The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSecurities and Exchange Commission ("SEC") onMarch 13, 2020 .
We may refer to the three months ended
Forward-Looking Statements
This Form 10-Q contains forward-looking statements which involve risks and uncertainties. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward looking statements by the use of forward-looking terminology such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," or "potential" or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Currently, one of the most significant factors is the potential adverse effect of the COVID-19 virus and ensuing economic turmoil on the financial condition, results of operations, cash flows and performance of Presidio, particularly our ability to collect rent, on the financial condition, results of operations, cash flows and performance of our tenants, and on the global economy and financial markets. The extent to which COVID-19 impacts the Company and its tenants will depend on current and future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, among others. Moreover, investors are cautioned to interpret many of the risks identified in the risk factors discussed in this 10-Q and our Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed onMarch 13, 2020 , as well as the risks set forth below, as being heightened as a result of the ongoing and numerous adverse impacts of COVID-19. Additional factors which may cause the actual results, performance, or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements include, but are not limited to the risks associated with the ownership of real estate in general and our real estate assets in particular; the economic health of the metro regions where we conduct business; the risk of failure to enter into/and or complete contemplated acquisitions and dispositions, within the price ranges anticipated and on the terms and timing anticipated; changes in the composition of our portfolio; fluctuations in interest rates; reductions in or actual or threatened changes to the timing of federal government spending; the risks related to use of third-party providers and joint venture partners; the ability to control our operating expenses; the economic health of our tenants; the supply of competing properties; shifts away from brick and mortar stores to e-commerce; the availability and terms of financing and capital and the general volatility of securities markets; compliance with applicable laws, including those concerning the environment and access by persons with disabilities; terrorist attacks or actions and/or cyber-attacks; weather conditions, natural disasters and pandemics; ability to maintain key personnel; failure to qualify and maintain our qualification as a REIT and the risks of changes in laws 19 -------------------------------------------------------------------------------- Table of Contents affecting REITs; and other risks and uncertainties detailed from time to time in our filings with theSEC , including our 2019 Form 10-K filed onMarch 13, 2020 , and subsequent Quarterly Reports on Form 10-Q. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise. Outlook OnMarch 11, 2020 , theWorld Health Organization declared COVID-19, a respiratory illness caused by the novel coronavirus, a pandemic, and onMarch 13, 2020 ,the United States declared a national emergency with respect to COVID-19. The COVID-19 pandemic caused state and local governments within our areas of business operations to institute quarantines, "shelter-in-place" mandates, including rules and restrictions on travel and the types of businesses that may continue to operate. While certain areas begin to re-open, others have seen an increase in the number of cases reported, prompting local government to enforce further restrictions. We continue to monitor our operations and government recommendations and have modified our normal operations, including requiring our employees to work remotely with the exception of essential personnel.
On
We continue to evaluate the relief options for us and our tenants available under the CARES Act, as well as other emergency relief initiatives and stimulus packages instituted by the federal government. A number of the relief options contain restrictions on future business activities, including ability to repurchase shares and pay dividends, that require careful evaluation and consideration. We will continue to assess these options, and any subsequent legislation or other relief packages, including the accompanying restrictions on our business, as the effects of the pandemic continue to evolve. The effects of the COVID-19 pandemic did not significantly impact our operating results during the first or second quarter of 2020. We continue to monitor and communicate with our tenants to assess their needs and ability to pay rent. We have negotiated and are continuing to negotiate lease amendments with certain tenantswho have demonstrated financial distress caused by the COVID-19 pandemic, which have included or may include rent deferral, temporary rent abatement, or reduced rental rates and/or lease extension periods. While these amendments have effected our short term cash flows, we do not believe they represent a change in the valuation of our assets for the properties effected and have not significantly effected our results of operations. Given the longevity of this pandemic, the COVID-19 outbreak may materially affect our financial condition and results of operations going forward, including, but not limited to, real estate rental revenues, credit losses, leasing activity, and potentially the valuation of our real estate assets. We expect that we may have additional rent deferrals, abatements and credit losses from our commercial tenants during the remainder of 2020 which may have a material impact on our real estate rental revenue and cash collections. We also expect that the effects of the COVID-19 pandemic will impact our ability to lease up available commercial space. Our business operations and activities in many regions may be subject to future quarantines, "shelter-in-place" rules, and various other restrictions for the foreseeable future. Due to the uncertainty of the future impacts of the COVID-19 pandemic, the extent of the financial impact cannot be reasonably estimated at this time. For more information, see Part II - Item 1A. Risk Factors" included elsewhere in this Quarterly Report on Form 10-Q.
OVERVIEW
The Company operates as an internally managed, diversified REIT, with holdings in office, industrial, retail, and model home properties. InOctober 2017 , we changed our name from "NetREIT, Inc. " to "Presidio Property Trust, Inc. " The Company acquires, owns and manages a geographically diversified portfolio of real estate assets including office, industrial, retail and model home residential properties leased to homebuilders located inthe United States . As ofJune 30, 2020 , the Company owned or had an equity interest in: •Ten office buildings and one industrial property ("Office/Industrial Properties "), which totals approximately 998,016 rentable square feet; •Four retail shopping centers ("Retail Properties "), which total approximately 131,722 rentable square feet; and •132Model Homes leased back on a triple-net basis to homebuilders that are owned by five affiliated limited partnerships and one wholly-owned corporation ("Model Home Properties "). The Company's office, industrial and retail properties are located primarily inColorado , with four properties located inNorth Dakota and three inCalifornia . While geographical clustering of real estate enables us to reduce our operating costs through economies of scale by servicing a number of properties with less staff, it makes us susceptible to changing market conditions in 20 -------------------------------------------------------------------------------- Table of Contents these discrete geographic areas, including those that have developed as a result of COVID-19. We do not develop properties but acquire properties that are stabilized or that we anticipate will be stabilized within two or three years of acquisition. We consider a property to be stabilized once it has achieved an 80% occupancy rate for a full year as ofJanuary 1 of such year or has been operating for three years. Most of our office and retail properties are leased to a variety of tenants ranging from small businesses to large public companies, many of which are not investment grade. We have in the past entered into, and intend in the future to enter into, purchase agreements for real estate having net leases that require the tenant to pay all of the operating expense or pay increases in operating expenses over specific base years. Most of our office leases are for terms of three to five years with annual rental increases. Our model homes are typically leased back for two to three years to the home builder on a triple net lease. Under a triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property. We seek to diversify our portfolio by commercial real estate segments to reduce the adverse effect of a single under-performing segment, geographic market and/or tenant. We further supplement this at the tenant level through our credit review process, which varies by tenant class. For example, our commercial and industrial tenants tend to be corporations or individual owned businesses. In these cases, we typically obtain financial records, including financial statements and tax returns (depending on the circumstance), and run credit reports for any prospective tenant to support our decision to enter into a rental arrangement. We also typically obtain security deposits from these commercial tenants. Our Model Home commercial tenants are reputable homebuilders with established credit histories. These tenants are subjected to financial review and analysis prior to us entering into a sales-leaseback transaction. Reverse Stock Split. OnJuly 29, 2020 , we amended our charter to effect a one-for-two reverse stock split of every outstanding share of our Series A Common Stock. The financial statements and accompanying footnotes have been retroactively restated to reflect the reverse stock split. SIGNIFICANT TRANSACTIONS IN 2020 AND 2019 Acquisitions - During the six months endedJune 30, 2020 , the Company acquired 17 model homes for approximately$6.3 million and leased them back to the homebuilders. The purchase price was paid through cash payments of approximately$1.9 million and mortgage notes of approximately$4.4 million . During the six months endedJune 30, 2019 , the Company acquired 18 model homes for approximately$6.1 million . The purchase price was paid through cash payments of approximately$1.8 million and mortgage notes of approximately$4.3 million . Dispositions - We review our portfolio of investment properties for value appreciation potential on an ongoing basis and dispose of any properties that no longer satisfy our requirements in this regard. The proceeds from any such property sale, after repayment of any associated mortgage, are available for investing in properties that we believe will have a much greater likelihood of future price appreciation, for the payment of other debt and for general corporate purposes. We disposed of the following properties during the six months endedJune 30, 2020 : •Centennial Tech Center, which was sold onFebruary 5, 2020 for approximately$15.0 million and the Company recognized a loss of approximately$913,000 . •Union Terrace, which was sold onMarch 13, 2020 for approximately$11.3 million and the Company recognized a gain of approximately$688,000 . •The Company disposed of 21 model homes for approximately$8.0 million and recognized a gain of approximately$557,000 . We disposed of the following properties during the six months endedJune 30, 2019 : •OnJanuary 15, 2019 , the Company sold theMorena Office Center for approximately$5.6 million and the Company recognized a gain of approximately$700,000 ; •Nightingale land was sold onMay 8, 2019 for approximately$875,000 and recognized a loss of approximately$93,000 . •The Company disposed of 26 model homes for approximately$9.4 million and recognized a gain of approximately$783,000 . 21 -------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING POLICIES There have been no material changes to our critical accounting policies as previously disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSEC onMarch 13, 2020 . MANAGEMENT EVALUATION OF RESULTS OF OPERATIONS Management's evaluation of operating results includes an assessment of our ability to generate cash flow necessary to pay operating expenses, general and administrative expenses, debt service and to fund distributions to our stockholders. As a result, management's assessment of operating results gives less emphasis to the effects of unrealized gains and losses and other non-cash charges, such as depreciation and amortization and impairment charges, which may cause fluctuations in net income for comparable periods but have no impact on cash flows. Management's evaluation of our potential for generating cash flow includes assessments of our recently acquired properties, our non-stabilized properties, long-term sustainability of our real estate portfolio, our future operating cash flow from anticipated acquisitions, and the proceeds from the sales of our real estate assets. In addition, management evaluates the results of our operations of our portfolio and individual properties with a primary focus on increasing and enhancing the value, quality and quantity of properties in our real estate holdings. Management focuses its efforts on improving underperforming assets through re-leasing efforts, including negotiation of lease renewals and rental rates. Properties that have reached goals in occupancy and rental rates are evaluated for potential added value appreciation and, if lacking such potential, are sold with the equity reinvested in properties that have better potential without foregoing cash flow. Our ability to increase assets under management is affected by our ability to raise borrowings and/or capital, coupled with our ability to identify appropriate investments. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDEDJUNE 30, 2020 AND 2019. The discussion that follows is based on our consolidated results of operations for the 2020 Quarter and 2019 Quarter. Although the COVID-19 pandemic did not significantly impact our operating results for the 2020 Quarter, we expect that the effects of the COVID-19 pandemic may significantly adversely affect our business, financial condition, results of operations and cash flows going forward, including but not limited to, real estate rental revenues, credit losses, and leasing activity, in ways that may vary widely depending on the duration and magnitude of the COVID-19 pandemic and ensuing economic turmoil, as well as numerous factors, many of which are outside of our control, as discussed under "Risk Factors." Revenues. Total revenue was$6.1 million for the three months endedJune 30, 2020 compared to$7.1 million for the same period in 2019, a decrease of$1.0 million or 14.0%, which is primarily due to a net decrease in rental income related to the sale of three properties in 2019 and two properties during the first quarter of 2020. The decrease in rental income is also attributed to COVID-19 related tenant workouts, which included rent abatements and deferrals that are being recognized over the remaining lease term. Rental Operating Costs. Rental operating costs decreased by$526,000 to$2.0 million for the three months endedJune 30, 2020 , compared to$2.5 million for the same period in 2019. Rental operating costs as a percentage of total revenue also decreased to 32.7% as compared to 35.5% for the three months endedJune 30, 2020 and 2019, respectively. The decrease in rental operating costs for the three months endedJune 30, 2020 as compared to 2019 is due to the sale of three properties in 2019 and two properties during the quarter endedJune 30, 2020 , as well as the mix of properties held to include a higher percentage of model homes period over period, which have significantly lower operating costs. General and Administrative Expenses. General & Administrative ("G&A") expenses decreased by$141,000 for the three months endedJune 30, 2020 compared to the same period in 2019. G&A expenses as a percentage of total revenue was 20.9% and 19.9% for three months endedJune 30, 2020 and 2019, respectively. The decrease in G&A expenses for the three months endedJune 30, 2020 as compared to 2019 is mainly due to an decrease in stock compensation expense. Depreciation and Amortization. Depreciation and amortization expense was$1.6 million for the three months endedJune 30, 2020 , compared to$1.7 million for the same period in 2019, representing a decrease of approximately$127,000 or 7.3%. The decrease in depreciation and amortization expense in 2020 compared to the same period in 2019 is primarily due to the sale of three properties in 2019 and two properties during the three months endedJune 30, 2020 , and the classification of two additional commercial properties as held for sale subsequent toJune 30, 2019 , upon which the Company ceased depreciation. Asset Impairments. We review the carrying value of each of our real estate properties quarterly to determine if circumstances indicate an impairment in the carrying value of these investments exists. During the three months endedJune 30, 2020 , the Company entered into lease renewal negotiations with a significant tenant at ourWaterman Plaza retail property at a lower 22 -------------------------------------------------------------------------------- Table of Contents market rental rate than the rental rate being charged. The Company obtained a broker opinion of value that considered the lower market rental rates and subsequently determined there was a material change to undiscounted cash flows on the property as ofJune 30, 2020 . Therefore, the Company recorded an$845,000 non-cash impairment in the Condensed Consolidated Statements of Operations during the three months endedJune 30, 2020 . Management considered the impact of COVID-19 on all remaining assets as ofJune 30, 2020 and determined that there was not sufficient data available to indicate an impairment had occurred as of that date. Interest Expense - Series B Preferred Stock. The Series B Preferred Stock issued inAugust 2014 included a mandatory redemption provision and therefore, was treated as a liability for financial reporting purposes. The interest paid and accrued and the amortization of the deferred offering costs are considered interest expense. The Series B Preferred Stock was redeemed during 2019 and was no longer outstanding as ofSeptember 30, 2019 . Interest expense, including amortization of the deferred offering costs, totaled$0.6 million for the three months endedJune 30, 2019 . Interest Expense - mortgage notes. Interest expense, including amortization of deferred finance charges was$1.5 million for the three months endedJune 30, 2020 compared to$1.9 million for the same period in 2019, a decrease of$387,000 or 20.8%. The decrease in mortgage interest expense relates to the decreased number of commercial properties owned in 2020 compared to 2019 and the related mortgage debt. The weighted average interest rate on our outstanding debt was 4.6% and 4.7% as ofJune 30, 2020 and 2019, respectively. Interest expense - note payable. OnSeptember 17, 2019 , the Company executed a Promissory Note pursuant to whichPolar Multi-Strategy Master Fund ("Polar"), extended a loan in the principal amount of$14.0 million to the Company ("Polar Note"). The Polar Note bears interest at a fixed rate of 8% per annum and requires monthly interest-only payments. Interest expense, including amortization of the deferred offering costs and Original Issue Discount ("OID") of$1.4 million , totaled$796,000 for the three months endedJune 30, 2020 . Gain on Sale of Real Estate Assets, net. The change in gain or loss on the sale of real estate assets is dependent on the mix of properties sold and the market conditions at the time of the sale. See "Significant Transactions in 2020 and 2019" above for further detail. Income allocated to non-controlling interests. Income allocated to non-controlling interests for the three months endedJune 30, 2020 totaled approximately$315,000 when compared to the income allocated during the three months endedJune 30, 2019 of$183,000 . The increase is related to the gains on properties held in joint interest during the three months endedJune 30, 2020 . RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDEDJUNE 30, 2020 AND 2019. Revenues. Total revenue was$13.2 million for the six months endedJune 30, 2020 compared to$14.3 million for the same period in 2019, a decrease of$1.1 million or 8.0%. The decrease in revenue for the six months period is primarily due to a decrease in rental income related to the sale of three properties during the fourth quarter of 2019 and two properties during the first quarter of 2020 and COVID-19 related tenant workouts, which included rent abatements and deferrals. Rental Operating Costs. Rental operating costs decreased$0.9 million , to$4.4 million for the six months endedJune 30, 2020 from$5.3 million for the six months endedJune 30, 2019 . Rental operating costs as a percentage of total revenue was 33.3% and 37.0% for the six months endedJune 30, 2020 and 2019, respectively. Rental operating costs as a percentage of total revenue decreased for the six months endedJune 30, 2020 as compared to 2019 due to the sale of three properties in 2019 and two properties during the six months endedJune 30, 2020 , as well as the mix of properties held to include a higher percentage of model homes period over period, which have significantly lower operating costs. General and Administrative Expenses. G&A expenses decreased by$550,000 , or 17.3%, to$2.6 million for the six months endedJune 30, 2020 compared to$3.2 million for the same period in 2019. G&A expenses as a percentage of total revenue was 20.0% and 22.2% for the six months endedJune 30, 2020 and 2019, respectively. The decrease in G&A expense is due to a decrease in stock compensation expense. Depreciation and Amortization. Depreciation and amortization expense totaled$3.2 million for the six months endedJune 30, 2020 , compared to$4.0 million for the same period in 2019, representing a decrease of$0.8 million or 19.3%. The decrease in depreciation and amortization during the six months endedJune 30, 2020 when compared to the same period in 2019 is primarily due to the sale of three properties in 2019 and two properties during the six months endedJune 30, 2020 , and the classification of two additional commercial properties as held for sale subsequent toJune 30, 2019 , upon which the Company ceased depreciation. 23 -------------------------------------------------------------------------------- Table of Contents Asset Impairments. We review the carrying value of each of our real estate properties quarterly to determine if circumstances indicate an impairment in the carrying value of these investments exists. During the six months endedJune 30, 2020 , the Company entered into lease renewal negotiations with a significant tenant at ourWaterman Plaza retail property at a lower market rental rate than the rental rate being charged. The Company obtained a broker opinion of value that considered the lower market rental rates and subsequently determined there was a material change to undiscounted cash flows on the property as ofJune 30, 2020 . Therefore, the Company recorded an$845,000 non-cash impairment in the Condensed Consolidated Statements of Operations during the six months endedJune 30, 2020 . Management considered the impact of COVID-19 on all remaining assets as ofJune 30, 2020 and determined that no other impairments had occurred as of that date. Interest Expense-Series B preferred stock. The Series B Preferred Stock issued inAugust 2014 included a mandatory redemption provision and therefore, was treated as a liability for financial reporting purposes. The interest paid and accrued and the amortization of the deferred offering costs are considered interest expense. The Series B Preferred Stock was redeemed during 2019 and was no longer outstanding as ofSeptember 30, 2019 . Interest expense, including amortization of the deferred offering costs, totaled$1.3 million for the six months endedJune 30, 2019 . Interest Expense-mortgage notes. Interest expense, including amortization of deferred finance charges was$3.2 million for the six months endedJune 30, 2020 when compared to$3.8 million for the same period in 2019, a decrease of$596,000 or 15.8%. The decrease in interest relates to the decreased number of commercial properties owned in 2019 compared to 2019 and the related debt. The weighted average interest rate on our outstanding debt was 4.6% and 4.7% as ofJune 30, 2020 and 2019, respectively. Interest expense - note payable. OnSeptember 17, 2019 , the Company executed a Promissory Note pursuant to whichPolar Multi-Strategy Master Fund ("Polar"), extended a loan in the principal amount of$14.0 million to the Company ("Polar Note"). The Polar Note bears interest at a fixed rate of 8% per annum and requires monthly interest-only payments. Interest expense, including amortization of the deferred offering costs and amortization of the Original Issue Discount ("OID") of$1.4 million , totaled$1.7 million for the six months endedJune 30, 2020 . Gain on Sale of Real Estate Assets, net. The change in gain or loss on the sale of real estate assets is dependent on the mix of properties sold and the market conditions at the time of the sale. See "Significant Transactions in 2020 and 2019" above for further detail. Income allocated to non-controlling interests. Income allocated to non-controlling interests for the six months endedJune 30, 2020 totaled approximately$490,000 when compared to the income allocated during the six months endedJune 30, 2019 of$949,000 . The decrease is related to the sale of 21Model Home Properties during the six months endedJune 30, 2020 compared to 26Model Home Properties during the six months endedJune 30, 2019 , for which the decrease is primarily attributable to homes were sold at a higher gain in 2019. LIQUIDITY AND CAPITAL RESOURCES Overview As the local and global economies have weakened as a result of COVID-19, ensuring adequate liquidity is critical. We believe we have access to adequate resources to meet the needs of our existing operations and working capital, to the extent we are not funded by cash provided by operating activities. However, we expect the COVID-19 pandemic may adversely impact our future operating cash flows due to the inability of some of our tenants to pay their rent on time or at all. We have negotiated and are currently negotiating lease amendments with certain tenantswho have demonstrated financial distress caused by the COVID-19 pandemic, which include rent deferral, temporary rent abatement, or reduced rental rates and/or lease extensions and may affect our short-term liquidity. The COVID-19 pandemic may also make financing more difficult for us to obtain, as well as for prospective buyers of our properties to obtain, resulting in difficulty in selling assets within our expected timeframe, or for our expected sales price. Our anticipated future sources of liquidity may include existing cash and cash equivalents, cash flows from operations, refinancing of existing mortgages, future real estate sales, new borrowings, financial aid from government programs instituted as a result of COVID-19, and the sale of equity or debt securities. Our cash and restricted cash atJune 30, 2020 was$8.7 million , which included our available liquidity of cash and cash equivalents of$6.0 million . OnApril 22, 2020 , the Company received an Economic Injury Disaster Loan of$10,000 and onApril 30, 2020 , the Company received a Paycheck Protection Program loan of$462,000 , each from theSmall Business Administration which will provide additional economic relief during the COVID-19 pandemic. We intend to use the funds for general corporate purposes and payroll related costs, respectively. 24 -------------------------------------------------------------------------------- Table of Contents Our future capital needs include paying down existing borrowings, maintaining our existing properties, funding tenant improvements, paying lease commissions (to the extent they are not covered by lender-held reserve deposits), and the payment of dividends to our stockholders. We also are actively seeking investments that are likely to produce income and achieve long term gains in order to pay dividends to our stockholders. To ensure that we can effectively execute these objectives, we routinely review our liquidity requirements and continually evaluate all potential sources of liquidity. We currently do not have a revolving line of credit but have been working to obtain such a line of credit. Our short-term liquidity needs include paying down the remaining balance of the Polar Note, paying our current operating costs, satisfying the debt service requirements of our existing mortgages, completing tenant improvements, paying leasing commissions, and funding dividends to stockholders. For the six months remaining in 2020 and the year endingDecember 31, 2021 , we have$6.2 million and$12.7 million of mortgage notes payable due, respectively, related to theModel Home Properties .Certain Model Home Properties will be sold and the underlying mortgage notes will be paid off with sales proceeds while other mortgage notes will be refinanced. For the six months remaining in 2020 and the year endingDecember 31, 2021 , we have$882,000 and$16.4 million of mortgage notes payments due, respectively, related to the commercial properties. We plan to sell certain commercial properties or refinance a significant portion of the mortgage notes payable in the event the commercial property securing the respective mortgage note is not sold on or before maturity. We believe that the cash flow from our existing portfolio, distributions from joint ventures in Model Home partnerships and property sales during 2020 will be sufficient to fund our near-term operating costs, capital expenditures and future dividends that may be paid to stockholders. If our cash flow from operating activities is not sufficient to fund our short-term liquidity needs, we plan to fund a portion of these needs from additional borrowings of secured or unsecured indebtedness, from real estate sales, issuance of debt instruments, additional investors, or we will reduce the rate of dividends to the stockholders. During the six months endedJune 30, 2020 , we did not paid any cash dividends to our common stockholders. Our long-term liquidity needs include proceeds necessary to grow and maintain our portfolio of investments. We believe that the potential financing capital available to us in the future is sufficient to fund our long-term liquidity needs. We are continually reviewing our existing portfolio to determine which properties have met our short- and long-term goals and reinvesting the proceeds in properties with better potential to increase performance. We expect to obtain additional cash in connection with refinancing of maturing mortgages and assumption of existing debt collateralized by some or all of our real property in the future to meet our long-term liquidity needs. If we are unable to arrange a line of credit, borrow on properties, issue debt instruments, privately place securities or sell securities to the public we may not be able to acquire additional properties to meet our long-term objectives. Cash Equivalents and Restricted Cash AtJune 30, 2020 andDecember 31, 2019 , we had approximately$6.0 million and$5.7 million in cash equivalents, respectively, and$2.7 million and$4.7 million of restricted cash, respectively. Our cash equivalents and restricted cash consist of invested cash, cash in our operating accounts and cash held in bank accounts at third party institutions. During 2020 and 2019, we did not experience any loss or lack of access to our cash or cash equivalents. Approximately$1.9 million of our cash balance is intended for capital expenditures on existing properties (net of deposits held in reserve accounts by our lenders). We intend to use the remainder of our existing cash and cash equivalents for reduction of principal debt, general corporate purposes and/or dividends to our stockholders. Secured Debt As ofJune 30, 2020 , the Company had one variable-rate mortgage note payable on a commercial property with a principal amount of$5.9 million and fixed-rate mortgage notes payable in the aggregate principal amount of$89.3 million , collateralized by a total of 15 commercial properties with loan terms at issuance ranging from 1 to 17 years. The weighted-average interest rate on these mortgage notes payable as ofJune 30, 2020 was approximately 4.6%, and our debt to estimated market value of these properties was approximately 57.7%. As ofJune 30, 2020 , the Company had 125 fixed-rate mortgage notes payable in the aggregate principal amount of$31.3 million , collateralized by a total of 125Model Homes . These loans generally have a term at issuance of three to five years. As ofJune 30, 2020 , the average loan balance per home outstanding and the weighted-average interest rate on these mortgage loans are approximately$250,000 and 4.3%, respectively. Our debt to estimated market value on these properties is approximately 57.7%. The Company has guaranteed between 25% - 100% of these mortgage loans. We have been able to refinance maturing mortgages to extend maturity dates and we have not experienced any notable difficulties financing our acquisitions. 25 -------------------------------------------------------------------------------- Table of Contents Cash Flows for the six months endedJune 30, 2020 andJune 30, 2019 Operating Activities: Net cash provided by operating activities for the six months endedJune 30, 2020 decreased by approximately$2.2 million to approximately$0.2 million from$2.4 million for the six months endedJune 30, 2019 . The decrease in net cash provided by operating activities is due to a$3.3 million increase in payments on accrued liabilities and accounts payable recognized over the period which fluctuate based on timing of receipt, as well as a decrease in cash flows from tenants that received COVID-19 related abatements or deferrals, offset by a decrease of$1.1 million in gain on sale of real estate due to the timing and mix of properties sold. Investing Activities: Net cash provided by investing activities during the six months endedJune 30, 2020 was approximately$20.6 million compared to approximately$3.4 million during the same period in 2019. The increase primarily related to gross proceeds from the sale of two office buildings for approximately$26.3 million , and$8.0 million from the sale of 21Model Homes as well as a decrease in capital expenditures of approximately$2.4 million year over year due to timing of capital expenditures during the COVID-19 pandemic. During the six months endedJune 30, 2019 , the Company received gross proceeds from sales of 26Model Homes for approximately$9.4 million and gross proceeds of$5.4 million from the sale of one office building. We currently project that we could spend up to$1.9 million (net of deposits held in reserve accounts by lenders) on capital improvements, tenant improvements and leasing costs for properties within our portfolio on an annual basis. Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to the properties. We may spend more on capital expenditures in the future due to rising construction costs. Tenant improvements and leasing costs may also fluctuate in any given year depending upon factors such as the property, the term of the lease, the type of lease, the involvement of external leasing agents and overall market conditions. Financing Activities: Net cash used in financing activities during the six months endedJune 30, 2020 was$22.5 million compared to$3.9 million for the same period in 2019 and was primarily due to the following activities for the six months endedJune 30, 2020 : •Net increase in repayment of mortgage notes payable of$13.2 million ; •Net increase in repayment of the Polar note payable of$5.2 million ; •Net decrease in proceeds from mortgage notes of$2.0 million ; offset by •Net decrease in dividends paid to stockholders of$1.1 million ; and •Redemption of mandatorily redeemable preferred stock of$900,000 during the six months endedJune 30, 2019 . Off-Balance Sheet Arrangements As ofJune 30, 2020 , we do not have any off-balance sheet arrangements or obligations, including contingent obligations. Non-GAAP Supplemental Financial Measures: Funds from Operations ("FFO") Management believes that FFO is a useful supplemental measure of our operating performance. We compute FFO using the definition outlined by theNational Association of Real Estate Investment Trusts ("NAREIT"). NAREIT defines FFO as net income (loss) in accordance with GAAP, plus depreciation and amortization of real estate assets (excluding amortization of deferred financing costs and depreciation of non-real estate assets) reduced by gains and losses from sales of depreciable operating property and extraordinary items, as defined by GAAP. Other REITs may use different methodologies for calculating FFO and, accordingly, our FFO may not be comparable to other REITs. Since FFO excludes depreciation and amortization, gains and losses from property dispositions that are available for distribution to stockholders and extraordinary items, it provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses and interest costs, providing a perspective not immediately apparent from net income. In addition, Management believes that FFO provides useful information to the investment community about our financial performance when compared to other REITs since FFO is generally recognized as the industry standard for reporting the operations of REITs. However, FFO should not be viewed as an alternative measure of our operating performance since it does not reflect either depreciation and amortization costs or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties which are significant economic costs and could materially impact our results from operations. 26 -------------------------------------------------------------------------------- Table of Contents Modified Funds from Operations ("MFFO") and Adjusted Modified Funds from Operations ("Adjusted MFFO") We define MFFO, a non-GAAP measure, consistent with theInvestment Program Association's ("IPA") Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REIT Modified Funds from Operations, or the Practice Guideline, issued by the IPA inNovember 2010 . The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above-market and below-market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; nonrecurring impairments of real estate-related investments (i.e., infrequent or unusual, not reasonably likely to recur in the ordinary course of business); mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, nonrecurring unrealized gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized. Our MFFO calculation complies with the IPA's Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses, amortization of above-market and below-market leases, deferred rent receivables and the adjustments of such items related to noncontrolling interests. In addition, our management uses an adjusted MFFO ("Adjusted MFFO") as an indicator of our ongoing performance. Adjusted MFFO provides adjustments to reduce MFFO related to operating expenses that are capitalized with respect to our deferred offering costs related to the Company's filing of a registration statement on Form S-11. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income. These expenses are paid in cash by us. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to such property. The acquisition of properties, and the corresponding acquisition fees and expenses, is the key operational feature of our business plan to generate operational income and cash flow to fund distributions to our stockholders. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. In addition, we view fair value adjustments of impairment charges and gains and losses from dispositions of assets as non-recurring items or items which are unrealized and may not ultimately be realized, and which are not reflective of on-going operations and are therefore typically adjusted for when assessing operating performance. In particular, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions which can change over time. An asset will only be evaluated for impairment if certain impairment indications exist and if the carrying, or book value, exceeds the total estimated undiscounted future cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) from such asset. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of MFFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges. 27 -------------------------------------------------------------------------------- Table of Contents The following table presents our FFO and MFFO for the three and six months endedJune 30, 2020 and 2019: For the Six Months Ended For the Three Months Ended June 30, June 30, 2020 2019 2020 2019 Net loss$ (1,922,815) $ (1,259,598) $ (3,029,946) $ (2,987,990) Adjustments: Income attributable to noncontrolling interests 315,282 182,924 490,293 949,379 Depreciation and amortization 1,622,230 1,749,113 3,196,756 3,959,194 Impairment of real estate assets 845,674 - 845,674 -
Loss (gain) on sale of real estate assets, net (334,096)
(176,392) (324,261) (1,390,634) FFO $ 526,275
$ (107,643)
(28,321) (34,272) (58,245) (64,416) Restricted stock compensation 203,872 202,473 361,243 635,758 Amortization of financing costs 369,841 172,757 733,024 400,131 MFFO $ 964,024$ 842,594 $ 2,053,954 $ 1,492,155 No conclusion or comparisons should be made from the presentation of these figures. Same-Store Property Operating Results for the three and six months endedJune 30, 2020 and 2019. The table below presents the operating results for the Company's commercial properties owned as ofJanuary 1st for each of the three and six months endedJune 30, 2020 and 2019 (unless subsequently disposed of), excluding the impact on our results of operations from the real estate properties acquired subsequently. The table below excludes model home operations as the rental rates do not fluctuate during the term of the lease and there are no operating expenses. The Company believes that this type of non-GAAP financial measure, when considered with our financial statements prepared in accordance with GAAP, allows investors to better understand the Company's operating results. Properties are included in this analysis if they were owned and operated for the entirety of both periods being compared. Further, same-property operating results is a measure for which there is no standard definition and, as such, it is not consistently defined or reported on among the Company's peers, and thus may not provide an adequate basis for comparison between REITs. The Company evaluates the performance of its same-store property operating results based upon net operating income from continuing operations ("NOI"), which is a non-GAAP supplemental financial measure. The Company defines NOI as operating revenues (rental income, tenant reimbursements and other operating income) less property and related expenses (property operating expenses, real estate taxes, insurance and provision for bad debt) less interest expense. NOI excludes certain items that are not considered to be controllable in connection with the management of an asset such as non-property income and expenses, depreciation and amortization, asset management fees and corporate general and administrative expenses. The Company believes that net income is the GAAP measure that is most directly comparable to NOI; however, NOI should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes the items described above. Additionally, NOI as defined above may not be comparable to other REITs or companies as their definitions of NOI may differ from the Company's definition. For the Six Months Ended June For The Three Months EndedJune 30, Variance 30, Variance 2020 2019 $ % 2020 2019 $ % Rental revenues$ 5,123,335 $ 4,951,523 $ 171,812 3.5 %$ 10,375,723 $ 9,732,939 $ 642,784 6.6 % Rental operating costs 2,010,505 1,997,754 12,751 0.6 % 4,225,931 4,162,216 63,715 1.5 % Net operating income$ 3,112,830 $ 2,953,769 $ 159,061 5.4 %$ 6,149,792 $ 5,570,723 $ 579,069 10.4 % Operating Ratios: Number of same properties 15 15 15 15 Occupancy, end of period 83.2 % 81.1 % 2.1 % 83.2 % 81.1 % 2.1 % Operating costs as a percentage of total revenues 39.2 % 40.3 % (1.1) % 40.7 % 42.8 % (2.1) % 28
--------------------------------------------------------------------------------
Table of Contents Overview Same-store property NOI increased 5.4% for the three months endedJune 30, 2020 compared to the corresponding period in 2019 primarily due to increased occupancy rates and lower rental operating cost. Rental revenues for the three months endedJune 30, 2020 increased by 3.5% compared to the same period in 2019. Same-store property NOI increased 10.4% for the six months endedJune 30, 2020 compared to the corresponding period in 2019 primarily due to increased occupancy rates and lower rental operating cost. Rental revenues for the six months endedJune 30, 2020 increased by 6.6% compared to the same period in 2019. These increases rental revenues are primarily due to the replacement of a major tenant atWorld Plaza , bringing that property to 100% occupancy from 22% during the previous period as well as increases in occupancy of between 4% - 7% atGenesis Plaza , Grand Pacific Center, and One Park Center, offset by decreases in occupancy atWaterman Plaza of 14% and at Dakota Center of 12%. Leasing Our same-store NOI increase for the six months endedJune 30, 2020 compared to the corresponding period in 2019 was primarily driven by net increased occupancy rates and lower rental operating cost per property. Over the long-term, we believe that the infill nature and strong demographics of our properties have provided us with a strategic advantage, allowing us to maintain relatively high occupancy and increase rental rates. We have continued to see signs of improvement for many of our tenants as well as increased interest from prospective tenants for our spaces. While there can be no assurance that these positive signs will continue, we remain cautiously optimistic regarding the trends we have seen over the past few years. We believe the locations of our properties and diverse tenant base mitigate the potentially negative impact of a poor economic environment, including that which as has arisen due to COVID-19. However, any reduction in our tenants' abilities to pay base rent, percentage rent or other charges during the COVID-19 pandemic, may adversely affect our financial condition and results of operations. During the three months endedJune 30, 2020 , we signed seven comparable leases (one new lease and six lease renewals) for a total of 11,946 square feet of comparable space, at an average rental rate increase of 3.2% on a cash basis due to rent abatement periods and an average rental increase of 10.9% on a straight-line basis. New leases for comparable office spaces were signed for 1,351 square feet at an average rental rate increase of 7.7% on a cash basis due to rent abatement periods and increase of 30.4% on a straight-line basis. Renewals for comparable office spaces were signed for 10,595 square feet at an average rental rate increase of 2.5% on a cash basis and increase of 8.2% on a straight-line basis. During the six months endedJune 30, 2020 , we signed 19 comparable leases (five new leases and 14 lease renewals) for a total of 58,791 square feet of comparable space, at an average rental rate decrease of 5.6% on a cash basis due to rent abatement periods and an average rental increase of 9.2% on a straight-line basis. New leases for comparable office spaces were signed for 11,921 square feet at an average rental rate decrease of 23.7% on a cash basis due to rent abatement periods and increase of 5.3% on a straight-line basis. Renewals for comparable office spaces were signed for 46,870 square feet at an average rental rate decrease of 1.0% on a cash basis and increase of 10.1% on a straight-line basis. Impact of Downtime and Rental Rate Changes The downtime between lease expiration and new lease commencement, typically ranging from 6-24 months, can negatively impact total NOI and same-store property NOI. In addition, commercial property leases, both new and lease renewals typically contain upfront rental and/or operating expense abatement periods which delay the cash flow benefits of the lease even after the new lease or renewal has commenced. If we are unable to replace expiring leases with new or renewal leases at rental rates equal to or greater than the expiring rates, rental rate roll downs can also negatively impact total NOI and same-store property NOI comparisons. Most of our leases are shorter than seven years and therefore the rental rate roll downs should not have a significant effect on future years. Our geographically diverse portfolio model results in rent renewal rates that can fluctuate widely on a market by market basis; however, given the volume of leasing activity over the last several years, we estimate that our portfolio, taken as a whole, is currently at market. Total NOI and same-store property NOI comparisons for any given period may still fluctuate as a result of rent roll ups and roll downs, however, depending on the leasing activity in individual geographic markets during the respective period.
© Edgar Online, source