash to utilize in executing our strategy. Our objectives are to maximize revenue for our existing properties and further enhance the value of our segments that produce attractive current yield and long-term risk-adjusted returns to our stockholders and to generate sustainable and predictable cash flow from our operations to distribute to our stockholders.
Our principal demands for funds will be:
to pay our expenses and the operating expenses of our properties;
to make distributions to our stockholders;
to service or pay-down our debt;
to fund capital expenditures;
to invest in properties;
to fund joint ventures and development investments; and
to fund our share repurchase program.
Generally, our cash needs will be funded from:
income earned on our investment properties;
interest income on investments and dividend and gain on sale income earned on our investment in marketable securities;
distributions from our joint venture investments;
proceeds from sales of properties;
proceeds from borrowings on properties; and
issuance of shares under our distribution reinvestment plan.
We declared cash distributions to our stockholders per weighted average number of shares outstanding during the period from January 1, 2011 to December 31, 2011 totaling $429.6 million or $.50 per share. These cash distributions were paid with $398 million from our cash flow from operations, $34 million provided by distributions from unconsolidated entities, as well as $6.1 million from gain on sales of properties.
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One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. The following chart summarizes the sources of our cash used to pay distributions. Our primary source of cash is cash flow provided by operating activities from our investments as presented in our cash flow statement. We also include distributions from unconsolidated entities related to distributions provided by investments in unconsolidated entities since the underlying real estate operations in these entities generate these cash flows. Gain on sales of properties relate to net profits from the sale of certain properties. Our presentation is not intended to be an alternative to our consolidated statements of cash flow and does not present all the sources and uses of our cash.
The following chart presents a historical view of our distribution coverage.
Cash flow provided by operations
Distributions from unconsolidated entities
Gain on sales of properties (1)
Distributions declared
Excess (deficiency)
Acquisitions and Investments
We completed approximately $449.3 million of real estate acquisitions in 2011 and $897.4 million of real estate acquisitions in 2010. These acquisitions were consummated through our subsidiaries and were funded with available cash, mortgage indebtedness, and the proceeds from the distribution reinvestment plan.
Stock Offering
We have completed two public offerings of our common stock as well as a public offering of common stock under our distribution reinvestment plan, or “DRP.” On March 16, 2011, we commenced a new public offering of shares of common stock under our DRP, pursuant to a registration statement on Form S-3 filed under the Securities Act. The purchase price under the DRP is currently equal to $7.22 per share. We will offer shares pursuant to the DRP until the earlier of March 16, 2015 or the date we sell all $803.0 million worth of shares in the offering. As of December 31, 2011, we had raised a total of approximately $8.6 billion of gross offering proceeds as a result of all of our offerings (inclusive of distribution reinvestments and net of redemptions).
During the year ended December 31, 2011, we sold a total of 24,855,275 shares and generated $200.0 million in gross offering proceeds under the DRP, as compared to 6,251,081 shares and $50.2 million during the year ended December 31, 2010. Our average distribution reinvestment plan participation was 47% for the year ended December 31, 2011, compared to 50% for the year ended December 31, 2010.
Our board adopted an Amended and Restated Share Repurchase Program, which was effective from April 11, 2011 through January 31, 2012 (the “First Amended Program”). Our board subsequently adopted a Second Amended and Restated Share Repurchase Program, which became effective as of February 1, 2012 (the “Second Amended Program”).
Under the First Amended Program, we were permitted to repurchase shares of our common stock, on a quarterly basis, upon the death of the beneficial owners of our shares. We were authorized to repurchase shares at a price per share equal to 90% of the most recently disclosed estimated per share value of our common stock, which, on
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each of the relevant repurchase dates, was equal to $7.23 per share. Our obligation to repurchase any shares under the First Amended Program was conditioned upon our having sufficient funds available to complete the repurchase. Our board had reserved $5.0 million per calendar quarter for this purpose. If our funds were insufficient to repurchase all of the shares for which repurchase requests have been submitted in a particular quarter, or if the number of shares accepted for repurchase would cause us to exceed the 5.0% limit set forth in the First Amended Program, we would repurchase the shares in chronological order, based upon the beneficial owner’s date of death.
Under the Second Amended Program, we may repurchase shares of our common stock, on a quarterly basis, from the beneficiary of a stockholder that has died or from stockholders that have a “qualifying disability” or are confined to a “long-term care facility” (together, referred to herein as “hardship repurchases”). We are authorized to repurchase shares at a price per share equal to 100% of the most recently disclosed estimated per share value of our common stock, which currently is equal to $7.22 per share. Our obligation to repurchase any shares under the Second Amended Program is conditioned upon our having sufficient funds available to complete the repurchase. Our board has initially reserved $10.0 million per calendar quarter for the purpose of funding repurchases associated with death and $15.0 million per calendar quarter for the purpose of funding hardship repurchases. If the funds reserved for either category of repurchase under the Second Amended Program are insufficient to repurchase all of the shares for which repurchase requests have been received for a particular quarter, or if the number of shares accepted for repurchase would cause us to exceed the 5.0% limit set forth therein, we will repurchase the shares in the following order: (1) for death repurchases, we will repurchase shares in chronological order, based upon the beneficial owner’s date of death; and (2) for hardship repurchases, we will repurchase shares on a pro rata basis, up to, but not in excess of, the limits described herein; provided, that in the event that the repurchase would result in a stockholder owning less than 150 shares, we will repurchase all of that stockholder’s shares.
For the year ended December 31, 2011, we received requests for the repurchase of 3,613,538 shares of our common stock. Of these requests, we repurchased 2,074,689 shares of common stock for $15 million. There are requests for an additional 1,538,849 shares remaining outstanding, which will be included with all other shares for which we have received repurchase requests in the next calendar quarter in which funds are available (unless withdrawn). The price per share for all shares repurchased during the year ended December 31, 2011 was $7.23 and all repurchases were funded from proceeds from our distribution reinvestment plan.
Borrowings
The table below presents, on a consolidated basis, the principal amount, weighted average interest rates and maturity date (by year) on our mortgage debt as of December 31, 2011 (dollar amounts are stated in thousands).
Maturing debt :
Fixed rate debt (mortgage loans)
Variable rate debt (mortgage loans)
Weighted average interest rate on debt:
The debt maturity excludes mortgage discounts associated with debt assumed at acquisition of which a discount of $30.7 million, net of accumulated amortization, is outstanding as of December 31, 2011.
As of December 31, 2011, we had approximately $671 million and $946 million in mortgage debt maturing in 2012 and 2013, respectively. Subsequent to December 31, 2011, we have refinanced or extended approximately $200 million of the debt maturing in 2012. We are currently negotiating refinancing the remaining 2012 debt
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with the existing lenders at terms that will most likely be at lower rates. We currently anticipate that we will be able to repay or refinance all of our debt on a timely basis, and believe we have adequate sources of funds to meet our short term cash needs. However, there can be no assurance that we can obtain such refinancing on satisfactory terms. Continued volatility in the capital markets could expose us to the risk of not being able to borrow on terms and conditions acceptable to us for future acquisitions or refinancings.
Mortgage loans outstanding as of December 31, 2011 and 2010 were $5.8 billion and $5.5 billion, respectively, and had a weighted average interest rate of 5.2% and 5.1% per annum, respectively. For the years ended December 31, 2011 and 2010, we borrowed $58.8 and $33.8 million, respectively, against our portfolio of marketable securities. For the years ended December 31, 2011 and 2010, we borrowed approximately $1.2 billion and $432.9 million, respectively, secured by mortgages on our properties and assumed $0 and $457.9 million, respectively, of debt at acquisition.
Summary of Cash Flows
Cash provided by operating activities
Cash used in investing activities
Cash used in financing activities
Decrease in cash and cash equivalents
Cash and cash equivalents, at beginning of year
Cash and cash equivalents, at end of year
Cash provided by operating activities was $398, $357 and $369 million for the years ended December 31, 2011, 2010 and 2009, respectively, and was generated primarily from operating income from property operations, and interest and dividends. The increase in cash flows from the years ended December 31, 2010 to December 31, 2011 was primarily due to the improved performance of the lodging and multi-family segments. The decrease in cash flows from the years ended December 31, 2009 to December 31, 2010 was primarily due to a decrease in interest and dividend income and an increase in interest expenses.
Cash used in investing activities was $287, $381 and $563 million for years ended December 31, 2011, 2010 and 2009, respectively. The decrease in cash used in investing activities from the years ended December 31, 2010 to December 31, 2011 was primarily due to the proceeds from the sale of unconsolidated entities. The decrease in cash used in investing activities from the years ended December 31, 2009 to December 31, 2010 was primarily due to the decrease in investment property purchases from 48 properties during the year ended December 31, 2009 to 35 properties during the year ended December 31, 2010. The cash used was offset by cash received from the sale of 14 investment properties during the year ended December 31, 2010. There were no property sales during the year ended December 31, 2009.
Cash used in financing activities was $161, $209 and $251 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in cash used in financing activities from the years ended December 31, 2010 to December 31, 2011 was primarily due to the increase in proceeds from our mortgage debt. Similarly, the decrease in cash used in financing activities from the years ended December 31, 2009 to December 31, 2010 was also primarily due to the increase in proceeds from our mortgage debt.
We consider all demand deposits, money market accounts and investments in certificates of deposit and repurchase agreements with a maturity of three months or less, at the date of purchase, to be cash equivalents. We maintain our cash and cash equivalents at financial institutions. The combined account balances at one or more institutions periodically exceed the Federal Depository Insurance Corporation (“FDIC”) insurance coverage
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and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage.
Contractual Obligations
The table below presents, on a consolidated basis, obligations and commitments to make future payments under debt obligations (including interest), lease agreements, and margin accounts on our marketable securities portfolio as of December 31, 2011 (dollar amounts are stated in thousands).
Long-Term Debt Obligations
Ground Lease Payments
Margins Payable
We have acquired several properties subject to the obligation to pay the seller additional monies depending on the future leasing and occupancy of the property. These earnout payments are based on a predetermined formula. Each earnout agreement has a time limit regarding the obligation to pay any additional monies. If at the end of the time period, certain space has not been leased and occupied, we will not have any further obligation. Assuming all the conditions are satisfied, as of December 31, 2011, we would be obligated to pay as much as $22 million in the future as vacant space covered by these earnout agreements is occupied and becomes rent producing. The information in the above table does not reflect these contractual obligations.
Off Balance Sheet Arrangements
Unconsolidated Real Estate Joint Ventures
Unconsolidated joint ventures are those where we have substantial influence over but do not control the entity. We account for our interest in these ventures using the equity method of accounting. For additional discussion of our investments in joint ventures. Please refer to Note 5 to our Consolidated Financial Statements, which is incorporated by reference into this Item 7. Our ownership percentage and related investment in each joint venture is summarized in the following table. (Dollar amounts stated in thousands.)
Joint Venture
Net Lease Strategic Asset Fund L.P.
Cobalt Industrial REIT II
D.R. Stephens Institutional Fund, LLC
Brixmor/IA JV, LLC
Other Unconsolidated Joint Ventures
Subsequent Events
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to market risk associated with changes in interest rates both in terms of variable-rate debt and the price of new fixed-rate debt upon maturity of existing debt and for acquisitions. We are also subject to market risk associated with our marketable securities investments.
Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. If market rates of interest on all of the floating rate debt as of December 31, 2011 permanently increased by 1%, the increase in interest expense on the floating rate debt would decrease future earnings and cash flows by approximately $15 million. If market rates of interest on all of the floating rate debt as of December 31, 2011 permanently decreased by 1%, the decrease in interest expense on the floating rate debt would increase future earnings and cash flows by approximately $15 million.
With regard to our variable rate financing, we assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. We maintain risk management control systems to monitor interest rate cash flow risk attributable to both of our outstanding or forecasted debt obligations as well as our potential offsetting hedge positions. The risk management control systems involve the use of analytical techniques, including cash flow sensitivity analysis, to estimate the expected impact of changes in interest rates on our future cash flows.
We monitor interest rate risk using a variety of techniques, including periodically evaluating fixed interest rate quotes on all variable rate debt and the costs associated with converting the debt to fixed rate debt. Also, existing fixed and variable rate loans that are scheduled to mature in the next year or two are evaluated for possible early refinancing and or extension due to consideration given to current interest rates.
We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our properties. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, it does not possess credit risk. It is our policy to enter into these transactions with the same party providing the financing. In the alternative, we seek to minimize the credit risk in derivative instruments by entering into transactions with what we believe are high-quality counterparties. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
We have entered into nine interest rate swap agreements that have converted $232.4 million or 15% of our variable rate mortgage loans from variable to fixed rates. As of December 31, 2011, the pay rates ranged from 0.63% to 3.32% with maturity dates from January 13, 2012 to October 22, 2013. The interest rate swaps have a notional amount of $289 million and fair value at $2.3 million and $3.5 million as of December 31, 2011 and 2010, respectively.
We have, and may in the future enter into, derivative positions that do not qualify for hedge accounting treatment. The gains or losses resulting from marking-to-market, these derivatives at the end of each reporting period are recognized as an increase or decrease in “interest expense” on our consolidated statements of income. In addition, we are, and may in the future be, subject to additional expense based on the notional amount of the derivative positions and a specified spread over LIBOR.
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Equity Price Risk
We are exposed to equity price risk as a result of our investments in marketable equity securities. Equity price risk is based on volatility of equity prices and the values of corresponding equity indices.
Other than temporary impairments on our investments in marketable securities were $24.4, $1.9 and $4.0 million for the years ended December 31, 2011, 2010 and 2009, respectively. The overall stock market and REIT stocks, including our REIT stock investments, have declined since mid-2007, which have resulted in our recognizing impairments. We believe that our investments will continue to generate dividend income and, if the REIT market recovers, we could continue to recognize gains on sale. However, due to general economic and credit market uncertainties it is difficult to project where the REIT market and our portfolio value will be in 2012.
Although it is difficult to project what factors may affect the prices of equity sectors and how much the effect might be, the table below illustrates the impact of a 10% increase and a 10% decrease in the price of the equities held by us would have on the value of the total assets and the book value of the Company as of December 31, 2011 (dollar amounts stated in thousands).
Equity securities
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(A Maryland Corporation)
Index
Item 8. Consolidated Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Financial Statements:
Consolidated Balance Sheets at December 31, 2011 and 2010
Consolidated Statements of Operations and Other Comprehensive Income for the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Changes in Equity for the years ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009
Notes to Consolidated Financial Statements
Real Estate and Accumulated Depreciation (Schedule III)
Schedules not filed:
All schedules other than the ones listed in the Index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.
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The Board of Directors and Stockholders
Inland American Real Estate Trust, Inc.:
We have audited the accompanying consolidated balance sheets of Inland American Real Estate Trust, Inc. (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations and other comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2011. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule III. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Inland American Real Estate Trust, Inc. as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/S/ KPMG LLP
Chicago, Illinois
March 8, 2012
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Consolidated Balance Sheets
(Dollar amounts in thousands, except share amounts)
Assets:
Investment properties:
Land
Building and other improvements
Construction in progress
Total
Less accumulated depreciation
Net investment properties
Cash and cash equivalents
Restricted cash and escrows
Investment in marketable securities
Investment in unconsolidated entities
Accounts and rents receivable (net of allowance of $9,488 and $7,905)
Intangible assets, net
Deferred costs and other assets
Liabilities:
Mortgages, notes and margins payable, net
Accounts payable and accrued expenses
Distributions payable
Intangible liabilities, net
Other liabilities
Total liabilities
Noncontrolling redeemable interests
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.001 par value, 40,000,000 shares authorized, none outstanding
Common stock, $.001 par value, 1,460,000,000 shares authorized, 869,187,360 and 846,406,774 shares issued and outstanding
Additional paid in capital (net of offering costs of $828,434, of which $788,272 was paid to affiliates)
Accumulated distributions in excess of net loss
Accumulated other comprehensive income
Total Company stockholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
See accompanying notes to the consolidated financial statements.
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Consolidated Statements of Operations and Other Comprehensive Income
(Dollar amounts in thousands, except per share amounts)
Depreciation and amortization
Business management fee
Provision for notes receivable impairment
Total expenses
Operating income
Interest and dividend income
Gain (loss) on consolidated investment
Realized gain (loss) and impairment on securities, net
Loss before income taxes
Income tax benefit (expense)
Net loss from continuing operations
Income (loss) from discontinued operations, net
Net loss
Less: Net income attributable to noncontrolling interests
Net loss attributable to Company
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Other comprehensive income (loss):
Unrealized gain (loss) on investment securities
Reversal of unrealized (gain) loss to realized gain (loss) on investment securities
Unrealized gain on derivatives
Comprehensive loss
Net loss, per common share, from continuing operations
Net income (loss), per common share, from discontinued operations
Net loss, per common share, basic and diluted
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Consolidated Statements of Changes in Equity
(Dollar amounts in thousands)
For the years ended December 31, 2011, 2010 and 2009
Balance at January 1, 2009
Net income (loss)
Unrealized gain on investment securities
Reversal of unrealized gain to realized gain on investment securities
Contributions from noncontrolling interests
Proceeds from offering
Offering costs
Proceeds from distribution reinvestment program
Share repurchase program
Issuance of stock options and discounts on shares issued to affiliates
Balance at December 31, 2009
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(continued)
Balance at January 1, 2010
Balance at December 31, 2010
846,406,774
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Balance at January 1, 2011
Unrealized loss on investment securities
Reversal of unrealized loss to realized loss on investment securities
Adjustment to redemption value for noncontrolling interest
Redemption of noncontrolling interests
Balance at December 31, 2011
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Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash provided by operating activities:
Amortization of above and below market leases, net
Amortization of debt premiums, discounts, and financing costs
Amortization of note receivable discount
Gain on sale of property, net
Equity in loss of unconsolidated of entities
(Gain) impairment of investment in unconsolidated entities, net
Realized (gain) loss on investments in securities
Impairment of investments in securities
Other non-cash adjustments
Changes in assets and liabilities:
Accounts and rents receivable
Net cash flows provided by operating activities
Cash flows from investing activities:
Purchase of investment properties
Acquired in-place and market-lease intangibles, net
Capital expenditures and tenant improvements
Investment in development projects
Sale of investment properties
Purchase of investment securities
Sale of investment securities
Proceeds from the sale of unconsolidated entities
Payment of leasing fees and franchise fees
Purchase of note receivable
Payments from notes receivable
Restricted escrows
Other assets
Net cash flows used in investing activities
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Cash flows from financing activities:
Proceeds from offering, net of offering costs
Proceeds from the distribution reinvestment program
Shares repurchased
Distributions paid
Proceeds from mortgage debt and notes payable
Payoffs of mortgage debt
Principal payments of mortgage debt
Proceeds from (paydown of) margin securities debt, net
Payment of loan fees and deposits
Distributions paid to noncontrolling interests
Distributions paid to noncontrolling redeemable interests
Due from related parties, net
Net cash flows used in financing activities
Net decrease in cash and cash equivalents
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Supplemental disclosure of cash flow information:
Tenant and real estate tax liabilities assumed at acquisition
Assumption of mortgage debt at acquisition
Non-cash (discount) premium
Cash paid for interest, net capitalized interest of $10,851, $4,302 and $9,648 for 2011, 2010 and 2009
Supplemental schedule of non-cash investing and financing activities:
Consolidation of Lauth assets
Assumption of mortgage debt at consolidation of Lauth
Liabilities assumed at consolidation of Lauth
Property surrendered in exchange for extinguishment of debt
Property acquired through exchange of notes receivable
Conversion of note receivable to equity interest
Redemption value adjustment for noncontrolling redeemable interest
Property acquired through transfer of equity interest
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Notes To Consolidated Financial Statements
December 31, 2011, 2010 and 2009
(1) Organization
Inland American Real Estate Trust, Inc. (the “Company”) was formed on October 4, 2004 (inception) to acquire and manage a diversified portfolio of commercial real estate, primarily retail properties and multi-family (both conventional and student housing), office, industrial and lodging properties, located in the United States and Canada. The Business Management Agreement (the “Agreement”) provides for Inland American Business Manager & Advisor, Inc. (the “Business Manager”), an affiliate of the Company’s sponsor, to be the business manager to the Company. On August 31, 2005, the Company commenced an initial public offering (the “Initial Offering”) of up to 500,000,000 shares of common stock (“Shares”) at $10.00 each and the issuance of 40,000,000 shares at $9.50 per share available to be distributed pursuant to the Company’s distribution reinvestment plan. On August 1, 2007, the Company commenced a second public offering (the “Second Offering”) of up to 500,000,000 shares of common stock at $10.00 per share and up to 40,000,000 shares at $9.50 per share available to be distributed through the Company’s distribution reinvestment plan. Effective April 6, 2009, the Company elected to terminate the Second Offering. On March 31, 2009, the Company filed a registration statement to register 50,000,000 shares to be issued under the distribution reinvestment plan or “DRP.” Under the DRP, as amended, the purchase price per share is equal to 100% of the “market price” of a share of the Company’s common stock until the shares become listed for trading. Beginning with reinvestments made after September 21, 2010 until December 29, 2011, the DRP purchase price was equal to $8.03 per share. After December 29, 2011, and until a new estimated value per share has been established, the DRP purchase price is equal to $7.22 per share.
The accompanying consolidated financial statements include the accounts of the Company, as well as all wholly owned subsidiaries and consolidated joint venture investments. Wholly owned subsidiaries generally consist of limited liability companies (LLCs) and limited partnerships (LPs). The effects of all significant intercompany transactions have been eliminated.
At December 31, 2011, the Company owned a portfolio of 964 commercial real estate properties compared to 980 properties at December 31, 2010. The breakdown by segment is as follows:
Segment
Property Count
Square Ft/Rooms/Units
(2) Summary of Significant Accounting Policies
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and require 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
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The Company commences revenue recognition on its leases based on a number of factors. In most cases, revenue recognition under a lease begins when the lessee takes possession of or controls the physical use of the leased asset. Generally, this occurs on the lease commencement date. The determination of who is the owner, for accounting purposes, of the tenant improvements determines the nature of the leased asset and when revenue recognition under a lease begins. If the Company is the owner, for accounting purposes, of the tenant improvements, then the leased asset is the finished space and revenue recognition begins when the lessee takes possession of the finished space, typically when the improvements are substantially complete. If the Company concludes it is not the owner, for accounting purposes, of the tenant improvements (the lessee is the owner), then the leased asset is the unimproved space and any tenant improvement allowances funded under the lease are treated as lease incentives which reduces revenue recognized over the term of the lease. In these circumstances, the Company begins revenue recognition when the lessee takes possession of the unimproved space for the lessee to construct their own improvements. The Company considers a number of different factors to evaluate whether it or the lessee is the owner of the tenant improvements for accounting purposes. These factors include:
The determination of who owns the tenant improvements, for accounting purposes, is subject to significant judgment. In making that determination, the Company considers all of the above factors. No one factor, however, necessarily establishes its determination.
Rental income is recognized on a straight-line basis over the term of each lease. The difference between rental income earned on a straight-line basis and the cash rent due under the provisions of the lease agreements is recorded as deferred rent receivable and is included as a component of accounts and rents receivable in the accompanying consolidated balance sheets.
Revenue for lodging facilities is recognized when the services are provided. Additionally, the Company collects sales, use, occupancy and similar taxes at its lodging facilities which it presents on a net basis (excluded from revenues) on the consolidated statements of operations and other comprehensive income.
The Company records lease termination income if there is a signed termination agreement, all of the conditions of the agreement have been met, the tenant is no longer occupying the property and amounts due are considered collectible.
The Company defers recognition of contingent rental income (i.e. percentage/excess rent) until the specified target that triggers the contingent rental income is achieved.
The Company evaluates its investments in limited liability companies and partnerships to determine whether such entities may be a variable interest entity (“VIE”). If the entity is a VIE, the determination of whether the
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Company is the primary beneficiary must be made. The primary beneficiary determination is based on a qualitative assessment as to whether the entity has (i) power to direct significant activities of the VIE and (ii) an obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. The Company will consolidate a VIE if it is deemed to be the primary beneficiary, as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic on Consolidation. The equity method of accounting is applied to entities in which the Company is not the primary beneficiary as defined in the Consolidation Topic of the FASB ASC, or the entity is not a VIE and the Company does not have effective control, but can exercise influence over the entity with respect to its operations and major decisions.
Reclassifications
Certain reclassifications have been made to the 2010 and 2009 consolidated financial statements to conform to the 2011 presentations. The reclasses primarily represent reclassifications of revenue and expenses to discontinued operations as a result of the sales of investment properties in 2011.
Capitalization and Depreciation
Real estate acquisitions are recorded at cost less accumulated depreciation. Ordinary repairs and maintenance are expensed as incurred.
Depreciation expense is computed using the straight line method. Building and other improvements are depreciated based upon estimated useful lives of 30 years for building and improvements and 5-15 years for furniture, fixtures and equipment and site improvements.
Tenant improvements are amortized on a straight line basis over the life of the related lease as a component of depreciation and amortization expense.
Leasing fees are amortized on a straight-line basis over the life of the related lease as a component of depreciation and amortization.
Loan fees are amortized on a straight-line basis, which approximates the effective interest method, over the life of the related loans as a component of interest expense.
Direct and indirect costs that are clearly related to the construction and improvements of investment properties are capitalized. Costs incurred for property taxes and insurance are capitalized during periods in which activities necessary to get the property ready for its intended use are in progress. Interest costs are also capitalized during such periods. Additionally, the Company treats investments accounted for by the equity method as assets qualifying for interest capitalization provided (1) the investee has activities in progress necessary to commence its planned principal operations and (2) the investee’s activities include the use of such funds to acquire qualifying assets.
Investment Properties Held for Sale
In determining whether to classify an investment property as held for sale, the Company considers whether: (i) management has committed to a plan to sell the investment property; (ii) the investment property is available for immediate sale, in its present condition; (iii) the Company has initiated a program to locate a buyer; (iv) the Company believes that the sale of the investment property is probable; (v) the Company has received a significant non-refundable deposit for the purchase of the property; (vi) the Company is actively marketing the
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investment property for sale at a price that is reasonable in relation to its fair value; and (vii) actions required for the Company to complete the plan indicate that it is unlikely that any significant changes will be made to the plan.
If all of the above criteria are met, the Company classifies the investment property as held for sale. On the day that these criteria are met, the Company suspends depreciation on the investment properties held for sale, including depreciation for tenant improvements and additions, as well as on the amortization of acquired in-place leases. The investment properties and liabilities associated with those investment properties that are held for sale are classified separately on the consolidated balance sheets for the most recent reporting period. Additionally, the operations for the periods presented are classified on the consolidated statements of operations and other comprehensive income as discontinued operations for all periods presented. As of December 31, 2011 and 2010, no investment properties were classified as held for sale.
The Company assesses the carrying values of the respective long-lived assets, whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be fully recoverable, such as a reduction in the expected holding period of the asset. If it is determined that the carrying value is not recoverable because the undiscounted cash flows do not exceed carrying value, the Company is required to record an impairment loss to the extent that the carrying value exceeds fair value. The valuation and possible subsequent impairment of investment properties is a significant estimate that can and does change based on our continuous process of analyzing each property and reviewing assumptions about uncertain inherent factors, as well as the economic condition of the property at a particular point in time.
The use of projected future cash flows and related holding period is based on assumptions that are consistent with the estimates of future expectations and the strategic plan the Company uses to manage its underlying business. However assumptions and estimates about future cash flows and capitalization rates are complex and subjective. Changes in economic and operating conditions and the Company’s ultimate investment intent that occur subsequent to the impairment analyses could impact these assumptions and result in future impairment charges of the real estate properties.
On a periodic basis, management assesses whether there are any indicators that the carrying value of the Company’s investments in unconsolidated entities may be other than temporarily impaired. To the extent impairment has occurred, the loss is measured as the excess of the carrying value of the investment over the fair value of the investment. The fair value of the underlying investment includes a review of expected cash flows to be received from the investee.
Derivative Instruments
In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company limits these risks by following established risk management policies and procedures including the use of derivatives to hedge interest rate risk on debt instruments.
The Company has a policy of only entering into contracts with established financial institutions based upon their credit ratings and other factors. When viewed in conjunction with the underlying and offsetting exposure that the derivatives are designed to hedge, the Company has not sustained a material loss from those instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives.
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The Company recognizes all derivatives in the balance sheet at fair value. Additionally, the fair value adjustments will affect either equity or net income depending on whether the derivative instruments qualify as a hedge for accounting purposes and, if so, the nature of the hedging activity. When the terms of an underlying transaction are modified, or when the underlying transaction is terminated or completed, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income each period until the instrument matures. Any derivative instrument used for risk management that does not meet the criteria for hedge accounting is marked-to-market each period in the income statement. The Company does not use derivatives for trading or speculative purposes.
Marketable Securities
The Company classifies its investment in securities in one of three categories: trading, available-for-sale, or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which the Company has the ability and intent to hold the security until maturity. All securities not included in trading or held-to-maturity are classified as available-for-sale. Investment in securities at December 31, 2011 and 2010 consists of common and preferred stock investments and investments in real estate related bonds that are all classified as available-for-sale securities and are recorded at fair value. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. When a security is impaired, the Company considers whether it has the ability and intent to hold the investment for a time sufficient to allow for any anticipated recovery in market value and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period end and forecasted performance of the investee.
Acquisition of Real Estate
The Company allocates the purchase price of each acquired business (as defined in the accounting guidance related to business combinations) between tangible and intangible assets at full fair value at the date of the transaction. Such tangible and intangible assets include land, building and improvements, acquired above market and below market leases, in-place lease value, customer relationships (if any), and any assumed financing that is determined to be above or below market terms. Any additional amounts are allocated to goodwill as required, based on the remaining purchase price in excess of the fair value of the tangible and intangible assets acquired and liabilities assumed. The allocation of the purchase price is an area that requires judgment and significant estimates.
The Company uses the information contained in the independent appraisal obtained at acquisition as the primary basis for the allocation to land and building and improvements. The Company determines whether any financing assumed is above or below market based upon comparison to similar financing terms for similar investment properties. The Company allocates a portion of the purchase price to the estimated acquired in-place lease costs based on estimated lease execution costs for similar leases as well as lost rent payments during assumed lease up
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period when calculating as if vacant fair values. The Company also evaluates each acquired lease based upon current market rates at the acquisition date and considers various factors including geographical location, size and location of leased space within the investment property, tenant profile, and the credit risk of the tenant in determining whether the acquired lease is above or below market lease costs. After an acquired lease is determined to be above or below market, the Company allocates a portion of the purchase price to such above or below acquired lease costs based upon the present value of the difference between the contractual lease rate and the estimated market rate. For below market leases with fixed rate renewals, renewal periods are included in the calculation of below market in-place lease values. The determination of the discount rate used in the present value calculation is based upon the “risk free rate” and current interest rates. This discount rate is a significant factor in determining the market valuation which requires judgment of subjective factors such as market knowledge, economics, demographics, location, visibility, age and physical condition of the property.
The Company expenses acquisition costs of all transactions as incurred. All costs related to finding, analyzing and negotiating a transaction are expensed as incurred as a general and administrative expense, whether or not the acquisition is completed. These expenses would include acquisition fees, if any, paid to an affiliate of the business manager.
Cash and Cash Equivalents
The Company considers all demand deposits, money market accounts and investments in certificates of deposit and repurchase agreements purchased with a maturity of three months or less, at the date of purchase, to be cash equivalents. The Company maintains its cash and cash equivalents at financial institutions. The combined account balances at one or more institutions periodically exceed the Federal Depository Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. The Company believes that the risk is not significant, as the Company does not anticipate the financial institutions’ non-performance.
Restricted Cash and Escrows
Restricted escrows primarily consist of cash held in escrow comprised of lenders’ restricted escrows of $35,728 and $28,376, post acquisition escrows of $16,052 and $17,650, and lodging furniture, fixtures and equipment reserves of $40,570 and $35,055 as of December 31, 2011 and 2010, respectively. As of December 31, 2011 and 2010, the restricted cash balance was $6,094 and $15,008, respectively.
Goodwill
The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed was recorded as goodwill. Goodwill has been recognized and allocated to specific properties in our lodging segment since each individual hotel property is an operating segment and considered a reporting unit. The Company tests goodwill for impairment annually or more frequently if events or changes in circumstances indicate impairment.
The Company tested goodwill for impairment by first comparing the estimated fair value of each property with goodwill to the carrying value of the property’s assets, including goodwill. The fair value is based on estimated future cash flow projections that utilize discount and capitalization rates, which are generally unobservable in the
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market place (Level 3 inputs), but approximate the inputs the Company believes would be utilized by market participants in assessing fair value. The estimates of future cash flows are based on a number of factors including the historical operating results, known trends, and market/economic conditions. If the carrying amount of the property’s assets, including goodwill, exceeds its estimated fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. In this second step, if the implied fair value of goodwill is less than the carrying amount of goodwill, an impairment charge is recorded in an amount equal to that excess.
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
(3) Acquired Properties
The Company records identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination at fair value. During the years ended December 31, 2011, 2010 and 2009, the Company incurred $1,680, $1,805 and $9,617, respectively, of acquisition and transaction costs that were recorded in general and administrative expenses on the consolidated statements of operations and other comprehensive income.
For the year ended December 31, 2010, the Company acquired 35 properties for a gross acquisition price of $897,400. The table below reflects acquisition activity for the year ended December 31, 2011.
Property
Date
Gross Acquisition
Price
Sq Ft/Units/Rooms
For properties acquired as of December 31, 2011, the Company recorded revenue of $46,512 and property net income of $9,074, not including related expensed acquisition costs. For properties acquired as of December 31, 2010, the Company recorded revenue of $84,789 and property net income of $51,497, not including related expensed acquisition costs.
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(4) Discontinued Operations
The Company sold 26 properties for the year ended December 31, 2011 and 14 properties for the year ended December 31, 2010 for a gross disposition price of $242,300 and $308,600, respectively. The table below reflects disposition activity for the year ended December 31, 2011.
Gross Disposition
Retail and Office
The Company has presented separately as discontinued operations in all periods the results of operations for all disposed assets in consolidated operations. The Company sold 26 assets and surrendered three properties to the lender for the year ended December 31, 2011 and sold 14 assets and surrendered assets previously held by a consolidated joint venture for the year ended December 31, 2010. The components of the Company’s discontinued operations are presented below and include the results of operations for the respective periods that the Company owned such assets or was involved with the operations of such ventures during the years ended December 31, 2011, 2010 and 2009.
Revenues
Expenses
Operating loss from discontinued operations
Gain (loss) on sale of properties, net
Gain on transfer of assets
Expenses include impairments of $57,846, $44,349 and $32,934 for the years ended December 31, 2011, 2010 and 2009.
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For the year ended December 31, 2011, the Company had proceeds from the sale of investment properties of $246,312. A gain of $11,964 was realized from the property sales as well as a gain of $10,848 on the extinguishment of debt and a gain of $4,546 on the transfer of assets on three properties surrendered to the lender. For the year ended December 31, 2010, the Company had proceeds from the sale of investment properties of $301,189. A gain of $55,412 was realized from the property sales. In addition, the Company realized a gain of $19,227 on extinguishment of debt on the transfer of assets previously held by a consolidated joint venture to the lender in satisfaction of the outstanding debt balance. All properties surrendered for the years ended December 31, 2011 and 2010 were in satisfaction of non-recourse debt. For the year ended December 31, 2009, there were no dispositions.
(5) Investment in Partially Owned Entities
Consolidated Entities
On October 11, 2005, the Company entered into a joint venture with Minto (Delaware), LLC, or Minto Delaware who owned all of the outstanding equity of Minto Builders (Florida), Inc. (“MB REIT”) prior to October 11, 2005. Pursuant to the terms of the purchase agreement, the Company purchased 920,000 shares of common stock of MB REIT at a price of $1,276 per share for a total investment of approximately $1,172,000 in MB REIT. MB REIT was not considered a VIE as defined in FASB ASC 810, Consolidation, however the Company had a controlling financial interest in MB REIT, had the direct ability to make major decisions for MB REIT through its voting interests, and held key management positions in MB REIT. Therefore this entity was consolidated by the Company and the outside ownership interests were reflected as noncontrolling interests in the accompanying consolidated financial statements.
On October 4, 2011, the Company bought out the common and preferred stock of the consolidated MB REIT joint venture for $293,480 by executing a promissory note of $218,000 and making a cash payment of $75,000. The outstanding promissory note was paid off in full by December 31, 2011. No gain or loss was recorded due to this transaction.
On June 8, 2007, the Company, through a 100% owned subsidiary, entered into the LIP Holdings, LLC (LIP-H) operating agreement for the purpose of funding the development and ownership of real estate projects in the office, distribution, retail, healthcare and mixed-use markets. As of January 6, 2009, control over LIP-H rested with the Company’s subsidiary, resulting in the consolidation of LIP-H. The assets of LIP-H consisted of eight operating office and retail projects and a mezzanine loan to LIP Development (LIP-D), an entity related to Lauth Investment Properties, LLC (Lauth). The mezzanine loan with LIP-D was secured primarily by development projects at various stages of completion, including vacant land. The consolidation resulted in a loss of $148,887 being recognized for the year ended December 31, 2009.
Entities under control of Lauth went into bankruptcy in May of 2009. On July 21, 2009, the Company filed an action against Lauth for their actions with regard to the Company’s losses with its investment in LIP-H (“the lawsuit”). On September 14, 2010, the Company approved a settlement agreement relative to the Lauth bankruptcy, which resolved all remaining issues. The agreement provided for the transfer of five additional properties and consideration of $1,000 in settlement of the mezzanine note. The closing of the settlement agreement and transfer of assets occurred on October 1, 2010 and was recorded by the Company in the fourth quarter of 2010 at fair value. The consolidation and retirement of the outstanding mezzanine loan resulted in a gain of $433 being recognized for the year ended December 31, 2010 representing the excess of the fair value of the collateral received over the carrying value of note receivable.
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The Company has ownership interests of 67% in various limited liability companies which own nine shopping centers. These entities are considered VIEs as defined in ASC 810, and the Company is considered the primary beneficiary of each of these entities. Therefore, these entities are consolidated by the Company. The entities agreements contain put/call provisions which grant the right to the outside owners and the Company to require these entities to redeem the ownership interests of the outside owners during future periods. Because the outside ownership interests are subject to a put/call arrangement requiring settlement for a fixed amount, these entities are treated as 100% owned subsidiaries by the Company with the amount of $47,762 as of December 31, 2011 due to the outside owners reflected as a financing and included within other liabilities in the accompanying consolidated financial statements. Interest expense is recorded on these liabilities in an amount generally equal to the preferred return due to the outside owners as provided in the entities agreements.
For the VIEs where the Company is the primary beneficiary, the following are the liabilities of the consolidated VIE, which are not recourse to the Company, and the assets that can be used only to settle those obligations.
Net assets
Unconsolidated Entities
The entities listed below are owned by the Company and other unaffiliated parties in joint ventures. Net income, distributions and capital transactions for these properties are allocated to the Company and its joint venture partners in accordance with the respective partnership agreements. These entities are not consolidated by the Company and the equity method of accounting is used to account for these investments. Under the equity method of accounting, the net equity investment of the Company and the Company’s share of net income or loss from the unconsolidated entity are reflected in the consolidated balance sheets and the consolidated statements of operations and other comprehensive income.
Entity
Description
NRF Healthcare, LLC
Other Unconsolidated Entities (f)
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The Company recorded an impairment of $113,621, $11,239 and $7,443 related to one, two and one of its unconsolidated entities for the years ended December 31, 2011, 2010 and 2009, respectively.
The Net Lease Strategic Assets Fund, L.P. agreement provides that (1) either limited partner can exercise the buy/sell right of the right of first offer after February 20, 2012 and (2) upon one limited partner’s exercise of either right, the responding partner may not again trigger the buy/sell right or the right of first offer until the termination of all procedures and time frames pursuant to the exercising partner’s chosen right.
On February 21, 2012, the Company delivered to LMLP its right of first offer under the partnership agreement with Net Lease Strategic Asset Fund, LP. Pursuant to the notice, the Company requested the venture sell the assets for a purchase price of $548,706. On February 20 and 21, 2012, LMLP delivered notice to the Company to exercised the buy sell option under the partnership agreement and provided the price of $213,014 at which they would be willing to purchase the assets. If the right of first offer is not accepted, the partnership agreement allows a third party buyer to be sought. For the year ended December 31, 2011, the Company valued the equity interest in part based on the fair value of the underlying assets of the investment using a discounted cash flow model, including discount rates and capitalization rates on the expected future cash flows of the properties. These factors resulted in the valuation of the Company’s investment in the entity at $26,508 and an impairment charge of $113,621.
Combined Financial Information
The following table presents the combined financial information for the Company’s investment in unconsolidated entities.
Balance Sheets:
Real estate assets, net of accumulated depreciation
Total Assets
Liabilities and Equity:
Mortgage debt
Equity
Total Liabilities and Equity
Company’s share of equity
Net excess of cost of investments over the net book value of underlying net assets (net of accumulated depreciation of $1,372 and $1,446, respectively)
Carrying value of investments in unconsolidated entities
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Statements of Operations:
Interest expense and loan cost amortization
Operating expenses, ground rent and general and administrative expenses
Impairments
Net loss before loss on sale of real estate
Gain on sale of real estate
Company’s share of:
Net loss, net of excess basis depreciation of $5, $84 and $587
Depreciation and amortization (real estate related)
The unconsolidated entities had total third party debt of $1,402,462 at December 31, 2011 that matures as follows:
The debt maturities of the unconsolidated entities are not recourse to the Company and the Company has no obligation to fund such debt maturities. It is anticipated that the ventures will be able to repay or refinance all of their debt on a timely basis.
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(6) Transactions with Related Parties
The following table summarizes the Company’s related party transactions for the years ended December 31, 2011, 2010 and 2009.
General and administrative:
General and administrative reimbursement (a)
Loan servicing (b)
Investment advisor fee (c)
Affiliate share purchase discounts (d)
Total general and administrative to related parties
Property management fees (e)
Business manager fee (f)
Loan placement fees (g)
Offering costs (h)
After the Company’s stockholders have received a non-cumulative, non-compounded return of 5% per annum on their “invested capital,” the Company pays its Business Manager an annual business management fee of up to 1% of the “average invested assets,” payable quarterly in an amount equal to 0.25% of the average invested assets as of the last day of the immediately preceding quarter. For the years ended
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As of December 31, 2011 and December 31, 2010, the Company had deposited $373 and $370, respectively, in Inland Bank and Trust, a subsidiary of Inland Bancorp, Inc., an affiliate of The Inland Real Estate Group, Inc.
The Company is party to an agreement with an LLC formed as an insurance association captive (the “Captive”), which is wholly-owned by the Company and three related parties, Inland Real Estate Corporation (“IRC”), Inland Western Real Estate Trust, Inc. and Inland Diversified Real Estate Trust, Inc. The Company paid insurance premiums of $9,627, $10,096 and $7,886 for the years ended December 31, 2011, 2010 and 2009, respectively.
In addition, the Company held 889,820 shares of IRC valued $6,848 as of December 31, 2011. As of December 31, 2010, the Company held 843,200 shares of IRC valued at $7,426.
(7) Investment in Marketable Securities
Investment in marketable securities of $289,365 and $268,726 at December 31, 2011 and December 31, 2010, respectively, consists of primarily preferred and common stock investments in other REITs and certain real estate related bonds which are classified as available-for-sale securities and recorded at fair value. The cost basis net of impairments of available-for-sale securities was $245,131 and $215,761 at December 31, 2011 and December 31, 2010, respectively.
Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and reported as a separate component of comprehensive income until realized. The Company has net accumulated other comprehensive income of $44,234, $52,965 and $39,753, which includes gross unrealized losses of $9,990, $5,433 and $3,696 as of December 31, 2011, 2010 and 2009, respectively. All such gross unrealized losses on investments have been in an unrealized position for less than twelve months and such investments have a related fair value of $60,507 as of December 31, 2011.
The Company’s policy for assessing recoverability of its available-for-sale securities is to record a charge against net earnings when the Company determines that a decline in the fair value of a security drops below the cost basis and believes that decline to be other-than-temporary. Factors in the assessment of other-than-temporary impairment include determining whether (1) the Company has the ability and intent to hold the security until it recovers, and (2) the length of time and degree to which the security’s price has declined. During the year ended
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December 31, 2011, the Company recorded impairment of $24,356 compared to an impairment of $1,856 and $4,038 for the years ended December 31, 2010 and 2009 for other-than-temporary declines on certain available-for-sale securities, which is included as a component of realized gain (loss) and impairment on securities, net on the consolidated statements of operations and other comprehensive income.
Dividend income is recognized when earned. During the years ended December 31, 2011, 2010 and 2009, dividend income of $18,586, $18,386 and $17,977 was recognized and is included in interest and dividend income on the consolidated statements of operations and other comprehensive income.
(8) Leases
Operating Leases
Minimum lease payments to be received under operating leases, excluding multi-family and lodging properties and rental income under master lease agreements and assuming no expiring leases are renewed, are as follows:
The remaining lease terms range from one year to 29 years. The majority of the revenue from the Company’s properties consists of rents received under long-term operating leases. Some leases provide for the payment of fixed base rent paid monthly in advance, and for the reimbursement by tenants to the Company for the tenant’s pro rata share of certain operating expenses including real estate taxes, special assessments, insurance, utilities, common area maintenance, management fees, and certain building repairs paid by the landlord and recoverable under the terms of the lease. Under these leases, the landlord pays all expenses and is reimbursed by the tenant for the tenant’s pro rata share of recoverable expenses paid. Certain other tenants are subject to net leases which provide that the tenant is responsible for fixed based rent as well as all costs and expenses associated with occupancy. Under net leases where all expenses are paid directly by the tenant rather than the landlord, such expenses are not included in the consolidated statements of operations and other comprehensive income. Under leases where all expenses are paid by the landlord, subject to reimbursement by the tenant, the expenses are included within property operating expenses and reimbursements are included in tenant recovery income on the consolidated statements of operations and other comprehensive income.
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(9) Intangible Assets and Goodwill
The following table summarizes the Company’s identified intangible assets, intangible liabilities and goodwill as of December 31, 2011 and December 31, 2010.
Intangible assets:
Acquired in-place lease
Acquired above market lease
Acquired below market ground lease
Advance bookings
Accumulated amortization
Net intangible assets
Goodwill, net
Total intangible assets, net
Intangible liabilities:
Acquired below market lease
Acquired above market ground lease
Net intangible liabilities
The portion of the purchase price allocated to acquired above market lease costs and acquired below market lease costs are amortized on a straight line basis over the life of the related lease, including the respective renewal period for below market lease costs with fixed rate renewals, as an adjustment to rental income. Amortization pertaining to the above market lease costs was applied as a reduction to rental income. Amortization pertaining to the below market lease costs was applied as an increase to rental income. The portion of the purchase price allocated to acquired in-place lease intangibles is amortized on a straight line basis over the life of the related lease.
The following table summarized the amortization related to acquired above and below market lease costs and acquired in-place lease intangibles for the years ended December 31, 2011, 2010 and 2009.
Amortization of:
Acquired above market lease costs
Acquired below market lease costs
Net rental income increase
Acquired in-place lease intangibles
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The following table presents the amortization during the next five years related to intangible assets and liabilities at December 31, 2011.
(10) Mortgages, Notes and Margins Payable
During the years ended December 31, 2011 and 2010, the following debt transactions occurred:
New financings
Assumed financings, net of discount
Paydown of debt
Extinguishment of debt
Amortization of discount/premium
Mortgage loans outstanding as of December 31, 2011 and December 31, 2010 were $5,812,595 and $5,508,668 and had a weighted average interest rate of 5.2% and 5.1% per annum, respectively. Mortgage premium and discount, net was a discount of $30,741 and $38,712 as of December 31, 2011 and December 31, 2010. As of December 31, 2011, scheduled maturities for the Company’s outstanding mortgage indebtedness had various due dates through December 2047.
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The Company is negotiating refinancing debt maturing in 2012 and 2013 with various lenders at terms that will allow us to pay lower interest rates. It is anticipated that the Company will be able to repay, refinance or extend the maturities and the Company believes it has adequate sources of funds to meet short term cash needs related to these refinancings. Of the total outstanding debt, approximately $828,785 is recourse to the Company.
Some of the mortgage loans require compliance with certain covenants, such as debt service ratios, investment restrictions and distribution limitations. As of December 31, 2011, the Company was in compliance with all mortgage loan requirements except six loans with a carrying value of $102,853; none of which are cross collateralized with any other mortgage loans or recourse to the Company. The stated maturities of the mortgage loans in default are reflected as follows: $12,100 in 2011, $5,310 in 2012, $9,757 in 2016 and $75,686 in 2017.
During the first quarter of 2011, the Company fully amortized the $10,368 of a mark to market mortgage discount on three properties. The recognition of the $10,368 discount was recorded as a result of the properties’ mortgage loans, totaling $63,955, being in default. During the fourth quarter of 2011, one of the properties was surrendered to the lender, therefore, $4,006 of the fully amortized mark to market discount was reflected in discontinued operations.
The Company has purchased a portion of its securities through margin accounts. As of December 31, 2011 and December 31, 2010, the Company has recorded a payable of $120,858 and $62,101, respectively, for securities purchased on margin. At December 31, 2011 and December 31, 2010, this rate was 0.621% and 0.609%. Interest expense in the amount of $473, $419 and $168 was recognized in interest expense on the consolidated statements of operations and other comprehensive income for the years ended December 31, 2011, 2010 and 2009, respectively.
(11) Derivatives
As of December 31, 2011, in connection with certain mortgages payable that have variable interest rates, the Company has entered into interest rate swap agreements, with a notional value of $289,087. The Company’s interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed rate payments over the life of the agreements without exchange of the underlying notional amount. The interest rate swaps were considered highly effective as of December 31, 2011. The change in the fair value of the Company’s swaps as reflected in other comprehensive income was $1,249, $300, and $5,220 for the years ended December 31, 2011, 2010 and 2009, respectively.
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The following table summarizes interest rate swap and cap contracts outstanding as of December 31, 2011 and December 31, 2010:
Date Entered
Effective Date
End Date
March 28,2008
November 16,2007
March 28, 2008
December 23,2008
January 16, 2009
August 19, 2010
October 15, 2010
January 7, 2011
April 28, 2011
September 1, 2011
October 14, 2011
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its debt funding and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to add stability to interest expense and to manage its exposure to interest rate movements.
Cash Flow Hedges of Interest Rate Risk
The Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
Derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The derivative instruments were reported at their fair value of $2,284 and $3,533 in other liabilities at December 31, 2011 and December 31, 2010, respectively. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the next 12 months, the Company estimates that $1,929 will be reclassified into earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.
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The tables below present the effect of the Company’s derivative financial instruments on the consolidated statements of operations and other comprehensive income for the years ended December 31, 2011, 2010 and 2009:
Derivatives in ASC815 Cash FlowHedgingRelationships
Interest Rate Products
(12) Fair Value Measurements
In accordance with ASC 820, Fair Value Measurement and Disclosures, the Company defines fair value based on the price that would be received upon sale of an asset or the exit price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:
Level 1 - Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 - Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The Company has estimated the fair value of its financial and non-financial instruments using available market information and valuation methodologies the Company believes to be appropriate for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that would be realized upon disposition.
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For assets and liabilities measured at fair value on a recurring basis, quantitative disclosure of the fair value for each major category of assets and liabilities is presented below:
Using SignificantOther ObservableInputs
(Level 2)
Using SignificantOther UnobservableInputs
(Level 3)
Available-for-sale real estate equity securities
Real estate related bonds
Derivative interest rate instruments
Commercial mortgage backed securities
Put/call agreement in MB REIT
Level 1
At December 31, 2011 and December 31, 2010, the fair value of the available for sale real estate equity securities have been estimated based upon quoted market prices for the same or similar issues when current quoted market prices are available. Unrealized gains or losses on investment are reflected in unrealized gain (loss) on investment securities in other comprehensive income on the consolidated statements of operations and other comprehensive income.
Level 2
To calculate the fair value of the real estate related bonds and the derivative interest rate instruments, the Company primarily uses quoted prices for similar securities and contracts. For the real estate related bonds, the Company reviews price histories for similar market transactions. For the derivatives, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements which utilizes Level 3 inputs, such as
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estimates of current credit spreads. However, as of December 31, 2011 and 2010, the Company has assessed that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Level 3
Recurring Measurements
The following table summarizes activity for the Company’s assets and liabilities measured at fair value on a recurring basis using Level 3 inputs as of December 31, 2011 and 2010:
Balance, December 31, 2009
Purchases
Sales
Realized gains
Unrealized gains
Balance, December 31, 2010
Unrealized losses
Balance, December 31, 2011
Non-Recurring Measurements
The following table summarizes activity for the Company’s assets measured at fair value on a non-recurring basis. The Company recognized certain non-cash gains and impairment charges to reflect the investments at their fair values for the years ended December 31, 2011 and 2010. The asset groups that were reflected at fair value through this evaluation are:
Investment properties
Notes receivable
Consolidated investment
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The Company’s estimated fair value relating to the investment properties’ impairment analysis is based on a comparison of letters of intent or purchase contracts, broker opinions of value and discounted cash flow models, which includes contractual inflows and outflows over a specific holding period. The cash flows consist of unobservable inputs such as contractual revenues and forecasted revenues and expenses. These unobservable inputs are based on market conditions and the Company’s expected growth rates. Capitalization rates and discount rates are utilized in the model and are based upon observable rates that the Company believes to be within a reasonable range of current market rates. During the year ended December 31, 2011, the Company identified certain properties which may have a reduction in the expected holding period and the Company reviewed the probability of these assets’ dispositions. For the years ended, December 31, 2011, 2010 and 2009, the impairment of the investment properties was $105,795, $3,180 and $1,117, respectively. Certain properties have been disposed and were impaired prior to disposition and the related impairment charge of $57,846, $44,349 and $32,934 is included in discontinued operations for the years ended December 31, 2011, 2010 and 2009, respectively.
When the Company assesses the potential impairment of notes receivable, an evaluation of the fair value of the collateral is performed through a review of third party appraisals and discounted cash flow models. The Company’s discounted cash flow model includes contractual inflows and outflows over a specific holding period and utilizes unobservable inputs based on market conditions and the Company’s expected growth rates. The Company believes the capitalization rates and discount rates utilized in the models are based upon observable rates that are within a reasonable range of current market rates.
On October 22, 2010, the Company entered into a restructure agreement with a borrower, being Stan Thomas Properties on three loans. As part of the restructure, the Company received title and all rights to two land parcels, located in Florida and California, that secured the notes receivable, and in return, the Company released its collateral rights to a third land parcel as well as the personal guarantees of Stan Thomas. Prior to foreclosure, the Company recorded its note receivable at the estimated fair values for the two land sites that were to be received as part of the restructure. For the year ended December 31, 2010, the Company recorded an impairment of $94,627. The unobservable inputs used in the Stan Thomas note receivable evaluation include significant judgments of future long-term real estate, governmental and economic conditions to develop cash-flowing investments from these land parcels. These primary inputs are conditioned on a long-term recovery of these real estate markets so that development of certain infrastructure relating to the parcels will deliver positive risk-adjusted returns.
For the years ended December 31, 2011, 2010 and 2009, the Company recorded $0, $111,896 and $74,136, respectively, of impairment losses.
The Company recognized an investment in unconsolidated entities of $17,150 equal to its equity investment in a trust which owns 100% of a hotel property. The investment was a result of a conversion of a note receivable to an equity interest in which the Company recognized a gain of $17,150. The fair value of hotel property was estimated based on analysis of appraisals, broker opinions of value, and discounted cash flow models, which includes contractual inflows and outflows over a specific holding period. The Company recognized an impairment charge in unconsolidated entities of $113,621 in part based on the fair value of the underlying assets of the investment using a discounted cash flow model, including discount rates and capitalization rates on the expected future cash flows of the properties. The cash flows consist of unobservable inputs such as contractual revenues and forecasted revenues and expenses. These unobservable inputs are based on market conditions and expected growth rates. Capitalization rates and discount rates are utilized in the model and are based upon observable rates that the Company believes to be within a reasonable range of current market rates.
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Financial Instruments not Measured at Fair Value
The table below represents the fair value of financial instruments presented at carrying values in our consolidated financial statements as of December 31, 2011 and December 31, 2010.
Mortgage and notes payable
Margins payable
The Company estimates the fair value of its mortgages and margins payable by discounting the future cash flows of each instrument at rates currently offered to the Company for similar debt instruments of comparable maturities by the Company’s lenders.
(13) Income Taxes
The Company is qualified and has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, for federal income tax purposes commencing with the tax year ending December 31, 2005. Since the Company qualifies for taxation as a REIT, the Company generally will not be subject to federal income tax on taxable income that is distributed to stockholders. A REIT is subject to a number of organizational and operational requirements, including a requirement that it currently distributes at least 90% of its REIT taxable income (subject to certain adjustments) to its stockholders. If the Company fails to qualify as a REIT in any taxable year, without the benefit of certain relief provisions, the Company will be subject to federal and state income tax on its taxable income at regular corporate tax rates. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income, property or net worth and federal income and excise taxes on its undistributed income.
The Company has elected to treat certain of its consolidated subsidiaries, and may in the future elect to treat newly formed subsidiaries, as taxable REIT subsidiaries pursuant to the Internal Revenue Code. Taxable REIT subsidiaries may participate in non-real estate related activities and/or perform non-customary services for tenants and are subject to federal and state income tax at regular corporate tax rates. The Company’s hotels are leased to certain of the Company’s taxable REIT subsidiaries. Lease revenue from these taxable REIT subsidiaries and its wholly-owned subsidiaries is eliminated in consolidation.
The components of income tax expense for the years ended December 31:
Current
Deferred
Total income expense (benefit)
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The components of the deferred tax assets and liabilities at December 31, 2011 and 2010 were as follows:
Net operating loss
Deferred income
Basis difference on development property
Lease acquisition costs
Depreciation expense
Miscellaneous
Total deferred tax assets
Less: Valuation allowance
Net deferred tax assets
Gain on sales of real estate, net of depreciation effect
Straight-line rents
Deferred tax liabilities
Federal net operating loss carryforwards amounting to $16,084 begin to expire in 2023, if not utilized by then.
Deferred tax assets are recognized only to the extent that it is more likely than not that they will be realized based on consideration of available evidence, including future reversal of existing taxable temporary difference, future projected taxable income, and tax planning strategies. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company has considered various factors, including future reversals of existing taxable temporary differences, projected future taxable income and tax-planning strategies in making this assessment.
Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance of $38,300 at December 31, 2011. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
Uncertain Tax Positions
The Company had no unrecognized tax benefits as of or during the three year period ended December 31, 2011. The Company expects no significant increases or decreases in unrecognized tax benefits due to changes in tax positions within one year of December 31, 2011. The Company has no material interest or penalties relating to income taxes recognized in the consolidated statements of operations and other comprehensive income for the years ended December 31, 2011, 2010 and 2009 or in the consolidated balance sheets as of December 31, 2011 and 2010. As of December 31, 2011, the Company’s 2010, 2009, and 2008 tax years remain subject to examination by U.S. and various state tax jurisdictions.
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For federal income tax purposes, distributions may consist of ordinary income, qualifying dividends, return of capital, capital gains or a combination thereof. Distributions to the extent of the Company’s current and accumulated earnings and profits for federal income tax purposes are taxable to the recipient as ordinary income. Distributions in excess of these earnings and profits will constitute a non-taxable return of capital rather than a dividend and will reduce the recipient’s basis in the shares.
A summary of the average taxable nature of the Company’s common distributions paid for each of the years in the three year period ended December 31, 2011 is as follows:
Ordinary income
Return of capital
Total distributions per share
(14) Segment Reporting
The Company has five business segments: Office, Retail, Industrial, Lodging and Multi-family. The Company evaluates segment performance primarily based on net property operations. Net property operations of the segments primarily exclude interest expense, depreciation and amortization, general and administrative expenses, net income of noncontrolling interest and other investment income from corporate investments. The non-segmented assets primarily include the Company’s cash and cash equivalents, investment in marketable securities, construction in progress, investment in unconsolidated entities and notes receivable.
Prior to October 1, 2010, the Company considered the net property operations of the assets of LIP Holdings, LLC, its 100% owned subsidiary (LIP-H), which consisted of eight operating office and retail properties, a segment. Due to the settlement and consolidation of the remaining Lauth assets and the disposition of four of eight LIP-H assets, the Company no longer evaluates the net property operations of these assets as a segment. For the year ended December 31, 2011, the assets of the LIP-H segment were classified into the appropriate segment as identified above. The Company has restated the prior years’ comparatives to conform with current year presentation.
For the year ended December 31, 2011, approximately 9% of the Company’s rental revenue was generated by over 400 retail banking properties leased to SunTrust Banks, Inc. Also, as of December 31, 2011, approximately 7% of the Company’s rental revenue was generated by three properties leased to AT&T, Inc. As a result of the concentration of revenue generated from these properties, if SunTrust or AT&T were to cease paying rent or fulfilling its other monetary obligations, the Company could have significantly reduced rental revenues or higher expenses until the defaults were cured or the properties were leased to a new tenant or tenants.
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The following table summarizes net property operations income by segment as of and for the year ended December 31, 2011.
Property rentals
Amortization of acquired above and below market leases, net
Total rental income
Operating expenses
Net property operations
Non allocated expenses (a)
Other income and expenses (b)
Loss from unconsolidated entities (c)
Loss from discontinued operations, net
Net income attributable to noncontrolling interests
Real estate assets, net
Non-segmented assets
Capital expenditures
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The following table summarizes net property operations income by segment as of and for the year ended December 31, 2010.
Income (loss) from unconsolidated entities (c)
Provision for asset impairment (d)
Gain on consolidated investment
Income from discontinued operations, net
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The following table summarizes net property operations income by segment as of and for the year ended December 31, 2009.
Loss on consolidated investment
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(15) Earnings (loss) per Share
Basic earnings (loss) per share (“EPS”) are computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period (the “common shares”). Diluted EPS is computed by dividing net income (loss) by the common shares plus potential common shares issuable upon exercising options or other contracts. There are an immaterial amount of potentially dilutive common shares.
The basic and diluted weighted average number of common shares outstanding was 858,637,707, 835,131,057 and 811,400,035 for the years ended December 31, 2011, 2010 and 2009.
(16) Commitments and Contingencies
On June 17, 2011, Crockett Capital Corporation and the Company agreed to a mutual customary release of all claims arising from or related to pending litigation, upon which, the Company made a payment of $5,100 which is reflected in other income (expense), net on the consolidated statements of operations and other comprehensive income.
Certain leases and operating agreements within the lodging segment require the Company to reserve funds relating to replacements and renewals of the hotels’ furniture, fixtures and equipment. As of December 31, 2011, the Company has funded $40,570 in reserves for future improvements. This amount is included in restricted cash and escrows on the consolidated balance sheet as of December 31, 2011.
The Company has also filed a number of eviction actions against tenants and is involved in a number of tenant bankruptcies. The tenants in some of the eviction cases may file counterclaims against the Company in an attempt to gain leverage against the Company in connection with the eviction. In the opinion of the Company, none of these counterclaims is likely to result in any material losses to the Company.
(17) Quarterly Supplemental Financial Information (unaudited)
The following represents the results of operations, for each quarterly period, during 2011 and 2010.
Net loss, per common share, basic and diluted (1)
Weighted average number of common shares outstanding, basic and diluted (1)
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Schedule III
Real Estate and Accumulated Depreciation
December 31, 2011
14th STREET MARKET
Plano, TX
24 HOUR FITNESS -THE WOODLANDS
Woodlands, TX
95th and CICERO
Oak Lawn, IL
ALCOA EXCHANGE
Bryant, AR
ALCOA EXCHANGE II
Benton, AR
ANDERSON CENTRAL Anderson, SC
ANTOINE TOWN CENTER
Houston, TX
ATASCOCITA SHOPPING CENTER
Humble, TX
BARTOW MARKETPLACE
Atlanta, GA
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BAY COLONY
League City, TX
BAY COLONY II
BEAR CREEK VILLAGE CENTER
Wildomar, CA
BELLERIVE PLAZA
Nicholasville, KY
BENT TREE PLAZA
Raleigh, NC
BI-LO—GREENVILLE
Greenville, SC
BLACKHAWK TOWN CENTER
BOYNTON COMMONS
Miami, FL
BRANDON CENTRE SOUTH
Brandon, FL
BROOKS CORNER
San Antonio, TX
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BUCKHEAD CROSSING
BUCKHORN PLAZA
Bloomsburg, PA
CAMPUS MARKETPLACE
San Marcos, CA
CANFIELD PLAZA
Canfield, OH
CENTERPLACE OF GREELEY
Greeley, CO
CHESAPEAKE COMMONS
Chesapeake, VA
CHEYENNE MEADOWS
Colorado Springs, CO
CHILI’S—HUNTING BAYOU
Jacinto City, TX
CINEMARK—JACINTO CITY
CITIZENS (CFG) CONNECTICUT
Hamden, CT
Colchester, CT
Deep River, CT
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East Lyme, CT
Montville, CT
Stonington, CT
East Hampton, CT
CITIZENS (CFG) DELAWARE
Lewes, DE
Wilmington, DE
CITIZENS (CFG) ILLINOIS
Orland Hills, IL
Calumet City, IL
Chicago, IL
Villa Park, IL
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Westchester, IL
Olympia Fields, IL
Chicago Heights, IL
CITIZENS (CFG) MELLON BANK BLD
Georgetown, DE
CITIZENS (CFG) MICHIGAN
Farmington, MI
Troy, MI
CITIZENS (CFG) NEW HAMPSHIRE
Keene, NH
Manchester, NH
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Salem, NH
Hinsdale, NH
Ossipee, NH
Pelham, NH
CITIZENS (CFG) NEW JERSEY
Haddon Heights, NJ
Marlton, NJ
CITIZENS (CFG) NEW YORK
Plattsburgh, NY
CITIZENS (CFG) OHIO
Fairlawn, OH
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Bedford, OH
Parma, OH
Parma Heights, OH
South Russell, OH
CITIZENS (CFG) PENNSYLVANIA
Altoona, PA
Ashley, PA
Brodheadsville, PA
Butler, PA
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Camp Hill, PA
Carnegie, PA
Charlerol, PA
Dallas, PA
Dallastown, PA
Dillsburg, PA
Drexel Hill, PA
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Ford City, PA
Glenside, PA
Greensburg, PA
Highspire, PA
Homestead, PA
Kingston, PA
Kittanning, PA
Matamoras, PA
McKees Rocks, PA
Mechanicsburg, PA
Mercer, PA
Milford, PA
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Philadelphia, PA
Pitcairn, PA
Pittsburgh, PA
Reading, PA
-113-
Souderton, PA
State College, PA
Tannersville, PA
Turtle Creek, PA
Tyrone, PA
Upper Darby, PA
West Chester, PA
West Hazelson, PA
York, PA
Aliquippa, PA
-114-
Allison Park, PA
Beaver Falls, PA
Carlisle, PA
Cranberry, PA
Erie, PA
Grove City, PA
Harrisburg, PA
Haertown, PA
Hollidaysburg, PA
Kutztown, PA
-115-
Lancaster, PA
Latrobe, PA
Lititz, PA
Lower Burrell, PA
Mountain Top, PA
Munhall, PA
New Stanton, PA
Oakmont, PA
Oil City, PA
-116-
Saxonburg, PA
Shippensburg, PA
Slovan, PA
Temple, PA
-117-
Verona, PA
Warrendale, PA
West Grove, PA
Wexford, PA
Wilkes-Barre, PA
Mount Lebanon, PA
CITIZENS (CFG) RHODE ISLAND
Coventry, RI
-118-
Cranston, RI
Johnston, RI
North Providence, RI
Providence, RI
Wakefield, RI
Warwick, RI
East Greenwich, RI
-119-
Rumford, RI
Warren, RI
CITIZENS (CFG) VERMONT
Middlebury, VT
CITIZENS (CFG) MASSACHUSETTS
Ludlow, MA
Malden, MA
Medford, MA
-120-
Milton, MA
Randolph, MA
South Dennis, MA
Springfield, MA
Woburn, MA
Dorchester, MA
Needham, MA
New Bedford, MA
-121-
Somerville, MA
Tewksbury, MA
Watertown, MA
Wilbraham, MA
Winthrop, MA
Dedham, MA
Hanover, MA
-122-
CITY CROSSING
Warner Robins, GA
COWETA CROSSING
Newnan, GA
CROSS TIMBERS COURT
Flower Mound, TX
CROSSROADS AT CHESAPEAKE SQUARE
CUSTER CREEK VILLAGE
Richardson, TX
CYFAIR TOWN CENTER
Cypress, TX
CYFAIR TOWN CENTER II
CYPRESS TOWN CENTER
DONELSON PLAZA
Nashville, TN
DOTHAN PAVILION
Dothan, AL
EAST GATE
Aiken, SC
-123-
ELDRIDGE TOWN CENTER
FABYAN RANDALL PLAZA
Batavia, IL
FAIRVIEW MARKET
Simpsonville, SC
FLOWER MOUND CROSSING
FOREST PLAZA
Fond du Lac, WI
FURY’S FERRY
Augusta, GA
GARDEN VILLAGE
San Pedro, CA
GATEWAY MARKET CENTER
Tampa, FL
GATEWAY PLAZA
Jacksonville, NC
GLENDALE HEIGHTS I, II, III
Glendale Heights, IL
GRAFTON COMMONS SHOPPING CENTER
Grafton, WI
-124-
GRAVOIS DILLON PLAZA
High Ridge, MO
HERITAGE CROSSING
Wilson, NC
HERITAGE HEIGHTS
Grapevine, TX
HERITAGE PLAZA—CHICAGO
Carol Stream, IL
HIGHLAND PLAZA
Katy, TX
HIRAM PAVILION
Hiram, GA
HUNTER’S GLEN CROSSING
HUNTING BAYOU
IA ORLANDO SAND
Orlando, FL
INTECH RETAIL
Indianapolis, IN
JAMES CENTER
Tacoma, WA
JOSEY OAKS CROSSING
Carrollton, TX
-125-
LA FITNESS AT ELDRIDGE LAKES
LAKEPORT COMMONS
Sioux City, IA
LAKEWOOD SHOPPING CENTER
Margate, FL
LAKEWOOD SHOPPING CTR PHASE II
LEGACY CROSSING
Marion, OH
LEXINGTON ROAD
Athens, GA
LINCOLN MALL
Lincoln, RI
LINCOLN VILLAGE
LORD SALISBURY CENTER
Salisbury, MD
MARKET AT MORSE / HAMILTON
Columbus, OH
-126-
MARKET AT WESTLAKE
Westlake Hills, TX
MCKINNEY TOWN CENTER
McKinney, TX
MERCHANTS CROSSING
Englewood, FL
MIDDLEBURG CROSSING
Middleburg, FL
MONADNOCK MARKETPLACE
NEW FOREST CROSSING II
NEWTOWN ROAD
Virginia Beach, VA
NORTHWEST MARKETPLACE
NTB ELDRIDGE
PALAZZO DEL LAGO
PALM HARBOR SHOPPING CENTER
Palm Coast, FL
-127-
PARADISE PLACE
West Palm Beach, FL
PARADISE SHOPS OF LARGO
Largo, FL
PARK WEST PLAZA
PARKWAY CENTRE NORTH
Grove City, OH
PARKWAY CENTRE NORTH OUTLOT B
PAVILION AT LAQUINTA
LaQuinta, CA
PAVILIONS AT HARTMAN HERITAGE
Independence, MO
PEACHLAND PROMENADE
Port Charlotte, FL
PENN PARK
Oklahoma City, OK
PIONEER PLAZA
Mesquite, TX
PLAZA AT EAGLE’S LANDING
Stockbridge, GA
-128-
PLEASANT HILL SQUARE
Duluth, GA
POPLIN PLACE
Monroe, NC
PRESTONWOOD SHOPPING CENTER
Dallas, TX
PROMENADE FULTONDALE
Fultondale, AL
RALEIGH HILLSBOROUGH
RIVERSTONE SHOPPING CENTER
Missouri City, TX
RIVERVIEW VILLAGE
Arlington, TX
ROSE CREEK
Woodstock, GA
ROSEWOOD SHOPPING CENTER
Columbia, SC
SALTGRASS RESTAURANT-HUNTING BAYOU
-129-
SARASOTA PAVILION
Sarasota, FL
SCOFIELD CROSSING
Austin, TX
SHALLOTTE COMMONS
Shallotte, NC
SHERMAN PLAZA
Evanston, IL
SHERMAN TOWN CENTER
Sherman, TX
SHERMAN TOWN CENTER II
SHILOH SQUARE
Garland, TX
SIEGEN PLAZA
East Baton Rouge, LA
SILVERLAKE
Erlanger, KY
SONIC AT ANTOINE TOWN CENTER
SOUTHGATE VILLAGE
Pelham, AL
-130-
SPARKS CROSSING
Sparks, NV
SPRING TOWN CENTER
Spring, TX
SPRING TOWN CENTER III
STABLES TOWN CENTER I and II
STATE STREET MARKET
Rockford, IL
STONE CREEK
San Marcos, TX
STONECREST MARKETPLACE
Lithonia, GA
STOP & SHOP—SICKLERVILLE
Sicklerville, NJ
STOP N SHOP—BRISTOL
Bristol, RI
STOP N SHOP—CUMBERLAND
Cumberland, RI
-131-
STOP N SHOP - FRAMINGHAM
Framingham, MA
STOP N SHOP—HYDE PARK
Hyde Park, NY
STOP N SHOP—MALDEN
STOP N SHOP—SOUTHINGTON
Southington, CT
STOP N SHOP—SWAMPSCOTT
Swampscott, MA
STREETS OF CRANBERRY
Cranberry Township, PA
STREETS OF INDIAN LAKES
Hendersonville, TN
SUNCREEK VILLAGE
SUNTRUST BANK I AL
Muscle Shoals, AL
Killen, AL
SUNTRUST BANK I DC
Brightwood, DC
SUNTRUST BANK I FL
Panama City, FL
-132-
Apopka, FL
Bayonet Point, FL
Daytona Beach, FL
Dade City, FL
Pensacola, FL
New Smyrna Beach, FL
Clearwater, FL
Deltona, FL
-133-
Boca Raton, FL
Ocala, FL
Fort Meade, FL
Fruitland Park, FL
Ormond Beach, FL
Gainesville, FL
Lakeland, FL
Hobe Sound, FL
-134-
Mulberry, FL
Indian Harbour Beach, FL
Inverness, FL
Lake Mary, FL
Melbourne, FL
St. Petersburg, FL
Lutz, FL
Marianna, FL
Vero Beach, FL
Mount Dora, FL
-135-
North Palm Beach, FL
Port St. Lucie, FL
Okeechobee, FL
Osprey, FL
Panama City Beach, FL
New Port Richey, FL
Pembroke Pines, FL
-136-
Pompano Beach, FL
Jacksonville, FL
Brooksville, FL
Rockledge, FL
Seminole, FL
-137-
Spring Hill, FL
St. Augustine, FL
Gulf Breeze, FL
Casselberry, FL
Winter Park, FL
Fort Pierce, FL
Plant City, FL
West St. Cloud, FL
-138-
Tamarac, FL
SUNTRUST BANK I GA
Brunswick, GA
Kennesaw, GA
Columbus, GA
Austell, GA
Chamblee, GA
Conyers, GA
Savannah, GA
Dunwoody, GA
Douglasville, GA
-139-
Albany, GA
Macon, GA
Thomson, GA
Madison, GA
Marietta, GA
Cartersville, GA
-140-
Peachtree City, GA
Stone Mountain, GA
Waycross, GA
Union City, GA
Morrow, GA
Norcross, GA
Sylvester, GA
-141-
Evans, GA
SUNTRUST BANK I MD
Annapolis, MD
Landover, MD
Avondale, MD
Cambridge, MD
Cockeysville, MD
Glen Burnie, MD
Prince Frederick, MD
SUNTRUST BANK I NC
Greensboro, NC
-142-
Apex, NC
Arden, NC
Asheboro, NC
Bessemer City, NC
Durham, NC
Charlotte, NC
Creedmoor, NC
Dunn, NC
Harrisburg, NC
-143-
Hendersonville, NC
Cary, NC
Mebane, NC
Lenoir, NC
Roxboro, NC
Winston-Salem, NC
Oxford, NC
Pittsboro, NC
Stanley, NC
Salisbury, NC
-144-
Stokesdale, NC
Sylva, NC
Lexington, NC
Walnut Cove, NC
Waynesville, NC
Concord, NC
Yadkinville, NC
Rural Hall, NC
Summerfield, NC
SUNTRUST BANK I SC
Fountain Inn, SC
Liberty, SC
-145-
Mauldin, SC
SUNTRUST BANK I TN
Kingsport, TN
Morristown, TN
Brentwood, TN
East Ridge, TN
-146-
Chattanooga, TN
Lebanon, TN
Loudon, TN
Soddy Daisy, TN
Oak Ridge, TN
Savannah, TN
Signal Mountain, TN
Smyrna, TN
Murfreesboro, TN
-147-
Johnson City, TN
SUNTRUST BANK I VA
Accomac, VA
Richmond, VA
Fairfax, VA
Fredericksburg, VA
Collinsville, VA
Doswell, VA
Lynchburg, VA
-148-
Stafford, VA
Gloucester, VA
Lexington, VA
Radford, VA
Williamsburg, VA
Salem, VA
Roanoke, VA
New Market, VA
Onancock, VA
Painter, VA
Stuart, VA
-149-
Vinton, VA
SUNTRUST II FLORIDA
Destin, FL
Dunedin, FL
Palm Harbor FL
Tallahassee, FL
Coral Springs, FL
-150-
South Daytona, FL
Fort Lauderdale, FL
Lake Wells, FL
Dunnellon, FL
Kissimmee, FL
Port Orange, FL
North Port, FL
-151-
Hudson, FL
SUNTRUST II GEORGIA
Bowden, GA
Cedartown, GA
St. Simons Island, GA
Jessup, GA
Roswell, GA
-152-
SUNTRUST II MARYLAND
Frederick, MD
Waldorf, MD
Ellicott City, MD
SUNTRUST II NORTH CAROLINA
Belmont, NC
Carrboro, NC
-153-
Burlington, NC
Mocksville, NC
Oakboro, NC
-154-
Matthews, NC
Zebulon, NC
SUNTRUST II SOUTH CAROLINA
Belton, SC
Anderson, SC
Travelers Rest, SC
SUNTRUST II TENNESSEE
-155-
Lavergne, TN
Chatanooga, TN
Madison, TN
SUNTRUST II VIRGINIA
Norfolk, VA
Cheriton, VA
Rocky Mount, VA
Petersburg, VA
-156-
SUNTRUST III DISTRICT OF COLUMBIA
Washington, DC
SUNTRUST III FLORIDA
Avon Park, FL
Bartow, FL
Belleview, FL
Beverly Hills, FL
Bradenton, FL
Cape Coral, FL
Crystal River, FL
Daytona Beach Shores, FL
-157-
Deland, FL
Edgewater, FL
Flager Beach, FL
Fort Myers, FL
Greenacres City, FL
Haines City, FL
Hallandale, FL
Hamosassa, FL
Hilaleah, FL
-158-
Jupiter, FL
Lady Lake, FL
Lake Placid, FL
Lynn Haven, FL
-159-
Miami Beach, FL
Palm Harbor, FL
Punta Gorda, FL
Roseland, FL
Sebring, FL
-160-
Stuart, FL
Sun City Center, FL
Valrico, FL
Wildwood, FL
Zephyhills, FL
SUNTRUST III GEORGIA
Alpharetta, GA
-161-
Baxley, GA
Douglas, GA
-162-
Jonesboro, GA
Lawrenceville, GA
Tucker, GA
SUNTRUST III MARYLAND
Bladensburg, MD
Chestertown, MD
Upper Marlboro, MD
-163-
SUNTRUST III NORTH CAROLINA
Black Mountain, NC
Butner, NC
Chapel Hill, NC
Denton, NC
Erwin, NC
Hudson, NC
-164-
Huntersville, NC
Kannapolis, NC
Kernersville, NC
Marshville, NC
Norwood, NC
-165-
Spencer, NC
Wake Forest, NC
Youngsville, NC
SUNTRUST III SOUTH CAROLINA
Spartanburg, SC
SUNTRUST III TENNESSEE
-166-
Cleveland, TN
Jonesborough, TN
Lake City, TN
Lawrenceburg, TN
-167-
SUNTRUST III VIRGINIA
Alexandria, VA
Arlington, VA
Beaverdam, VA
Franklin, VA
Harrisonburg, VA
Lightfoot, VA
Madison Heights, VA
Manassas, VA
Mechanicsville, VA
Nassawadox, VA
-168-
South Boston, VA
Spotsylvania, VA
SYCAMORE COMMONS
THE CENTER AT HUGH HOWELL
-169-
THE HIGHLANDS
THE MARKET AT HILLIARD
Hilliard, OH
THOMAS CROSSROADS
TOMBALL TOWN CENTER
Tomball, TX
TRIANGLE CENTER
Longview, WA
TULSA HILLS SHOPPING CENTER
Tulsa, OK
UNIVERSAL PLAZA
Lauderhill, FL
UNIVERSITY OAKS SHOPPING CENTER
Round Rock, TX
VENTURE POINT
VICTORY LAKES TOWN CENTER
-170-
WARDS CROSSING
WASHINGTON PARK PLAZA
Homewood, IL
WHITE OAK CROSSING
Garner, NC
WILLIS TOWN CENTER
Willis, TX
WINCHESTER TOWN CENTER
WINDERMERE VILLAGE
WOODBRIDGE
Wylie, TX
WOODLAKE CROSSING
11500 MARKET STREET
AMERICAN EXPRESS—GREENSBORO
-171-
AMERICAN EXPRESS—SALT LAKE CITY
Salt Lake City, UT
SBC CENTER
Hoffman Estates, IL
AT&T—ST LOUIS
St Louis, MO
AT&T CLEVELAND
Cleveland, OH
BRIDGESIDE POINT OFFICE BLDG
Pittsburg, PA
COMMONS DRIVE
Aurora, IL
CRYSTAL LAKE MEDICAL
Crystal Lake, IL
DAKOTA RIDGE MEDICAL
Littleton, CO
DENVER HIGHLANDS
Highlands Ranch, CO
DULLES EXECUTIVE PLAZA
Herndon, VA
HOUSTON LAKES
-172-
IDS CENTER
Minneapolis, MN
KINROSS LAKES
Richfield, OH
MCP ONE
MCP TWO
MCP THREE
MIDLOTHIAN MEDICAL
Midlothian, VA
REGIONAL ROAD
SANOFI AVENTIS
Bridgewater, NJ
SANTEE—CIVIC CENTER
Santee, CA
SUNTRUST OFFICE I FL
Bal Harbour, FL
Bushnell, FL
-173-
SUNTRUST OFFICE I GA
SUNTRUST OFFICE I MD
Bethesda, MD
SUNTRUST OFFICE I NC
SUNTRUST OFFICE I VA
SUNTRUST II OFFICE GEORGIA
SUNTRUST III OFFICE FLORIDA
Holy Hill, FL
SUNTRUST III OFFICE GEORGIA
-174-
Gainesville, GA
UNITED HEALTH—CYPRESS
Cypress, CA
UNITED HEALTH—FREDERICK
UNTIED HEALTH—GREEN BAY
Green Bay, WI
UNITED HEALTH—INDIANAPOLIS
UNITED HEALTH—ONALASKA
Onalaska, WI
UNITED HEALTH—WAUWATOSA
Wauwatosa, WI
WASHINGTON MUTUAL—ARLINGTON
-175-
WORLDGATE PLAZA
Apartment
14th STREET—UAB
Birmingham, AL
BLOCK 121
BRAZOS RANCH APARTMENTS
Rosenberg, TX
ENCINO CANYON APARTMENTS
FANNIN STREET STATION APARTMENTS
FIELDS APARTMENT HOMES
Bloomington, IN
GROGANS LANDING APARTMENTS
The Woodlands, TX
LANDINGS AT CLEARLAKE
Webster, TX
-176-
LEGACY AT ART QUARTER
LEGACY CORNER
Midwest City, OK
LEGACY WOODS
Edmond, OK
NANTUCKET APARTMENTS
Loveland, OH
OAK PARK
OAK PARK II
OAK PARK TRS
PARKSIDE APARTMENTS
SEVEN PALMS APARTMENTS
SOUTHGATE APARTMENTS
Louisville, KY
STERLING RIDGE ESTATES
-177-
THE RADIAN (PENN)
Radian, PA
UNIV HOUSE AT GAINESVILLE
UNIV HOUSE AT HUNTSVILLE
Huntsville, TX
UNIV HOUSE AT LAFAYETTE
Lafayette, AL
VILLAGES AT KITTY HAWK
Universal City, TX
VILLAS AT SHADOW CREEK
Pearland, TX
WATERFORD PLACE AT SHADOW CREEK
WOODRIDGE APARTMENTS The Woodlands, TX
11500 MELROSE AVE -294 TOLLWAY
Franklin Park, IL
-178-
1800 BRUNING
Itasca, IL
500 HARTLAND
Hartland, WI
55th STREET
Kenosha, WI
AIRPORT DISTRIB CENTER #10
Memphis, TN
AIRPORT DISTRIB CENTER #11
AIRPORT DISTRIB CENTER #15
AIRPORT DISTRIB CENTER #16
AIRPORT DISTRIB CENTER #18
AIRPORT DISTRIB CENTER #19
-179-
AIRPORT DISTRIB CENTER #2
AIRPORT DISTRIB CENTER #4
AIRPORT DISTRIB CENTER #7
AIRPORT DISTRIB CENTER #8
AIRPORT DISTRIB CENTER #9
ANHEUSER BUSCH
Devens, MA
ATLAS—BELVIDERE
Belvidere, IL
ATLAS—CARTERSVILLE
ATLAS—DOUGLAS
ATLAS—GAFFNEY
Gaffney, SC
ATLAS—GAINESVILLE
ATLAS—PENDERGRASS
Pendergrass, GA
-180-
ATLAS—PIEDMONT
Piedmont, SC
ATLAS—ST PAUL
St. Paul, MN
ATLAS-BROOKLYN PARK
Brooklyn Park, MN
ATLAS-NEW ULM
New Ulm, MN
ATLAS-ZUMBROTA
Zumbrota, MN
BAYMEADOW—GLEN BURNIE
C&S—ABERDEEN
Aberdeen, MD
C&S—BIRMINGHAM
C&S—NORTH HATFIELD
Hatfield, MA
C&S—SOUTH HATFIELD
C&S—WESTFIELD
Westfield, MA
CLARION
Clarion, IA
-181-
COLOMA
Coloma, MI
DEER PARK SEACO
Deer Park, TX
DELP DISTRIBUTION CENTER #2
DELP DISTRIBUTION CENTER #5
DELP DISTRIBUTION CENTER #8
DORAL—WAUKESHA
Waukesha, WI
HASKELL-ROLLING PLAINS FACILITY
Haskell, TX
HOME DEPOT—LAKE PARK
Valdosta, GA
HOME DEPOT—MACALLA
MaCalla, AL
-182-
HUDSON CORRECTIONAL FACILITY
Hudson, CO
IMAGINE AVONDALE
Avondale, AZ
IMAGINE COOLIDGE
Coolidge, AZ
II Coolidge, AZ
IMAGINE DISCOVERY
Baltimore, MD
IMAGINE FIRESTONE
Firestone, CO
IMAGINE HOPE LAMOND
IMAGINE INDIGO RANCH
IMAGINE TOWN CENTER
INDUSTRIAL DRIVE
Horican, WI
KATO/MILMONT
Fremont, CA
-183-
KINSTON
Kinston, NC
KIRK ROAD
St. Charles, IL
LIBERTYVILLE ASSOCIATES
Libertyville, IL
MOUNT ZION ROAD
Lebanon, IN
NORTH POINTE ONE
Hanahan, SC
NORTH POINTE PARK
OTTAWA
Ottawa, IL
SCHNEIDER ELECTRIC
Loves Park, IL
SOUTHWIDE INDUSTRIAL CENTER #5
SOUTHWIDE INDUSTRIAL CENTER #6
-184-
SOUTHWIDE INDUSTRIAL CENTER #7
SOUTHWIDE INDUSTRIAL CENTER #8
STONE FORT DISTRIB CENTER #1
STONE FORT DISTRIB CENTER #4
THERMO PROCESS SYSTEMS
Sugar Land, TX
TRI-STATE HOLDINGS I
Wood Dale, IL
TRI-STATE HOLDINGS II
TRI-STATE HOLDINGS III
Mosinee, WI
UNION VENTURE
West Chester, OH
UPS E-LOGISTICS
Elizabethtown, KY
-185-
WESTPORT—MECHANICSBURG
Hotel
ALOFT CHAPEL HILL
COMFORT INN—CROSS CREEK
Fayetteville, NC
COURTYARD BY MARRIOTT QUORUM
Addison, TX
COURTYARD BY MARRIOTT
Ann Arbor, MI
COURTYARD BY MARRIOTT DUNN LORING-FAIRFAX
Vienna, VA
COURTYARD—DOWNTOWN AT UAB
COURTYARD—FORT MEADE AT NBP
Annapolis Junction, MD
COURTYARD BY MARRIOTT -WEST LANDS END
Fort Worth, TX
-186-
COURTYARD—FT WORTH
Harlingen, TX
COURTYARD BY MARRIOTT—NORTHWEST
COURTYARD BY MARRIOTT—WESTCHASE
COURTYARD BY MARRIOTT WEST UNIVERSITY
COURTYARD BY MARRIOTT—COUNTRY CLUB PLAZA
Kansas City, MO
Lebanon, NJ
COURTYARD—NEWARK ELIZABETH
Elizabeth, NJ
-187-
COURTYARD—PITTSBURGH DOWNTOWN
COURTYARD—PITTSBURGH WEST HOME
COURTYARD—RICHMOND
COURTYARD BY MARRIOTT—ROANOKE AIRPORT
COURTYARD BY MARRIOTT SEATTLE—FEDERAL WAY
Federal Way, WA
COURTYARD BY MARRIOTT CHICAGO- ST.CHARLES St.
Charles, IL
COURTYARD BY MARRIOTT—WILLIAM CENTER
Tucson, AZ
Wilmington, NC
-188-
COURTYARD—WEST PALM AIRPORT
DOUBLETREE—ATLANTA GALLERIA
DOUBLETREE—WASHINGTON DC
EMBASSY SUITES—BALTIMORE
Hunt Valley, MD
FAIRFIELD INN
FAIRMONT—DALLAS
HAMPTON INN SUITES—DENVER
HAMPTON INN ATLANTA—PERIMETER CENTER
-189-
HAMPTON INN BALTIMORE-INNER HARBOR
HAMPTON INN RALEIGH-CARY
HAMPTON INN UNIVERSITY PLACE
HAMPTON INN SUITES DULUTH-GWINNETT
HAMPTON INN WHITE PLAINS-TARRYTOWN
Elmsford, NY
HAMPTON INN
HGI—BOSTON BURLINGTON
Burlington, MA
HGI—COLORADO SPRINGS
HGI—SAN ANTONIO AIRPORT
-190-
HGI—WASHINGTON DC
HILTON GARDEN INN TAMPA YBOR
HILTON GARDEN INN—AKRON
Akron, OH
HILTON GARDEN INN ALBANY AIRPORT
Albany, NY
HILTON GARDEN INN ATLANTA WINWARD
HILTON GARDEN INN
HILTON GARDEN INN RALEIGH -DURHAM
Westbury, NY
-191-
HILTON GARDEN INN HARTFORD NORTH
Windsor, CT
HILTON GARDEN INN PHOENIX
Phoenix, AZ
HILTON—UNIVERSITY OF FLORIDA
HOLIDAY INN EXPRESS—CLEARWATER GATEWAY
HOLIDAY INN HARMON MEADOW SECAUCUS
Secaucus, NJ
HOMEWOOD—HOUSTON GALLERIA
HOMEWOOD SUITES
Albuquerque, NM
Baton Rouge, LA
-192-
HOMEWOOD SUITES HOUSTON - CLEARLAKE
HOMEWOOD SUITES METRO CENTER
Princeton, NJ
HOMEWOOD SUITES CRABTREE VALLEY
HOMEWOOD SUITES CLEVELAND SOLON
Solon, OH
HOMEWOOD SUITES COLORADO SPRINGS NORTH
HYATT REGENCY—OC
Orange County, CA
-193-
HYATT—BOSTON/MEDFORD
MARRIOTT—ATL CENTURY CENTER
MARRIOTT—CHICAGO—MED DIST UIC
MARRIOTT—CHARLESTON
Charleston, SC
MARRIOTT—DALLAS
MARRIOTT—NAPA VALLEY
Napa Valley, CA
MARRIOTT—WOODLANDS WATERWAY
MARRIOTT—WEST DES MOINES
Des Moines, IA
QUALITY SUITES Charleston, SC
-194-
RESIDENCE INN—BALTIMORE
RESIDENCE INN
Brownsville, TX
RESIDENCE INN—CAMBRIDGE
Cambridge, MA
RESIDENCE INN SOUTH BRUNSWICK-CRANBURY
Cranbury, NJ
RESIDENCE INN CYPRESS—LOS ALAMITS
RESIDENCE INN DFW AIRPORT NORTH
Dallas-Fort Worth, TX
RESIDENCE INN PARK CENTRAL
Dallas , TX
-195-
RESIDENCE INN SOMERSET-FRANKLIN
Franklin , NJ
Hauppauge, NY
RESIDENCE INN WESTCHASE
Westchase, TX
RESIDENCE INN WEST UNIVERSITY
RESIDENCE INN NASHVILLE AIRPORT
RESIDENCE INN—POUGHKEEPSIE
Poughkeepsie, NY
RESIDENCE INN ROANOKE AIRPORT
RESIDENCE INN WILLIAMS CENTRE
-196-
RESIDENCE INN—NEWARK ELIZABETH
SPRINGHILL SUITES
Danbury, CT
Balance
-197-
Schedule III (continued)
Notes:
Balance at January 1,
Acquisitions and capital improvements
Intangible assets
Intangible liabilities
Balance at December 31,
Buildings and improvements
Tenant improvements
Furniture, fixtures & equipment
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
As required by Rule 13a-15(b) and Rule 15d-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our principal executive officer and our principal financial officer evaluated as of December 31, 2011, the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and Rule 15d-15(e). Based on that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures, as of December 31, 2011, were effective for the purpose of ensuring that information required to be disclosed by us in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including the principal executive officer and our principal financial officer as appropriate to allow timely decisions regarding required disclosures.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management, including our principal executive officer and principal financial officer, evaluated as of December 31, 2011, the effectiveness of our internal control over financial reporting based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on its evaluation, our management has concluded that we maintained effective internal control over financial reporting as of December 31, 2011.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to permanent deferral of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the fourth quarter of 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
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Part III
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item will be presented in our definitive proxy statement for the 2012 annual meeting of stockholders, which is expected to be filed with the Securities and Exchange Commission no later than April 29, 2012, and is incorporated herein by reference.
Code of Ethics
We have adopted a code of ethics applicable to our directors, officers and employees, which is available on our website free of charge athttp://www.inlandamerican.com. We will provide the code of ethics free of charge upon request to our customer relations group.
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Item 14. Principal Accounting Fees and Services.
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Part IV
Item 15. Exhibits and Financial Statement Schedules
All schedules other than those indicated in the index have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ Brenda G. Gujral
By:
Date:
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
/s/ Robert D. Parks
/s/ Jack Potts
/s/ Anna N. Fitzgerald
/s/ J. Michael Borden
/s/ Thomas F. Meagher
/s/ Paula Saban
/s/ William J. Wierzbicki
/s/ Thomas F. Glavin
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EXHIBIT INDEX
DESCRIPTION
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