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KBS STRA : STRATEGIC OPPORTUNITY REIT, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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11/09/2018 | 08:47pm CET
The following discussion and analysis should be read in conjunction with the
accompanying financial statements of KBS Strategic Opportunity REIT, Inc. and
the notes thereto. As used herein, the terms "we," "our" and "us" refer to
KBS Strategic Opportunity REIT, Inc., a Maryland corporation, and, as required
by context, KBS Strategic Opportunity Limited Partnership, a Delaware limited
partnership, which we refer to as the "Operating Partnership," and to their
subsidiaries.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are
forward-looking statements. Those statements include statements regarding the
intent, belief or current expectations of KBS Strategic Opportunity REIT, Inc.
and members of our management team, as well as the assumptions on which such
statements are based, and generally are identified by the use of words such as
"may," "will," "seeks," "anticipates," "believes," "estimates," "expects,"
"plans," "intends," "should" or similar expressions. Actual results may differ
materially from those contemplated by such forward-looking statements. Further,
forward-looking statements speak only as of the date they are made, and we
undertake no obligation to update or revise forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or changes
to future operating results over time, unless required by law.
The following are some of the risks and uncertainties, although not all of the
risks and uncertainties, that could cause our actual results to differ
materially from those presented in our forward-looking statements:
•      We depend on tenants for our revenue and, accordingly, our revenue is
       dependent upon the success and economic viability of our tenants. Revenues
       from our property investments could decrease due to a reduction in tenants
       (caused by factors including, but not limited to, tenant defaults, tenant
       insolvency, early termination of tenant leases and non-renewal of existing
       tenant leases) and/or lower rental rates, limiting our ability to pay
       distributions to our stockholders.


•      Our opportunistic investment strategy involves a higher risk of loss than
       would a strategy of investing in some other types of real estate and real
       estate-related investments.


•      We have paid distributions from financings and in the future we may not
       pay distributions solely from our cash flow from operations or gains from
       asset sales. To the extent that we pay distributions from sources other
       than our cash flow from operations or gains from asset sales, we will have
       less funds available for investment in loans, properties and other assets,
       the overall return to our stockholders may be reduced and subsequent
       investors may experience dilution.


•      All of our executive officers and some of our directors and other key real
       estate and debt finance professionals are also officers, directors,
       managers, key professionals and/or holders of a direct or indirect
       controlling interest in our advisor, our dealer manager and other
       KBS-affiliated entities. As a result, they face conflicts of interest,
       including significant conflicts created by our advisor's compensation
       arrangements with us and other KBS-advised programs and investors and
       conflicts in allocating time among us and these other programs and
       investors. These conflicts could result in unanticipated actions. Fees
       paid to our advisor in connection with transactions involving the
       origination, acquisition and management of our investments are based on
       the cost of the investment, not on the quality of the investment or
       services rendered to us. This arrangement could influence our advisor to
       recommend riskier transactions to us.


•      We pay substantial fees to and expenses of our advisor and its affiliates.
       These payments increase the risk that our stockholders will not earn a
       profit on their investment in us and increase our stockholders' risk of
       loss.


•      We cannot predict with any certainty how much, if any, of our dividend
       reinvestment plan proceeds will be available for general corporate
       purposes, including, but not limited to, the redemption of shares under
       our share redemption program, future funding obligations under any real
       estate loans receivable we acquire, the funding of capital expenditures on
       our real estate investments or the repayment of debt. If such funds are
       not available from the dividend reinvestment plan offering, then we may
       have to use a greater proportion of our cash flow from operations to meet
       these cash requirements, which would reduce cash available for
       distributions and could limit our ability to redeem shares under our share
       redemption program.


•      We have focused, and may continue to focus, our investments in
       non-performing real estate and real estate-related loans, real
       estate-related loans secured by non-stabilized assets and real
       estate-related securities, which involve more risk than investments in
       performing real estate and real estate-related assets

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017 and in Part II, Item IA of our Quarterly Report on Form 10-Q for the period ended March 31, 2018, both as filed with the Securities and Exchange Commission (the "SEC").


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  Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)


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

of Operations (continued)

Overview

We were formed on October 8, 2008 as a Maryland corporation, elected to be taxed
as a real estate investment trust ("REIT") beginning with the taxable year ended
December 31, 2010 and intend to operate in such manner. KBS Capital Advisors LLC
("KBS Capital Advisors") is our advisor. As our advisor, KBS Capital Advisors
manages our day-to-day operations and our portfolio of investments. KBS Capital
Advisors also has the authority to make all of the decisions regarding our
investments, subject to the limitations in our charter and the direction and
oversight of our board of directors. KBS Capital Advisors also provides
asset-management, marketing, investor-relations and other administrative
services on our behalf. We have sought to invest in and manage a diverse
portfolio of real estate­related loans, opportunistic real estate, real
estate-related debt securities and other real estate-related investments. We
conduct our business primarily through our operating partnership, of which we
are the sole general partner.
On January 8, 2009, we filed a registration statement on Form S-11 with the SEC
to offer a minimum of 250,000 shares and a maximum of 140,000,000 shares of
common stock for sale to the public, of which 100,000,000 shares were registered
in our primary offering and 40,000,000 shares were registered under our dividend
reinvestment plan. We ceased offering shares of common stock in our primary
offering on November 14, 2012. We sold 56,584,976 shares of common stock in the
primary offering for gross offering proceeds of $561.7 million. We continue to
offer shares of common stock under the dividend reinvestment plan. As of
September 30, 2018, we had sold 6,743,649 shares of common stock under the
dividend reinvestment plan for gross offering proceeds of $75.5 million. Also as
of September 30, 2018, we had redeemed 22,463,092 of the shares sold in our
offering for $272.3 million. As of September 30, 2018, we had issued 13,069,487
shares of common stock in connection with the December 2017 special dividend.
Additionally, on December 29, 2011 and October 23, 2012, we issued 220,994
shares and 55,249 shares of common stock, respectively, for $2.0 million and
$0.5 million, respectively, in private transactions exempt from the registration
requirements pursuant to Section 4(2) of the Securities Act of 1933, as amended.
On March 2, 2016, KBS Strategic Opportunity (BVI) Holdings, Ltd. ("KBS Strategic
Opportunity BVI"), our wholly owned subsidiary, filed a final prospectus with
the Israel Securities Authority for a proposed offering of up to 1,000,000,000
Israeli new Shekels of Series A debentures (the "Debentures") at an annual
interest rate not to exceed 4.25%. On March 1, 2016, KBS Strategic Opportunity
BVI commenced the institutional tender of the Debentures and accepted
application for 842.5 million Israeli new Shekels. On March 7, 2016, KBS
Strategic Opportunity BVI commenced the public tender of the Debentures and
accepted 127.7 million Israeli new Shekels.  In the aggregate, KBS Strategic
Opportunity BVI accepted 970.2 million Israeli new Shekels (approximately $249.2
million as of March 8, 2016) in both the institutional and public tenders at an
annual interest rate of 4.25%.  KBS Strategic Opportunity BVI issued the
Debentures on March 8, 2016. The terms of the Debentures require principal
installment payments equal to 20% of the face value of the Debentures on March
1st of each year from 2019 to 2023.
As of September 30, 2018, we consolidated six office properties, one office
portfolio consisting of four office buildings and 14 acres of undeveloped land,
one office/flex/industrial portfolio consisting of 21 buildings, one retail
property, two apartment properties, three investments in undeveloped land with
approximately 1,000 developable acres, and owned three investments in
unconsolidated joint ventures, an investment in real estate debt securities and
three investments in real estate equity securities.
Market Outlook - Real Estate and Real Estate Finance Markets
Volatility in global financial markets and changing political environments can
cause fluctuations  in the performance of the U.S. commercial real estate
markets.  Possible future declines in rental rates, slower or potentially
negative net absorption of leased space and expectations of future rental
concessions, including free rent to renew tenants early, to retain tenants who
are up for renewal or to attract new tenants, may result in decreases in cash
flows from investment properties. Increases in the cost of financing due to
higher interest rates  may cause difficulty in refinancing debt obligations
prior to or at maturity or at terms as favorable as the terms of existing
indebtedness. Further, increases in interest rates would increase the amount of
our debt payments on our variable rate debt to the extent the interest rates on
such debt are not limited by interest rate caps. Market conditions can change
quickly, potentially negatively impacting the value of real estate investments.
Management continuously reviews our investment and debt financing strategies to
optimize our portfolio and the cost of our debt exposure.

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  Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)


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

of Operations (continued)

Liquidity and Capital Resources Our principal demand for funds during the short and long-term is and will be for the acquisition of real estate and real estate-related investments, payment of operating expenses, capital expenditures and general and administrative expenses, payments under debt obligations, redemptions and purchases of our common stock and payments of distributions to stockholders. To date, we have had six primary sources of capital for meeting our cash requirements: • Proceeds from the primary portion of our initial public offering;

• Proceeds from our dividend reinvestment plan;

• Proceeds from our public bond offering in Israel;

• Debt financing;


•      Proceeds from the sale of real estate and the repayment of real
       estate-related investments; and

• Cash flow generated by our real estate and real estate-related investments.



We sold 56,584,976 shares of common stock in the primary portion of our initial
public offering for gross offering proceeds of $561.7 million. We ceased
offering shares in the primary portion of our initial public offering on
November 14, 2012. We continue to offer shares of common stock under the
dividend reinvestment plan. As of September 30, 2018, we had sold 6,743,649
shares of common stock under the dividend reinvestment plan for gross offering
proceeds of $75.5 million. To date, we have invested all of the net proceeds
from our initial public offering in real estate and real estate-related
investments. We intend to use our cash on hand, proceeds from asset sales,
proceeds from debt financing, cash flow generated by our real estate operations
and real estate-related investments and proceeds from our dividend reinvestment
plan as our primary sources of immediate and long-term liquidity.
Our investments in real estate generate cash flow in the form of rental revenues
and tenant reimbursements, which are reduced by operating expenditures and
corporate general and administrative expenses.  Cash flow from operations from
our real estate investments is primarily dependent upon the occupancy levels of
our properties, the net effective rental rates on our leases, the collectibility
of rent and operating recoveries from our tenants and how well we manage our
expenditures.  As of September 30, 2018, our office and retail properties were
collectively 76% occupied and our apartment properties were collectively 94%
occupied.
Investments in real estate debt securities generate cash flow in the form of
interest income, which are reduced by loan service fees, asset management fees
and corporate general and administrative expenses. Investments in real estate
equity securities generate cash flow in the form of dividend income, which is
reduced by asset management fees. As of September 30, 2018, we had an investment
in real estate debt securities outstanding with a total book value of $17.9
million and three investments in real estate equity securities outstanding with
a total carrying value of $98.7 million.
Under our charter, we are required to limit our total operating expenses to the
greater of 2% of our average invested assets or 25% of our net income for the
four most recently completed fiscal quarters, as these terms are defined in our
charter, unless the conflicts committee of our board of directors has determined
that such excess expenses were justified based on unusual and non-recurring
factors. Operating expense reimbursements for the four fiscal quarters ended
September 30, 2018 did not exceed the charter-imposed limitation.
For the nine months ended September 30, 2018, our cash needs for capital
expenditures, redemptions of common stock and debt servicing were met with
proceeds from dispositions of real estate and undeveloped land, proceeds from
debt financing, proceeds from our dividend reinvestment plan and cash on hand.
Operating cash needs during the same period were met through cash flow generated
by our real estate and real estate-related investments and cash on hand. As of
September 30, 2018, we had outstanding debt obligations in the aggregate
principal amount of $749.8 million, with a weighted-average remaining term of
2.4 years. As of September 30, 2018, we had a total of $138.0 million of debt
obligations scheduled to mature within 12 months of that date. We plan to
exercise our extension options available under our loan agreements or pay down
or refinance the related notes payable prior to their maturity dates.
We have elected to be taxed as a REIT and intend to operate as a REIT. To
maintain our qualification as a REIT, we are required to make aggregate annual
distributions to our stockholders of at least 90% of our REIT taxable income
(computed without regard to the dividends paid deduction and excluding net
capital gain). Our board of directors may authorize distributions in excess of
those required for us to maintain REIT status depending on our financial
condition and such other factors as our board of directors deems relevant. We
have not established a minimum distribution level.

                                       38

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  Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)


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

of Operations (continued)




Cash Flows from Operating Activities
As of September 30, 2018, we consolidated six office properties, one office
portfolio consisting of four office buildings and 14 acres of undeveloped land,
one office/flex/industrial portfolio consisting of 21 buildings, one retail
property, two apartment properties, three investments in undeveloped land with
approximately 1,000 developable acres, and owned three investments in
unconsolidated joint ventures, an investment in real estate debt securities and
three investments in real estate equity securities. During the nine months ended
September 30, 2018, net cash provided by operating activities was $0.4 million.
We expect that our cash flows from operating activities will increase in future
periods as a result of owning assets acquired during 2018 for an entire period,
leasing additional space that is currently unoccupied and anticipated future
acquisitions of real estate and real estate-related investments. However, our
cash flows from operating activities may decrease to the extent that we dispose
of additional assets.
Cash Flows from Investing Activities
Net cash used in investing activities was $260.9 million for the nine months
ended September 30, 2018 and primarily consisted of the following:
• Acquisition of three office properties for $312.3 million;


•      Proceeds from the sale of 109 acres of undeveloped land and one office
       building of $85.6 million;

• Improvements to real estate of $21.1 million;

• Investment in real estate equity securities of $15.9 million;

• Distribution of capital from an unconsolidated joint venture of $2.2 million;

• Reimbursement of construction costs of $1.6 million;

• Contribution to an unconsolidated joint venture of $1.3 million;

• Funding of development obligations of $1.2 million;

• Proceeds for future development obligations of $1.1 million;

• Proceeds from the sale of real estate equity securities of $0.6 million; and

• Purchase of an interest rate cap for $0.2 million.

Cash Flows from Financing Activities Net cash used in financing activities was $12.0 million for the nine months ended September 30, 2018 and consisted primarily of the following: • $147.3 million of net cash provided by debt and other financings as a

       result of proceeds from notes payable of $184.4 million, partially offset
       by principal payments on notes and bonds payable of $34.3 million and
       payments of deferred financing costs of $2.8 million;

$120.5 million of cash used for redemptions of common stock;

$39.0 million of net cash distributions to stockholders, after giving
       effect to distributions reinvested by stockholders of $1.4 million;

$0.8 million of contributions from noncontrolling interests; and

$0.5 million of payments made in connection with a potential offering.

In order to execute our investment strategy, we utilize secured debt and we may, to the extent available, utilize unsecured debt, to finance a portion of our investment portfolio. Management remains vigilant in monitoring the risks inherent with the use of debt in our portfolio and is taking actions to ensure that these risks, including refinancing and interest risks, are properly balanced with the benefit of using leverage. There is no limitation on the amount we may borrow for any single investment. Our charter limits our total liabilities such that our total liabilities may not exceed 75% of the cost of our tangible assets; however, we may exceed that limit if a majority of the conflicts committee approves each borrowing in excess of our charter limitation and we disclose such borrowing to our common stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. As of September 30, 2018, our borrowings and other liabilities were approximately 69% and 68% and of the cost (before depreciation and other noncash reserves) and book value (before depreciation) of our tangible assets, respectively.


                                       39

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  Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)


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

of Operations (continued)




In March 2016, we, through a wholly-owned subsidiary, issued 970.2 million
Israeli new Shekels (approximately $249.2 million as of March 8, 2016) in 4.25%
bonds to investors in Israel pursuant to a public offering registered in Israel.
The bonds have a seven year term, with principal payable in five equal annual
installments from 2019 to 2023. We have used a majority of the proceeds from the
issuance of these bonds to make additional investments.
In addition to making investments in accordance with our investment objectives,
we use or have used our capital resources to make certain payments to our
advisor and our dealer manager. During our offering stage, these payments
included payments to our dealer manager for selling commissions and dealer
manager fees related to sales in our primary offering and payments to our dealer
manager and our advisor for reimbursement of certain organization and other
offering expenses related both to the primary offering and the dividend
reinvestment plan. During our acquisition and development stage, we expect to
continue to make payments to our advisor in connection with the selection and
origination or purchase of investments, the management of our assets and costs
incurred by our advisor in providing services to us as well as for any
dispositions of assets (including the discounted payoff of non-performing
loans). In addition, an affiliate of our advisor, KBS Management Group, was
formed to provide property management services with respect to certain
properties owned by KBS-advised companies.  In the future, we may engage KBS
Management Group with respect to one or more of our properties to provide
property management services.  With respect to any such properties, we would
expect to pay KBS Management Group a monthly fee equal to a percentage of the
rent (to be determined on a property by property basis, consistent with current
market rates).
The advisory agreement has a one-year term but may be renewed for an unlimited
number of successive one-year periods upon the mutual consent of our advisor and
our conflicts committee.
Among the fees payable to our advisor is an asset management fee. With respect
to investments in loans and any investments other than real property, the asset
management fee is a monthly fee calculated, each month, as one-twelfth of 0.75%
of the lesser of (i) the amount actually paid or allocated to acquire or fund
the loan or other investment, inclusive of fees and expenses related thereto and
the amount of any debt associated with or used to acquire or fund such
investment and (ii) the outstanding principal amount of such loan or other
investment, plus the fees and expenses related to the acquisition or funding of
such investment, as of the time of calculation. With respect to investments in
real property, the asset management fee is a monthly fee equal to one-twelfth of
0.75% of the sum of the amount paid or allocated to acquire the investment, plus
the cost of any subsequent development, construction or improvements to the
property, and inclusive of fees and expenses related thereto and the amount of
any debt associated with or used to acquire such investment. In the case of
investments made through joint ventures, the asset management fee will be
determined based on our proportionate share of the underlying investment,
inclusive of our proportionate share of any fees and expenses related thereto.
Contractual Commitments and Contingencies
The following is a summary of our contractual obligations as of September 30,
2018 (in thousands):

© Edgar Online, source Glimpses

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