Form 10-Q Pacific Oak Strategic For: Jun 30
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E-mailUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________
FORM 10-Q
______________________________________________________
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended June 30, 2022
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from to
Commission file number 000-54382
______________________________________________________
(Exact Name of Registrant as Specified in Its Charter)
______________________________________________________
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | ||||||||||
| (Address of Principal Executive Offices) | (Zip Code) | ||||||||||
(424 ) 208-8100
(Registrant’s Telephone Number, Including Area Code)
______________________________________________________________________
Securities registered pursuant to Section 12(b) for the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| None | N/A | N/A | ||||||
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large Accelerated Filer | ☐ | Accelerated Filer | ☐ | |||||||||||||||||
| ☒ | Smaller reporting company | |||||||||||||||||||
| Emerging growth company | ||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of August 10, 2022, there were 104,140,141 outstanding shares of common stock of Pacific Oak Strategic Opportunity REIT, Inc.
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
FORM 10-Q
June 30, 2022
INDEX
| PART I. | |||||||||||
| Item 1. | |||||||||||
Consolidated Balance Sheets as of June 30, 2022 (unaudited) and December 31, 2021 | |||||||||||
Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2022 and 2021 | |||||||||||
Consolidated Statements of Equity (unaudited) for the Three and Six Months Ended June 30, 2022 and 2021 | |||||||||||
Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2022 and 2021 | |||||||||||
| Item 2. | |||||||||||
| Item 3. | |||||||||||
| Item 4. | |||||||||||
| PART II. | |||||||||||
| Item 1. | |||||||||||
| Item 1A. | |||||||||||
| Item 2. | |||||||||||
| Item 3. | |||||||||||
| Item 4. | |||||||||||
| Item 5. | |||||||||||
| Item 6. | |||||||||||
1
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
| June 30, 2022 | December 31, 2021 | |||||||||||||
| (unaudited) | ||||||||||||||
| Assets | ||||||||||||||
| Real estate held for investment, net | $ | $ | ||||||||||||
| Real estate held for sale, net | ||||||||||||||
| Real estate equity securities | ||||||||||||||
| Total real estate and real estate-related investments, net | ||||||||||||||
| Cash and cash equivalents | ||||||||||||||
| Restricted cash | ||||||||||||||
| Investments in unconsolidated entities | ||||||||||||||
| Rents and other receivables, net | ||||||||||||||
| Above-market leases, net | ||||||||||||||
Due from affiliate | ||||||||||||||
| Prepaid expenses and other assets | ||||||||||||||
| Goodwill | ||||||||||||||
| Assets related to real estate held for sale, net | ||||||||||||||
| Total assets | $ | $ | ||||||||||||
| Liabilities, mezzanine equity and equity | ||||||||||||||
| Notes and bonds payable related to real estate held for investment, net | $ | $ | ||||||||||||
| Note payable related to real estate held for sale, net | ||||||||||||||
| Notes and bonds payable, net | ||||||||||||||
| Accounts payable and accrued liabilities | ||||||||||||||
Due to affiliates | ||||||||||||||
| Below-market leases, net | ||||||||||||||
| Other liabilities | ||||||||||||||
| Redeemable common stock payable | ||||||||||||||
| Restricted stock payable | ||||||||||||||
| Dividends payable | ||||||||||||||
| Total liabilities | ||||||||||||||
Commitments and contingencies | ||||||||||||||
| Mezzanine equity | ||||||||||||||
Noncontrolling cumulative convertible redeemable preferred stock | ||||||||||||||
Redeemable noncontrolling interest | ||||||||||||||
| Equity | ||||||||||||||
| Pacific Oak Strategic Opportunity REIT, Inc. stockholders’ equity | ||||||||||||||
Preferred stock, $ | ||||||||||||||
Common stock, $ | ||||||||||||||
| Additional paid-in capital | ||||||||||||||
| Cumulative distributions and net loss | ( | ( | ||||||||||||
| Total Pacific Oak Strategic Opportunity REIT, Inc. stockholders’ equity | ||||||||||||||
| Noncontrolling interests | ||||||||||||||
| Total equity | ||||||||||||||
| Total liabilities, mezzanine equity and equity | $ | $ | ||||||||||||
See accompanying condensed notes to consolidated financial statements.
2
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Revenues: | ||||||||||||||||||||||||||
| Rental income | $ | $ | $ | $ | ||||||||||||||||||||||
| Hotel revenues | ||||||||||||||||||||||||||
| Other operating income | ||||||||||||||||||||||||||
| Dividend income from real estate equity securities | ||||||||||||||||||||||||||
| Total revenues | ||||||||||||||||||||||||||
| Expenses: | ||||||||||||||||||||||||||
| Operating, maintenance, and management | ||||||||||||||||||||||||||
| Real estate taxes and insurance | ||||||||||||||||||||||||||
| Hotel expenses | ||||||||||||||||||||||||||
| Asset management fees to affiliate | ||||||||||||||||||||||||||
| General and administrative expenses | ||||||||||||||||||||||||||
| Foreign currency transaction (gain) loss, net | ( | ( | ( | |||||||||||||||||||||||
| Depreciation and amortization | ||||||||||||||||||||||||||
| Interest expense | ||||||||||||||||||||||||||
| Total expenses | ||||||||||||||||||||||||||
| Other (loss) income: | ||||||||||||||||||||||||||
| Equity in (loss) income of unconsolidated entities | ( | ( | ||||||||||||||||||||||||
| Other interest income | ||||||||||||||||||||||||||
| (Loss) gain on real estate equity securities | ( | ( | ||||||||||||||||||||||||
Change in subordinated performance fee due upon termination to affiliate | ( | |||||||||||||||||||||||||
| (Loss) gain on sale of real estate | ( | |||||||||||||||||||||||||
| Gain on extinguishment of debt | ||||||||||||||||||||||||||
| Total other (loss) income, net | ( | ( | ||||||||||||||||||||||||
| Net (loss) income | ( | ( | ||||||||||||||||||||||||
| Net (income) loss attributable to noncontrolling interests | ( | ( | ||||||||||||||||||||||||
| Net loss attributable to redeemable noncontrolling interest | ||||||||||||||||||||||||||
| Preferred stock dividends | ( | ( | ( | ( | ||||||||||||||||||||||
| Net (loss) income attributable to common stockholders | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| Net (loss) income per common share, basic and diluted | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| Weighted-average number of common shares outstanding, basic and diluted | ||||||||||||||||||||||||||
See accompanying condensed notes to consolidated financial statements.
3
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONSOLIDATED STATEMENTS OF EQUITY
For the Three Months Ended June 30, 2022 and 2021
(unaudited)
(in thousands, except share amounts)
| Common Stock | Additional Paid-in Capital | Cumulative Distributions and Net Income (Loss) | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||
| Shares | Amounts | ||||||||||||||||||||||||||||||||||||||||
Balance, March 31, 2022 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Net (loss) income | — | — | — | ( | ( | ( | |||||||||||||||||||||||||||||||||||
| Transfers to redeemable common stock | — | — | — | — | |||||||||||||||||||||||||||||||||||||
| Redemptions of common stock | ( | ( | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Adjustment to value of redeemable noncontrolling interest | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Stock distribution issued | — | ( | — | ||||||||||||||||||||||||||||||||||||||
| Noncontrolling interest distribution | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||
Balance, June 30, 2022 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Common Stock | Additional Paid-in Capital | Cumulative Distributions and Net Income (Loss) | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||
| Shares | Amounts | ||||||||||||||||||||||||||||||||||||||||
| Balance, March 31, 2021 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | ( | |||||||||||||||||||||||||||||||||||||
| Transfers to redeemable common stock | — | — | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Redemptions of common stock | ( | — | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Noncontrolling interests contributions | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Balance, June 30, 2021 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
See accompanying condensed notes to consolidated financial statements.
4
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONSOLIDATED STATEMENTS OF EQUITY
For the Six Months Ended June 30, 2022 and 2021
(unaudited)
(in thousands, except share amounts)
| Common Stock | Additional Paid-in Capital | Cumulative Distributions and Net Income (Loss) | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||
| Shares | Amounts | ||||||||||||||||||||||||||||||||||||||||
Balance, December 31, 2021 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Net (loss) income | — | — | — | ( | ( | ( | |||||||||||||||||||||||||||||||||||
| Transfers to redeemable common stock | — | — | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Redemptions of common stock | ( | ( | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Adjustment to value of redeemable noncontrolling interest | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Stock distribution issued | ( | — | |||||||||||||||||||||||||||||||||||||||
| Noncontrolling interest distribution | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||
Balance, June 30, 2022 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Common Stock | Additional Paid-in Capital | Cumulative Distributions and Net Income (Loss) | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||
| Shares | Amounts | ||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | ( | |||||||||||||||||||||||||||||||||||||
| Transfers to redeemable common stock | — | — | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Redemptions of common stock | ( | — | ( | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Noncontrolling interests contributions | — | — | — | — | ` | ||||||||||||||||||||||||||||||||||||
| Balance, June 30, 2021 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||
See accompanying condensed notes to consolidated financial statements.
5
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended June 30, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Cash Flows from Operating Activities: | ||||||||||||||
| Net (loss) income | $ | ( | $ | |||||||||||
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||||||||
| Change in subordinated performance fee due upon termination to affiliate | ||||||||||||||
| Equity in loss (income) of unconsolidated entities | ( | |||||||||||||
| Depreciation and amortization | ||||||||||||||
| Loss (gain) on real estate equity securities | ( | |||||||||||||
| Gain on sale of real estate | ( | ( | ||||||||||||
| Unrealized (gain) loss on interest rate caps | ( | |||||||||||||
| Deferred rent | ( | ( | ||||||||||||
| Gain on extinguishment of debt | ( | ( | ||||||||||||
| Amortization of above- and below-market leases, net | ( | ( | ||||||||||||
| Amortization of deferred financing costs and discount on bonds and notes payable | ||||||||||||||
| Foreign currency transaction gain, net | ( | ( | ||||||||||||
| Changes in assets and liabilities: | ||||||||||||||
| Rents and other receivables | ( | |||||||||||||
| Prepaid expenses and other assets | ( | ( | ||||||||||||
| Accounts payable and accrued liabilities | ( | |||||||||||||
| Due to affiliates | ( | |||||||||||||
| Other liabilities | ||||||||||||||
| Net cash provided by operating activities | ||||||||||||||
| Cash Flows from Investing Activities: | ||||||||||||||
| Acquisitions of real estate | ( | |||||||||||||
| Improvements to real estate | ( | ( | ||||||||||||
| Proceeds from sales of real estate, net | ||||||||||||||
| Contributions to unconsolidated entities | ( | ( | ||||||||||||
| Distributions of capital from unconsolidated entities | ||||||||||||||
| Purchase of interest rate cap | ( | ( | ||||||||||||
| Proceeds from the sale of real estate equity securities | ||||||||||||||
| Advance to affiliate | ( | |||||||||||||
| Proceeds from advances due from affiliates | ||||||||||||||
| Escrow deposits for future real estate sales | ||||||||||||||
| Proceeds for future development obligations | ||||||||||||||
| Funding for development obligations | ( | |||||||||||||
| Net cash (used in) provided by investing activities | ( | |||||||||||||
| Cash Flows from Financing Activities: | ||||||||||||||
| Proceeds from notes and bonds payable | ||||||||||||||
| Principal payments on notes and bonds payable | ( | ( | ||||||||||||
| Payments of deferred financing costs | ( | ( | ||||||||||||
| Payments to redeem common stock | ( | ( | ||||||||||||
| Payment of prepaid other offering costs | ( | |||||||||||||
| Distributions paid | ( | |||||||||||||
| Preferred dividends paid | ( | ( | ||||||||||||
| Noncontrolling interests distribution | ( | |||||||||||||
| Noncontrolling interests contributions | ||||||||||||||
| Other financing proceeds | ||||||||||||||
| Net cash provided by financing activities | ||||||||||||||
| Effect of exchange rate changes on cash, cash equivalents and restricted cash | ( | ( | ||||||||||||
| Net increase in cash, cash equivalents and restricted cash | ||||||||||||||
| Cash, cash equivalents and restricted cash, beginning of period | ||||||||||||||
| Cash, cash equivalents and restricted cash, end of period | $ | $ | ||||||||||||
See accompanying condensed notes to consolidated financial statements.
6
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2022
(unaudited)
1.ORGANIZATION
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no significant changes to the Company’s accounting policies since it filed its audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2021. For further information about the Company’s accounting policies, refer to the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2021 included in the Company’s Annual Report on Form 10-K filed with the SEC.
Principles of Consolidation and Basis of Presentation
7
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Liquidity
The Company generally finances its real estate investments using notes payable that are typically structured as non-recourse secured mortgages with maturities of approximately to five years , with short term extension options available upon the Company meeting certain debt covenants. Each reporting period management evaluates the Company’s ability to continue as a going concern by evaluating conditions and events, including assessing the liquidity needs to satisfy upcoming debt obligations and the ability to satisfy debt covenant requirements. Through the normal course of operations and as further discussed in Note 5, the Company has $467.5 million of debt obligations coming due over the next 12-month period. In order to satisfy obligations as they mature, management will evaluate its options and may seek to utilize extension options available in the respective loan agreements, may make partial loan paydowns to meet debt covenant requirements, may seek to refinance certain debt instruments, may sell real estate equity securities to convert to cash to make principal payments, may market one or more properties for sale or may negotiate a turnover of one or more secured properties back to the related mortgage lender and remit payment for any associated loan guarantee. Historically, the Company has successfully refinanced debt instruments or utilized extension options in order to satisfy debt obligations as they come due and has not negotiated a turnover of a secured property back to a lender, though the Company may utilize such option if necessary. Based upon these plans, management believes it will have sufficient liquidity to satisfy its obligations as they come due and to continue as a going concern. There can be no assurance as to the certainty or timing of any of management’s plans. Refer to Note 5 for further details.
Reclassifications
Use of Estimates
Restricted Cash
Segments
8
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Per Share Data
Square Footage, Occupancy and Other Measures
3. REAL ESTATE HELD FOR INVESTMENT
As of June 30, 2022, the Company owned eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, encompassing, in the aggregate, approximately 3.2 million rentable square feet. As of June 30, 2022, these properties were 72 % occupied. In addition, the Company owned one residential home portfolio consisting of 1,815 single-family homes and encompassing approximately 2.5 million rental square feet and two apartment properties, containing 609 units and encompassing approximately 0.5 million rentable square feet, which were 92 % and 92 % occupied, respectively, as of June 30, 2022. As of June 30, 2022, the Company also owned two hotel properties with an aggregate of 649 rooms and three investments in undeveloped land with approximately 800 developable acres and one office/retail development property. The following table summarizes the Company’s real estate held for investment as of June 30, 2022 and December 31, 2021, respectively (in thousands):
| June 30, 2022 | December 31, 2021 | |||||||||||||
| Land | $ | $ | ||||||||||||
| Buildings and improvements | ||||||||||||||
| Tenant origination and absorption costs | ||||||||||||||
| Total real estate, cost | ||||||||||||||
| Accumulated depreciation and amortization | ( | ( | ||||||||||||
| Total real estate, net | $ | $ | ||||||||||||
Operating Leases
Certain of the Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of June 30, 2022, the leases, excluding options to extend, apartment leases and single-family homes, which have terms that are generally one year or less, had remaining terms of up to 13.2 years with a weighted-average remaining term of 3.7 years. Some of the leases have provisions to extend the lease agreements, options for early termination after paying a specified penalty and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Generally, upon the execution of a lease, the Company requires a security deposit from tenants in the form of a cash deposit and/or a letter of credit. The amount required as a security deposit varies depending upon the terms of the respective leases and the creditworthiness of the tenant, but generally are not significant amounts. Therefore, exposure to credit risk exists to the extent that a receivable from a tenant exceeds the amount of its security deposit. Security deposits received in cash and assumed in real estate acquisitions related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets totaled $6.1 million and $6.0 million as of June 30, 2022 and December 31, 2021, respectively.
9
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
During the three and six months ended June 30, 2022, the Company recognized deferred rent from tenants of $0.4 million and $1.4 million, respectively, net of lease incentive amortization. During the three and six months ended June 30, 2021, the Company recognized deferred rent from tenants of $0.03 million and $1.1 million, respectively, net of lease incentive amortization. As of June 30, 2022 and December 31, 2021, the cumulative deferred rent receivable balance, including unamortized lease incentive receivables, was $17.0 million and $16.3 million, respectively, and is included in rents and other receivables on the accompanying consolidated balance sheets. The cumulative deferred rent balance included $2.8 million and $3.3 million of unamortized lease incentives as of June 30, 2022 and December 31, 2021, respectively.
July 1, 2022 through December 31, 2022 | $ | ||||
| 2023 | |||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| Thereafter | |||||
| $ | |||||
As of June 30, 2022, the Company’s commercial real estate properties were leased to approximately 300 tenants over a diverse range of industries and geographic areas. The Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:
| Industry | Number of Tenants | Annualized Base Rent (1) (in thousands) | Percentage of Annualized Base Rent | |||||||||||||||||
| Professional, Scientific, and Technical Services | $ | % | ||||||||||||||||||
| Public Administration | % | |||||||||||||||||||
| Computer Systems Design and Related Services | % | |||||||||||||||||||
| $ | % | |||||||||||||||||||
Geographic Concentration Risk
As of June 30, 2022, the Company’s real estate investments in California and Georgia represented 21.6 % and 10.0 %, respectively, of the Company’s total assets. As a result, the geographic concentration of the Company’s portfolio makes it particularly susceptible to adverse economic developments in the California and Georgia real estate markets. Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for office space resulting from the local business climate, could adversely affect the Company’s operating results and its ability to make distributions to stockholders.
10
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Hotel Properties
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Hotel revenues: | ||||||||||||||||||||||||||
| Room | $ | $ | $ | $ | ||||||||||||||||||||||
| Food, beverage and convention services | ||||||||||||||||||||||||||
| Campground | ||||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||||
| Hotel revenues | $ | $ | $ | $ | ||||||||||||||||||||||
Contract Liabilities
| June 30, 2022 | December 31, 2021 | |||||||||||||
| Contract liability | $ | $ | ||||||||||||
| Revenue recognized in the period from: | ||||||||||||||
| Amounts included in contract liability at the beginning of the period | $ | $ | ||||||||||||
Recent Real Estate Sale
On January 24, 2022, the Company, through an indirect wholly owned subsidiary, sold two office buildings related to the Richardson Portfolio and containing 141,950 rentable square feet in Richardson, Texas (“Greenway Buildings”) to a purchaser unaffiliated with the Company or the Advisor (as defined in Note 7), for $11.0 million, before closing costs and credits. The carrying value of the Greenway Buildings as of the disposition date was $5.6 million, which was net of $3.2 million of accumulated depreciation and amortization. In connection with the sale of the Greenway Buildings, the Company repaid $9.1 million of the outstanding principal balance due under the mortgage loan secured by the Greenway Buildings. The Company recognized a gain on sale of $3.6 million related to the disposition of the Greenway Buildings, net of closing costs and adjustments. As a result of the sale of the Greenway Buildings, certain assets and liabilities were reclassified to held for sale on the consolidated balance sheets as of December 31, 2021.
Park Highlands Land Purchase and Sale Contracts
The Company enters into land purchase and sale contracts to dispose of Park Highlands developed and undeveloped land. Under these contracts, the Company will receive a stated deposit from the buyer, held in escrow, in consideration for the right, but not the obligation, to purchase the land at a future point in time with predetermined terms. After a contractually specified date, the deposits are not refundable even in the event the contract terminates, at which point the Company records restricted cash and other liabilities on the consolidated balance sheets.
11
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
On November 11, 2021, the Company, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement, as amended, to sell 234 (previously 238 and amended to reduce by 4 acres) developable acres of undeveloped land located in North Las Vegas, Nevada, (“Park Highlands”) for gross sales proceeds of approximately $124.5 million, before closing costs and credits. The due diligence period expired on February 23, 2022 and the buyer’s deposit of $13.5 million is no longer refundable and is recognized as restricted cash on the consolidated balance sheets. This deposit is held in an escrow account and will become available once the sale is completed. Actions are required by the Company to complete the planned sale.
On March 10, 2022, the Company, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement, as amended, to sell 77 developable acres of Park Highlands for gross sales proceeds of approximately $52.9 million, before closing costs and credits. The due diligence period expired on May 31, 2022 and the buyer’s deposit of $3.5 million is no longer refundable and is recognized as restricted cash on the consolidated balance sheets. This deposit is held in an escrow account and will become available once the sale is completed. Actions are required by the Company to complete the planned sale.
On June 22, 2022, the Company, through an indirect wholly owned subsidiary, entered into a purchase and sale agreement, to sell 67 developable acres of Park Highlands for gross sales proceeds of approximately $55.0 million, before closing costs and credits. The due diligence period expires on October 20, 2022, after which the buyer’s deposit of $3.0 million will no longer be refundable and will be recognized as restricted cash on the consolidated balance sheets. This deposit is held in an escrow account and will become available once the sale is completed. Actions are required by the Company to complete the planned sale.
4. REAL ESTATE EQUITY SECURITIES
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Net (loss) gain recognized during the period on real estate equity securities | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
| Less net gain recognized during the period on real estate equity securities sold during the period | ( | |||||||||||||||||||||||||
| Unrealized (loss) gain recognized during the reporting period on real estate equity securities held at the end of the period | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||
12
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
5. NOTES AND BONDS PAYABLE
As of June 30, 2022 and December 31, 2021, the Company’s notes and bonds payable, including notes payable related to real estate held for sale, consisted of the following (dollars in thousands):
Book Value as of June 30, 2022 | Book Value as of December 31, 2021 | Contractual Interest Rate as of June 30, 2022 | Effective Interest Rate at June 30, 2022 (1) | Payment Type (2) | Maturity Date (3) | ||||||||||||||||||||||||||||||
| Richardson Portfolio Mortgage Loan | $ | $ | Floating Rate + | Principal & Interest | 11/01/2022 | ||||||||||||||||||||||||||||||
Park Centre Mortgage Loan | Floating Rate + | Interest Only | 06/27/2023 | ||||||||||||||||||||||||||||||||
1180 Raymond Mortgage Loan (4) | Floating Rate + | Interest Only | 12/01/2023 | ||||||||||||||||||||||||||||||||
Pacific Oak SOR (BVI) Holdings, Ltd. Series B Debentures (5) | (5) | 01/31/2026 | |||||||||||||||||||||||||||||||||
| Crown Pointe Mortgage Loan | Floating Rate + | Interest Only | 04/01/2025 | ||||||||||||||||||||||||||||||||
| The Marq Mortgage Loan | Floating Rate + | Principal & Interest | 06/06/2023 | ||||||||||||||||||||||||||||||||
| Eight & Nine Corporate Centre Mortgage Loan | Floating Rate + | Principal & Interest | 06/08/2023 | ||||||||||||||||||||||||||||||||
| Georgia 400 Center Mortgage Loan | Floating Rate + | Interest Only | 05/22/2023 | ||||||||||||||||||||||||||||||||
| PORT Mortgage Loan 1 | Interest Only | 10/01/2025 | |||||||||||||||||||||||||||||||||
| PORT Mortgage Loan 2 | Interest Only | 03/01/2026 | |||||||||||||||||||||||||||||||||
| PORT MetLife Loan | Interest Only | 04/10/2026 | |||||||||||||||||||||||||||||||||
| Springmaid Beach Resort Mortgage Loan | Floating Rate + | Principal & Interest | 08/12/2022 (7) | ||||||||||||||||||||||||||||||||
| Q&C Hotel Mortgage Loan | Floating Rate + | Principal & Interest | 12/23/2022 | ||||||||||||||||||||||||||||||||
Lincoln Court Mortgage Loan (4) | Floating Rate + | Principal & Interest | 08/1/2022 (9) | ||||||||||||||||||||||||||||||||
| Lofts at NoHo Commons Mortgage Loan | Floating Rate + | Interest Only | 09/09/2022 | ||||||||||||||||||||||||||||||||
210 West 31st Street Mortgage Loan (4) | Floating Rate + | Principal & Interest | 06/16/2022 (11) | ||||||||||||||||||||||||||||||||
| Oakland City Center Mortgage Loan | Floating Rate + | Principal & Interest | 09/01/2022 | ||||||||||||||||||||||||||||||||
| Madison Square Mortgage Loan | Interest Only | 10/07/2024 | |||||||||||||||||||||||||||||||||
| Total Notes and Bonds Payable principal outstanding | |||||||||||||||||||||||||||||||||||
Discount on Notes and Bonds Payable, net (12) | ( | ( | |||||||||||||||||||||||||||||||||
| Deferred financing costs, net | ( | ( | |||||||||||||||||||||||||||||||||
| Total Notes and Bonds Payable, net | $ | $ | |||||||||||||||||||||||||||||||||
_____________________
(1) Contractual interest rate represents the interest rate in effect under the loan as of June 30, 2022. Effective interest rate is calculated as the actual interest rate in effect as of June 30, 2022 (consisting of the contractual interest rate and contractual floor rates), using interest rate indices at June 30, 2022, where applicable.
(2) Represents the payment type required under the loan as of June 30, 2022. Certain future monthly payments due under this loan also include amortizing principal payments. For more information of the Company’s contractual obligations under its notes and bonds payable, see five-year maturity table below.
(3) Represents the initial maturity date or the maturity date as extended as of June 30, 2022; subject to certain conditions, the maturity dates of certain loans may be extended beyond the date shown.
(4) The Company’s notes and bond’s payable are generally non-recourse. These mortgage loans have guarantees over certain balances whereby the Company would be required to make guaranteed payments in the event that the Company turned the property over to the lender. The guarantees are typically 25 % of the outstanding loan balance. As of June 30, 2022, the guaranteed amount in the aggregate was $21.9 million.
13
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
(5) See “Israeli Bond Financings” below.
(6) The interest rate is variable at the higher of one-month LIBOR + 2.25 % or 5.77 %.
(7) Subsequent to June 30, 2022, the Company extended the Springmaid Beach Resort Mortgage Loan to October 10, 2022.
(8) The interest rate is variable at the higher of one-month LIBOR + 2.5 % or 4.5 %.
(9) On July 29, 2022, the Company refinanced the Lincoln Court Mortgage Loan with a new lender for an amount up to $39.4 million, of which $35.3 million was funded at the time of closing. The loan is an interest only with an annual variable rate of 3.25 % plus the floating rate (SOFR). Additionally, the loan has an initial maturity date of August 7, 2025 with an available three-year extension.
(10) The LIBOR rate is variable at the higher of one-month LIBOR or 1.75 %, plus 2.18 %.
(11) Subsequent to June 30, 2022, the Company extended the maturity of the 210 West 31st Street Mortgage Loan to December 16, 2022. Monthly principal payments of $1.0 million beginning on July 10, 2022.
(12) Represents the unamortized premium/discount on notes and bonds payable due to the above- and below-market interest rates when the debt was assumed. The discount/premium is amortized over the remaining life of the notes and bonds payable.
During the three and six months ended June 30, 2022, the Company incurred $10.8 million and $20.3 million, respectively, of interest expense. Included in interest expense for the three and six months ended June 30, 2022 was $0.8 million and $1.6 million, respectively, of amortization of deferred financing costs. Included in interest expense for the three and six months ended June 30, 2022 was $1.2 million and $2.3 million, respectively, of amortization on discount on notes and bonds payable, net. Additionally, during the three and six months ended June 30, 2022, the Company capitalized $0.5 million and $1.0 million, respectively, of interest related to its investments in undeveloped land.
During the three and six months ended June 30, 2021, the Company incurred $10.7 million and $20.6 million, respectively, of interest expense. Included in interest expense for the three and six months ended June 30, 2021 was $0.8 million and $1.6 million, respectively, of amortization of deferred financing costs. Included in interest expense for the three and six months ended June 30, 2021 was $1.0 million and $1.4 million, respectively, of amortization of discount on notes and bonds payable, net. Additionally, during the three and six months ended June 30, 2021, the Company capitalized $0.5 million and $1.1 million, respectively of interest related to its investments in undeveloped land.
As of June 30, 2022 and December 31, 2021, the Company’s interest payable was $7.9 million and $6.6 million, respectively.
July 1, 2022 through December 31, 2022 | $ | |||||||
| 2023 | ||||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 | ||||||||
| Thereafter | ||||||||
| $ | ||||||||
As of August 12, 2022, the Company had a total of $467.5 million of debt obligations scheduled to mature over the next 12 months. The Company has extension options with respect to $258.8 million of the debt obligations outstanding that are scheduled to mature over the next 12 months; however, the Company cannot exercise these options if not then in compliance with certain financial covenants in the loans without making a cash payment and there is no assurance that the Company will be able to meet these requirements. All of the Company’s debt obligations are generally non-recourse, subject to certain limited guaranty payments, as outlined in the table above, except for the Company’s Series B Debentures. The Company plans to utilize available extension options or refinance the notes payable. The Company may also choose to market the properties for sale or may negotiate a turnover of the secured properties back to the related mortgage lender.
14
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
The Company’s notes payable contain financial debt covenants, including minimum equity requirements and liquidity ratios. As of June 30, 2022, the Company was in compliance with all of these debt covenants with the exception that the Oakland City Center Mortgage Loan and Georgia 400 Center Mortgage Loan which were not in compliance with the debt service coverage requirement and the Lofts at Noho Commons Mortgage Loan which was not in compliance with the debt yield requirement. As a result of such non-compliance, the Company is required to provide a cash sweep for the Lofts at NoHo Commons Mortgage Loan and the Georgia 400 Center Mortgage Loan, as well as a deposit for the Georgia 400 Center Mortgage Loan. On April 4, 2022, the Company paid a deposit of $20.4 million to the lender of the Georgia 400 Center Mortgage Loan and recorded as restricted cash on the consolidated balance sheets. Additionally, the Company may be required to partially pay down the Oakland City Center Mortgage Loan if the non-compliance continues.
Israeli Bond Financings
On February 16, 2020, Pacific Oak SOR BVI issued 254.1 million Israeli new Shekels (approximately $74.1 million as of February 16, 2020) of Series B Debentures to Israeli investors pursuant to a public offering registered with the Israel Securities Authority. The Series B Debentures will bear interest at the rate of 3.93 % per year. The Series B Debentures have principal installment payments equal to 33.33 % of the face amount of the Series B Debentures on January 31st of each year from 2024 to 2026. On November 1, 2021, Pacific Oak SOR BVI issued additional Series B Debentures in the amount of 536.4 million Israeli new Shekels par value through a public offering. The public offering Series B Debentures were issued at a 2.6 % discount resulting in a total consideration of 522.4 million Israeli new Shekels ($166.8 million as of November 1, 2021). On November 8, 2021, Pacific Oak SOR BVI also issued Series B Debentures in the amount of 53.6 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 3.1 % discount resulting in a total consideration of 52.0 million Israeli new Shekels ($16.7 million as of November 8, 2021).
Additionally, on May 2, 2022, Pacific Oak SOR BVI issued Series B Debentures in the amount of 320.4 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 4.0 % discount, resulting in a total consideration of 307.6 million Israeli new Shekels ($95.3 million as of May 2, 2022). The additional Series B Debentures have an equal level of security, pari passu, amongst themselves and between them and the initial Series B Debentures, without any right of precedence or preference between any of them.
The deed of trust that governs the Series B Debentures contain various financial covenants. As of June 30, 2022, the Company was in compliance with all of these financial debt covenants.
6. FAIR VALUE DISCLOSURES
June 30, 2022 | December 31, 2021 | |||||||||||||||||||||||||||||||||||||
| Face Value | Carrying Amount | Fair Value | Face Value | Carrying Amount | Fair Value | |||||||||||||||||||||||||||||||||
| Financial liabilities (Level 3): | ||||||||||||||||||||||||||||||||||||||
| Notes and bond payable | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Financial liabilities (Level 1): | ||||||||||||||||||||||||||||||||||||||
| Pacific Oak SOR (BVI) Holdings, Ltd. Series B Debentures | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
15
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
As of June 30, 2022, the Company measured the following assets at fair value (in thousands):
| Fair Value Measurements Using | ||||||||||||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||||||
| Recurring Basis: | ||||||||||||||||||||||||||
| Real estate equity securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Asset derivative - interest rate caps | $ | $ | $ | $ | ||||||||||||||||||||||
As of December 31, 2021, the Company measured the following assets and liabilities at fair value (in thousands):
| Fair Value Measurements Using | ||||||||||||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||||||||||||
| Recurring Basis: | ||||||||||||||||||||||||||
| Real estate equity securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Asset derivative - interest rate caps | $ | $ | $ | $ | ||||||||||||||||||||||
7. RELATED PARTY TRANSACTIONS
As described further below, the Company has entered into agreements with certain affiliates pursuant to which they provide services to the Company. Keith D. Hall and Peter McMillan III control and indirectly own Pacific Oak Holding Group, LLC (“Pacific Oak Holding”), the Company’s sponsor since November 1, 2019. Pacific Oak Holding is the sole owner of Pacific Oak Capital Advisors, LLC (the “Advisor”), the Company’s advisor since November 1, 2019. Messrs. Hall and McMillan are also two of the Company’s executive officers and directors.
Subject to certain restrictions and limitations, the business of the Company is externally managed by the Advisor pursuant to an advisory agreement (the “Advisory Agreement”). The Advisory Agreement is currently effective through November 1, 2022; however the Company or the Advisor may terminate the Advisory Agreement without cause or penalty upon providing 60 days’ written notice. The Advisor conducts the Company’s operations and manages its portfolio of real estate and other real estate-related investments.
16
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Pursuant to the terms of the Advisory Agreement, summarized below are the related-party costs incurred by the Company for the three and six months ended June 30, 2022 and 2021, respectively, and any related amounts payable as of June 30, 2022 and December 31, 2021 (in thousands):
| Incurred | Payable as of | ||||||||||||||||||||||||||||||||||
Three Months Ended June 30, | Six Months Ended June 30, | June 30, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||
| Expensed | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||||
| Asset management fees | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
Property management fees (1) | |||||||||||||||||||||||||||||||||||
Disposition fees (2) | |||||||||||||||||||||||||||||||||||
Change in subordinated performance fee due upon termination to affiliate (3) | ( | (3) | (3) | ||||||||||||||||||||||||||||||||
| Capitalized | |||||||||||||||||||||||||||||||||||
Acquisition fees on real estate (4) | |||||||||||||||||||||||||||||||||||
| Acquisition fee on investment in unconsolidated entities | |||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
_____________________
(1) Property management fees are for single-family homes and paid to an affiliate of the Advisor. These fees are included in the line item “Operating, maintenance, and management cost” in the consolidated statement of operations.
(2) Disposition fees with respect to real estate sold are included in the gain (loss) on sale of real estate in the accompanying consolidated statements of operations.
(3) Change in estimate of fees payable to the Company’s previous advisor, KBS Capital Advisors LLC (“KBS Capital Advisors) due to the termination of the former advisory agreement with KBS Capital Advisors.
(4) Acquisition fees associated with asset acquisitions are capitalized, while costs associated with business combinations expensed as incurred.
During the six months ended June 30, 2022, the Company provided $1.2 million of funding to the 110 William Joint Venture, an unconsolidated entity, for mortgage loan refinancing fees. In the prior year, the Company provided $7.0 million of funding to the 353 Sacramento Joint Venture, an unconsolidated entity, for mortgage loan refinancing fees and was partially repaid during the six months ended June 30, 2022. As of June 30, 2022 and December 31, 2021, the Company recognized a due from affiliate of $1.8 million and $7.0 million, respectively.
On June 24, 2022, the Company’s board of directors authorized and approved the redemption of the 510,816 Special Common Units of PORT OP LP, a consolidated subsidiary of the Company (“PORT OP”), representing approximately 3.20 % interest, held by BPT Holdings, LLC (“BPT Holdings”), a subsidiary of the Advisor, for a price of $13.09 per unit. The Special Common Units are included as due to affiliates on the consolidated balance sheets. In July 2022, the Company redeemed the special common units of PORT OP for $6.7 million. Following the redemption, the Company owned 100 % of PORT OP.
17
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Pacific Oak Opportunity Zone Fund I
As of June 30, 2022, the Company contributed $27.4 million to the Pacific Oak Opportunity Zone Fund I, LLC (“Pacific Oak Opportunity Zone Fund I”), which is included in investments in unconsolidated entities on the consolidated balance sheets. The Advisor is entitled to certain fees in connection with the fund. Pacific Oak Opportunity Zone Fund I will pay an acquisition fee equal to 1.5 % of the purchase price of each asset (including any debt incurred or assumed and significant capital improvement costs budgeted as of the date of acquisition) with a purchase price less than or equal to $25.0 million plus 1.0 % of the purchase price in excess of $25.0 million; a quarterly asset management fee equal to 0.25 % of the total purchase price of all assets (including any debt incurred or assumed and significant capital improvement costs budgeted as of the date of acquisition) as of the end of the applicable quarter; and a financing fee equal to 0.5 % of the original principal amount of any indebtedness incurred (reduced by any financing fee previously paid with respect to indebtedness being refinanced). In the case of investments made through joint ventures, the fees above will be determined based on the Company’s proportionate share of the investment. The Advisor is also entitled to certain distributions paid by the Pacific Oak Opportunity Zone Fund I after the Class A Members have received their preferred return. These fees and distributions have been waived for the Company’s investment. In addition, side letter agreements between the Advisor and Pacific Oak Opportunity Zone Fund I were executed on February 28, 2020 and stipulate that any asset management fees allocable to the Company and waived by Pacific Oak Capital Advisors for Pacific Oak Opportunity Zone Fund I will distributed to the Company. During the three and six months ended June 30, 2022, the Company recorded $0.1 million and $0.2 million, respectively, of waived asset management fees recorded as equity in income of unconsolidated entities, of which $0 was a receivable as of June 30, 2022. During the three and six months ended June 30, 2021, the Company recorded $0.2 million and $0.3 million, respectively, of waived asset management fees recorded as equity in income of unconsolidated entities.
PORT II
As of June 30, 2022, the Company contributed $34.0 million in PORT II OP LP (“PORT II OP”), a wholly owned subsidiary of Pacific Oak Residential Trust II, Inc. (“PORT II”). On August 31, 2020, PORT II entered into an advisory agreement (as subsequently amended and restated on October 9, 2020, “PORT II Advisory Agreement”) with Pacific Oak Residential Advisors, LLC (“PORA”), an affiliate of the Advisor. Pursuant to the PORT II Advisory Agreement, PORT II has engaged PORA to act as its external advisor with respect to PORT II’s operations and assets. Because the Company has separately engaged the Advisor to manage its operations and assets, including its interests in PORT II, on November 12, 2020, the Company and the Advisor agreed to amend their advisory agreement to provide that PORT II’s operations and assets will be managed by PORA and not by the Advisor.
On July 1, 2022, the Company determined that it became the primary beneficiary of PORT II as a result of events that occurred, including a tender offer arrangement to return equity to unrelated investors. As such, in July 2022, the Company consolidated PORT II into the Company’s consolidated financial statements. See Note 13 for further details.
On August 31, 2020, PORT II entered into a property management agreement with DMH Realty, LLC (“DMH”), an affiliate of the Advisor and PORA. Pursuant to the property management agreement, PORT II will pay to DMH a base fee equal to the following: (a) for all rent collections up to $50 million per year, 8 %; (b) for all rent collections in excess of $50 million per year, but less than or equal to $75 million per year, 7 %; and (c) for all rent collections in excess of $75 million per year, 6 %. PORT II will also pay DMH market-based leasing fees that will depend on the type of tenant, shared fees equal to 100 % of any application fees collected and 50 % of any insufficient funds fees, late fees and certain other fees collected. DMH may also perform additional services at rates that would be payable to unrelated parties.
18
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
8. INVESTMENT IN UNCONSOLIDATED ENTITIES
Number of Properties as of June 30, 2022 | Investment Balance at | |||||||||||||||||||||||||||||||
| Joint Venture | Location | Ownership % | June 30, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||
| 110 William Joint Venture | New York, New York | $ | $ | |||||||||||||||||||||||||||||
| 353 Sacramento Joint Venture | San Francisco, California | |||||||||||||||||||||||||||||||
| Pacific Oak Opportunity Zone Fund I | Various | |||||||||||||||||||||||||||||||
| PORT II OP LP | Various | |||||||||||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||||||||
PORT II
PORT II is a Maryland corporation formed and sponsored by the Advisor to acquire, own and operate single family homes as rental properties as well as to acquire and own other interests, including mortgages on or securities related to single family homes. As of June 30, 2022, the Company owns 600 shares of common stock of PORT II. The Company exercises significant influence over the operations, financial policies and decision making with respect to PORT II, but does not control it. The Company made its investment through PORT OP, of which the Company owns 94.2 % of PORT II OP as of June 30, 2022. During the six months ended June 30, 2022, the Company contributed an additional $22.5 million to PORT II OP. As of June 30, 2022, the Company has concluded that PORT II OP qualifies as a VIE because there is insufficient equity at risk to finance the entity’s activities and the entity is structured with non-substantive voting rights. The Company concluded it is not the primary beneficiary of this VIE since it does not have the power to direct the activities that most significantly impact the entity’s economic performance and will account for its investment under the equity method of accounting. During the three and six months ended June 30, 2022, the Company recognized losses of $0.4 million and $0.5 million, respectively, related to this investment. During both of the three and six months ended June 30, 2021, the Company recognized losses of $12,000
On July 1, 2022, the Company determined that it became the primary beneficiary of PORT II as a result of events that occurred, including a tender offer arrangement to return equity to unrelated investors. As such, in July 2022, the Company consolidated PORT II into the Company’s consolidated financial statements. See Note 13 for further details.
9. SUPPLEMENTAL CASH FLOW AND SIGNIFICANT NONCASH TRANSACTION DISCLOSURES
Six Months Ended June 30, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Supplemental Disclosure of Cash Flow Information: | ||||||||||||||
Interest paid, net of capitalized interest of $ | $ | $ | ||||||||||||
| Supplemental Disclosure of Significant Noncash Transactions: | ||||||||||||||
| Accrued improvements to real estate | ||||||||||||||
| Redeemable common stock payable | ||||||||||||||
| Distributions paid to common stockholders through common stock issuances | ||||||||||||||
19
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
10. REPORTING SEGMENTS
The Company recognizes three The selected financial information for reporting segments for the three and six months ended June 30, 2022 and 2021 are as follows (in thousands):
Three Months Ended June 30, 2022 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | |||||||||||||||||||
| Total expenses | ( | ( | ( | ( | |||||||||||||||||||
| Total other (loss) income | ( | ( | ( | ||||||||||||||||||||
| Net (loss) income | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
Six Months Ended June 30, 2022 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | |||||||||||||||||||
| Total expenses | ( | ( | ( | ( | |||||||||||||||||||
| Total other (loss) income | ( | ( | ( | ||||||||||||||||||||
| Net (loss) income | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||
Three Months Ended June 30, 2021 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | |||||||||||||||||||
| Total expenses | ( | ( | ( | ( | |||||||||||||||||||
| Total other income | |||||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | $ | ||||||||||||||||||
Six Months Ended June 30, 2021 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total revenues | $ | $ | $ | $ | |||||||||||||||||||
| Total expenses | ( | ( | $ | ( | ( | ||||||||||||||||||
| Total other income | $ | ||||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | ( | $ | |||||||||||||||||
20
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
| June 30, 2022 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Goodwill | |||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||
| Strategic Opportunistic Properties | Single-Family Homes | Hotels | Total | ||||||||||||||||||||
| Total assets | $ | $ | $ | $ | |||||||||||||||||||
| Goodwill | |||||||||||||||||||||||
11. PORT MEZZANINE EQUITY
The following is a reconciliation of PORT’s noncontrolling cumulative convertible redeemable preferred stock for the six months ended June 30, 2022 and 2021 (dollars in thousands):
| Series A Preferred Stock | Series B Preferred Stock | ||||||||||||||||||||||
| Shares | Amounts | Shares | Amounts | ||||||||||||||||||||
Balance, December 31, 2021 | $ | $ | |||||||||||||||||||||
| Dividends Available Upon Redemption | — | — | |||||||||||||||||||||
| Dividends Paid | — | ( | — | ( | |||||||||||||||||||
Balance, June 30, 2022 | $ | $ | |||||||||||||||||||||
| Series A Preferred Stock | Series B Preferred Stock | ||||||||||||||||||||||
| Shares | Amounts | Shares | Amounts | ||||||||||||||||||||
| Balance, December 31, 2020 | $ | $ | |||||||||||||||||||||
| Dividends Available Upon Redemption | — | — | |||||||||||||||||||||
| Dividends Paid | — | ( | — | ||||||||||||||||||||
Balance, June 30, 2021 | $ | $ | |||||||||||||||||||||
On July 1, 2020, the Company acquired, through its subsidiaries, Battery Point Trust Inc. (“Battery Point”). Battery Point is a real estate investment trust that owned, at the time of acquisition, 559 single-family rental homes throughout the midwestern and southeastern United States. All of these assets are held by the Company through its subsidiary, PORT OP.
21
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
The Company acquired Battery Point by acquiring all the 1,000,000 outstanding shares of Battery Point common stock from BPT Holdings. The Advisor is the Company’s external advisor and is owned and controlled by Keith D. Hall, the Company’s Chief Executive Officer and a director, and Peter M. McMillan, the Company’s President and Chairman of the Board. In exchange, BPT Holdings received 510,816 Special Common Units in PORT OP, approximately 4.5 % of the outstanding common equity units, as of July 1, 2020. The value of the interests exchanged was estimated by the participants at approximately $3.0 million. The common equity units issued to BPT Holdings are redeemable after one year at the request of BPT Holdings for all or a portion of the common equity units at a redemption price equal to and in the form of cash based on the unit price of PORT OP. The following table summarizes the redeemable non-controlling interest activity related to the PORT OP equity units held by BPT Holdings for the six months ended June 30, 2022 and 2021 (in thousands):
December 31, 2021 | $ | |||||||
| Net loss attributable to redeemable noncontrolling interest | ( | |||||||
Adjustment to value of redeemable noncontrolling interest (1) | ||||||||
| June 30, 2022 | $ | |||||||
| December 31, 2020 | $ | |||||||
| Net loss attributable to redeemable noncontrolling interest | ( | |||||||
| June 30, 2021 | $ | |||||||
_____________________
(1) On June 24, 2022, the Company’s board of directors approved the redemption of the 510,816 PORT OP Special Common Units held by BPT Holdings for a price of $13.09 per unit. As the Company determined that the redemption of the units was certain of occurrence, as of June 30, 2022, the Company reclassified the redeemable noncontrolling interests to due to affiliates on the consolidated balance sheets and recorded at its fair value. The Company redeemed the noncontrolling interest in PORT OP in July 2022. See Note 7 for further details.
12. COMMITMENTS AND CONTINGENCIES
The Company owns two hotels, Springmaid Beach Resort and Q&C Hotel. The operation for both hotels are externally managed by third-party hotel operators, in which the Company have contractual obligations under the management agreements.
Management Agreement
Springmaid Beach Resort
The consolidated joint venture entity through which the Company leases the operations for Springmaid Beach Resort has entered into a management agreement with Doubletree Management LLC, an independent third-party hotel operator (the “Operator”) pursuant to which the Operator will manage and operate the Springmaid Beach Resort. The hotel was branded a DoubleTree by Hilton in September 2016 (the “Brand Commencement Date”).
22
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
The management agreement expires on December 31 of the 20th full year following the Brand Commencement Date. Upon mutual agreement, the parties may extend the term of the agreement for two successive periods of five years each. If an event of default occurs and continues beyond any applicable notice and cure periods set forth in the management agreement, the non-defaulting party generally has, among other remedies, the option of terminating the management agreement upon written notice to the defaulting party with no termination fee payable to the Operator. In addition, the Company has the right to terminate the management agreement without the payment of a termination fee if the Operator fails to achieve certain criteria relating to the performance of the hotel for any two consecutive years following the Brand Commencement Date. Under certain circumstances following a casualty or condemnation event, either party may terminate the management agreement provided the Operator receives a termination fee an amount equal to two years of the base fee. The Company is permitted to terminate the management agreement upon a sale, lease or other transfer of the Springmaid Beach Resort at any time so long as the buyer is approved for, and enters into the Operator’s franchise agreement for the balance of the agreement’s term. Finally, the Company is restricted in its ability to assign the management agreement upon a sale, lease or other transfer of the Springmaid Beach Resort unless the transferee is approved by the Operator to assume the management agreement.
Pursuant to the management agreement the Operator receives the following fees:
•a base fee, which is a percentage of total operating revenue that starts at 2.5 % and increases to 2.75 % in the second year following the Brand Commencement Date and further increases in the third year following the Brand Commencement Date and thereafter to 3.0 %;
•a campground area management fee, which is 2 % of any campground revenue;
•an incentive fee, which is 15 % of operating cash flow (after deduction for capital renewals reserve and the joint venture owner’s priority, which is 12 % of the joint venture owner’s total investment);
•an additional services fee in the amount reasonably determined by the Operator from time to time; and
•a brand services fee in the amount of 4 % of total rooms revenue, and an other brand services fee in an amount determined by the Operator from time to time.
The management agreement contains specific standards for the operation and maintenance of the hotel, which allows the Operator to maintain uniformity in the system created by the Operator’s franchise. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with the management agreement will require the Company to make significant expenditures for capital improvements.
During the three and six months ended June 30, 2022, the Company incurred $0.3 million and $0.4 million, respectively, of fees related to the management agreement, which are included in hotel expenses on the accompanying consolidated statements of operations. During the three and six months ended June 30, 2021, the Company incurred $0.2 million and $0.3 million, respectively, of fees related to the management agreement, which are included in hotel expenses on the accompanying consolidated statements of operations.
23
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
Q&C Hotel
A wholly owned subsidiary of the joint venture through which the Company leases the operations of the Q&C Hotel (“Q&C Hotel Operations”) has entered into a management agreement with Encore Hospitality, LLC (“Encore Hospitality”), an affiliate of the joint venture partner, pursuant to which Encore Hospitality will manage and operate the Q&C Hotel. The management agreement expires on December 17, 2035. Subject to certain conditions, Encore Hospitality may extend the term of the agreement for a period of five years . Pursuant to the management agreement Encore Hospitality will receive a base fee, which is 4.0 % of gross revenue (as defined in the management agreement). During the three and six months ended June 30, 2022, the Company incurred $0.1 million and $0.2 million, respectively, of fees related to the management agreement, which are included in hotel expenses on the accompanying consolidated statements of operations. During the three and six months ended June 30, 2021, the Company incurred $0.05 million and $0.1 million, respectively, of fees related to the management agreement, which are included in hotel expenses on the accompanying consolidated statements of operations.
Q&C Hotel Operations has also entered into a franchise agreement with Marriott International (“Marriott”) pursuant to which Marriott has granted Q&C Hotel Operations a limited, non-exclusive license to establish and operate the Q&C Hotel using certain of Marriott’s proprietary marks and systems. The hotel was branded as a Marriott Autograph Collection hotel on May 25, 2016. The franchise agreement will expire on May 25, 2041. Pursuant to the franchise agreement, Q&C Hotel Operations pays Marriott a monthly franchise fee equal to a percent of gross room sales on a sliding scale that is initially 2 % and increases to 5 % on May 25, 2019 and a monthly marketing fund contribution fee equal to 1.5 % of the Q&C Hotel’s gross room sales. In addition, the franchise agreement requires the maintenance of a reserve account to fund all renovations at the hotel based on a percentage of gross revenues which starts at 2 % of gross revenues and increases to 5 % of gross revenues on May 25, 2019. Q&C Hotel Operations is also responsible for the payment of certain other fees, charges and costs as set forth in the agreement. During the three and six months ended June 30, 2022, the Company incurred $0.3 million and $0.5 million, respectively, of fees related to the Marriott franchise agreement, which are included in hotel expenses on the accompanying consolidated statement of operations. During the three and six months ended June 30, 2021, the Company incurred $0.1 million and $0.2 million, respectively, of fees related to the Marriott franchise agreement, which are included in hotel expenses on the accompanying consolidated statement of operations.
In addition, in connection with the execution of the franchise agreement, SOR US Properties II, a wholly owned subsidiary of the Company, is providing an unconditional guarantee that all Q&C Hotel Operations’ obligations under the franchise agreement will be punctually paid and performed. Finally, certain transfers of the Q&C Hotel or an ownership interest therein are subject to a notice and consent requirement, and the franchise agreement further provides Marriott with a right of first refusal with respect to a sale of the hotel to a competitor of Marriott.
Lease Obligations
| Right-of-use asset (included in real estate held for investment, net) | $ | |||||||
| Lease obligation (included in other liabilities) | ||||||||
| Remaining lease term | ||||||||
| Discount rate | % | |||||||
| The components of lease expense were as follows: | ||||||||
Interest on lease obligation for the three months ended June 30, 2022 | ||||||||
Interest on lease obligation for the six months ended June 30, 2022 | ||||||||
24
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
As of June 30, 2022, the Company had a leasehold interest expiring in 2114. Future minimum lease payments owed by the Company under the finance lease as of June 30, 2022 are as follows (in thousands):
| July 1, 2021 through December 31, 2021 | $ | |||||||
| 2022 | ||||||||
| 2023 | ||||||||
| 2024 | ||||||||
| 2025 | ||||||||
| Thereafter | ||||||||
| Total expected minimum lease obligations | ||||||||
Less: Amount representing interest (1) | ( | |||||||
Present value of net minimum lease payments (2) | $ | |||||||
_____________________
(1) Interest includes the amount necessary to reduce the total expected minimum lease obligations to present value calculated at the Company’s incremental borrowing rate at acquisition.
(2) The present value of net minimum lease payments are presented in other liabilities in the accompanying consolidated balance sheets.
Economic Dependency
The Company is dependent on the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, origination, acquisition and disposition of investments; management of the daily operations of the Company’s investment portfolio; and other general and administrative responsibilities. In the event that the Advisor is unable to provide these services, the Company will be required to obtain such services from other sources.
Environmental
As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Although there can be no assurance, the Company is not aware of any environmental liability that could have a material adverse effect on its financial condition or results of operations as of June 30, 2022. However, changes in applicable environmental laws and regulations, the uses and conditions of properties in the vicinity of the Company’s properties, the activities of its tenants and other environmental conditions of which the Company is unaware with respect to the properties could result in future environmental liabilities.
Legal Matters
25
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 1. Financial Statements (continued)
PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
June 30, 2022
(unaudited)
13. SUBSEQUENT EVENTS
The Company evaluates subsequent events up until the date the consolidated financial statements are issued.
PORT II Reconsideration
On July 1, 2022, the Company, through PORT OP, made a tender offer to purchase 76,735 shares of PORT II common stock held by unrelated parties for a price of $14.66 per share. As a result, the Company determined that it became the primary beneficiary of PORT II, which resulted in the consolidation of PORT II into the Company’s consolidated financial statements. On July 29, 2022, the Company consummated the transactions with the unrelated parties and owned 100 % of PORT II. The Company is in the process of assessing the fair value of the assets and liabilities to be consolidated. The Company’s preliminary fair values are: $135.1 million of 588 single-family homes and $82.6 million to the notes payable. There are no liquidity arrangements or agreements to fund capital or purchase assets that could require the Company to provide financial support to PORT II. The Company and the aforementioned unrelated parties did not guarantee any debt in connection with the transaction. Please refer to Notes 8 and 9 for additional details.
Springmaid Beach Resort Purchase and Sale Contract
On July 14, 2022, the Company’s board of directors committed to a plan to sell the Springmaid Beach Resort to an unrelated party. On July 15, 2022, the Company, through an indirect wholly owned subsidiary, entered into an amended purchase and sale agreement, to sell the Springmaid Beach Resort for $91.0 million, before closing costs and credits. The mortgage loan secured by the property had an outstanding principal balance of $53.1 million as of July 15, 2022. The due diligence period has expired and the buyer’s deposit of $2.0 million is no longer refundable. The Company expects to close the transaction in the third quarter of 2022, but can give no assurances that the sale will be completed.
26
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the accompanying financial statements of Pacific Oak Strategic Opportunity REIT, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to Pacific Oak Strategic Opportunity REIT, Inc., a Maryland corporation, and, as required by context, Pacific Oak 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 Pacific Oak 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 our advisor to conduct our operations and eventually dispose of our investments.
•Because our advisor, Pacific Oak Capital Advisors, LLC, was recently formed, it could face challenges with employee hiring and retention, information technology, vendor relationships, and funding; if Pacific Oak Capital Advisors faces challenges in performing its obligations to us, it could negatively impact our ability to achieve our investment objectives.
•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 Pacific Oak-affiliated entities. As a result, they face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and other Pacific Oak-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.
27
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
•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, 2021, as filed with the Securities and Exchange Commission (the “SEC”).
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. Pacific Oak Capital Advisors, LLC (“Pacific Oak Capital Advisors”) is our advisor and as our advisor, Pacific Oak Capital Advisors manages our day-to-day operations and our portfolio of investments. Pacific Oak 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. Pacific Oak 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 estate-related 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.
As of June 30, 2022, we consolidated eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, two apartment properties, two hotel properties, one residential home portfolio consisting of 1,815 single-family homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned four investments in unconsolidated entities 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. To the extent there are increases in the cost of financing due to higher interest rates, this may cause difficulty in refinancing debt obligations 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.
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.
28
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
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 June 30, 2022, we had sold 6,851,969 shares of common stock under the dividend reinvestment plan for gross offering proceeds of $76.5 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 collectability of rent and operating recoveries from our tenants and how well we manage our expenditures. As of June 30, 2022, our office properties were collectively 72% occupied, our residential home portfolio was 92% occupied and our apartment properties were 92% occupied.
Our investments in hotel properties generate cash flow in the form of room, food, beverage and convention services, campground and other revenues, which are reduced by hotel expenses, capital expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our hotel properties are primarily dependent upon the occupancy levels of our hotels, the average daily rates and how well we manage our expenditures. The following table provides summary information regarding our hotel properties for the six months ended June 30, 2022 and 2021:
Percentage Occupied for the Six Months Ended June 30, | Average Daily Rate for the Six Months Ended June 30, | Average Revenue per Available Room for the Six Months Ended June 30, | ||||||||||||||||||||||||||||||||||||||||||
| Property | Number of Rooms | 2022 | 2021 | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||||||||||||||||
Springmaid Beach Resort | 453 | 57.0% | 49.1% | $199.36 | $191.62 | $113.63 | $94.12 | |||||||||||||||||||||||||||||||||||||
Q&C Hotel | 196 | 66.3% | 33.0% | $207.64 | $118.99 | $137.63 | $39.30 | |||||||||||||||||||||||||||||||||||||
Investments in real estate equity securities generate cash flow in the form of dividend income, which is reduced by asset management fees. As of June 30, 2022, we had three investments in real estate equity securities outstanding with a total carrying value of $84.5 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 has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expenses for the four fiscal quarters ended June 30, 2022 did not exceed the charter-imposed limitation.
For the six months ended June 30, 2022, our cash needs for capital expenditures, redemptions of common stock and debt servicing were met with proceeds from dispositions of real estate, proceeds from debt financing 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 June 30, 2022, we had outstanding debt obligations in the aggregate principal amount of $1.1 billion, with a weighted-average remaining term of 1.1 years. As of June 30, 2022, we had a total of $502.6 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.
29
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 June 30, 2022, we consolidated eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, two apartment properties, two hotel properties, one residential home portfolio consisting of 1,815 single-family homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned four investments in unconsolidated entities and three investments in real estate equity securities. During the six months ended June 30, 2022, net cash provided by operating activities was $12.3 million. We expect that our cash flows from operating activities will increase in future periods as a result of 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 $14.0 million for the six months ended June 30, 2022 and primarily consisted of the following:
•Contributions to an unconsolidated entity of $22.5 million;
•Earnest money received of $17.0 million related to the pending sale of Park Highlands land;
•Improvements to real estate of $10.1 million;
•Proceeds from advances due from affiliates of $6.4 million; and
•Funding of $4.0 million for development obligations related to Park Highlands land.
Cash Flows from Financing Activities
Net cash provided by financing activities was $66.6 million for the six months ended June 30, 2022 and primarily consisted of the following:
•$80.7 million of net cash provided by proceeds from notes payable of $145.1 million and partially offset by principal payments on notes payable of $61.6 million and payments of deferred financing costs of $2.8 million;
•$11.0 million of cash distributions paid; and
•$2.3 million of cash used for redemptions of common stock.
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 June 30, 2022, our borrowings and other liabilities were both approximately 67% of the cost (before depreciation and other noncash reserves) and the book value (before depreciation) of our tangible assets.
On February 16, 2020, Pacific Oak Strategic Opportunity BVI issued 254.1 million Israeli new Shekels (approximately $74.1 million as of February 16, 2020) of the Series B Debentures to Israeli investors pursuant to a public offering registered with the Israel Securities Authority. The Series B Debentures will bear interest at the rate of 3.93% per year. The Series B Debentures have principal installment payments equal to 33.33% of the face amount of the Series B Debentures on January 31st of each year from 2024 to 2026. On November 1, 2021, Pacific Oak Strategic Opportunity BVI issued additional Series B Debentures in the amount of 536.4 million Israeli new Shekels par value through a public offering. The public offering Series B Debentures were issued at a 2.6% discount resulting in a total consideration of 522.4 million Israeli new Shekels ($166.8 million as of November 1, 2021). On November 8, 2021, Pacific Oak Strategic Opportunity BVI also issued Series B Debentures in the amount of 53.6 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 3.1% discount resulting in a total consideration of 52.0 million Israeli new Shekels ($16.7 million as of November 8, 2021).
30
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Additionally, on May 2, 2022, Pacific Oak Strategic Opportunity BVI also issued Series B Debentures in the amount of 320.4 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 4.0% discount resulting in a total consideration of 307.6 million Israeli new Shekels ($95.3 million as of May 2, 2022). All additional Series B Debentures have an equal level of security, pari passu, amongst themselves and between them and the initial Series B Debentures, which were initially issued, without any right of precedence or preference between any of them.
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).
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 June 30, 2022 (in thousands):
| Payments Due During the Years Ending December 31, | ||||||||||||||||||||||||||||||||
| Contractual Obligations | Total | Remainder of 2022 | 2023-2024 | 2025-2026 | Thereafter | |||||||||||||||||||||||||||
Outstanding debt obligations (1) | $ | 1,060,304 | $ | 306,320 | $ | 356,162 | $ | 397,822 | $ | — | ||||||||||||||||||||||
Interest payments on outstanding debt obligations (2) | 68,906 | 17,141 | 42,043 | 9,722 | — | |||||||||||||||||||||||||||
| Finance lease obligation | 53,856 | 180 | 720 | 789 | 52,167 | |||||||||||||||||||||||||||
_____________________
(1) Amounts include principal payments only.
(2) Projected interest payments are based on the outstanding principal amounts, maturity dates, foreign currency rates and interest rates in effect at June 30, 2022.
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Results of Operations
Overview
As of June 30, 2022, we consolidated eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, two apartment properties, two hotel properties, one residential home portfolio consisting of 1,815 single-family homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned four investments in unconsolidated entities and three investments in real estate equity securities. As of June 30, 2021, we consolidated nine office properties (of which one office property was held for sale), one office portfolio consisting of four office buildings and 14 acres of undeveloped land, two apartment properties, two hotel properties, one residential home portfolio consisting of 1,807 single-family homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned four investments in unconsolidated entities and three investments in real estate equity securities. Our results of operations for the three and six months ended June 30, 2022 may not be indicative of those in future periods due to acquisition and disposition activities. Additionally, the occupancy in our properties, excluding our residential home portfolio, has not been stabilized. As of June 30, 2022, our office properties were collectively 72% occupied, our residential home portfolio was 92% occupied and our apartment properties were 92% occupied. However, due to the amount of near-term lease expirations, we do not put significant emphasis on quarterly changes in occupancy (positive or negative) in the short run. Our underwriting and valuations are generally more sensitive to “terminal values” that may be realized upon the disposition of the assets in the portfolio and less sensitive to ongoing cash flows generated by the portfolio in the years leading up to an eventual sale. There are no guarantees that occupancies of our assets will increase, or that we will recognize a gain on the sale of our assets. In general, we expect that our income and expenses related to our portfolio will increase in future periods as a result of leasing additional space and acquiring additional assets but decrease due to disposition activity.
Comparison of the three months ended June 30, 2022 versus the three months ended June 30, 2021
The following table provides summary information about our results of operations for the three months ended June 30, 2022 and 2021 (dollar amounts in thousands):
Three Months Ended June 30, | Increase (Decrease) | Percentage Change | $ Change Due to Acquisitions/ Dispositions (1) | $ Change Due to Investments Held Throughout Both Periods (2) | ||||||||||||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||||||||||||||||
| Rental income | $ | 28,979 | $ | 32,670 | $ | (3,691) | (11) | % | $ | (4,191) | $ | 500 | ||||||||||||||||||||||||||
| Hotel revenues | 12,854 | 9,849 | 3,005 | 31 | % | — | 3,005 | |||||||||||||||||||||||||||||||
| Other operating income | 887 | 1,218 | (331) | (27) | % | (278) | (53) | |||||||||||||||||||||||||||||||
| Dividend income from real estate equity securities | 819 | 751 | 68 | 9 | % | — | 68 | |||||||||||||||||||||||||||||||
| Operating, maintenance, and management | 10,342 | 10,342 | — | — | % | (1,088) | 1,088 | |||||||||||||||||||||||||||||||
| Real estate taxes and insurance | 5,079 | 5,399 | (320) | (6) | % | (536) | 216 | |||||||||||||||||||||||||||||||
| Hotel expenses | 6,998 | 5,841 | 1,157 | 20 | % | — | 1,157 | |||||||||||||||||||||||||||||||
| Asset management fees to affiliate | 3,189 | 3,527 | (338) | (10) | % | (303) | (35) | |||||||||||||||||||||||||||||||
| General and administrative expenses | 2,983 | 2,888 | 95 | 3 | % | n/a | n/a | |||||||||||||||||||||||||||||||
| Foreign currency transaction (gain) loss, net | (23,833) | 5,507 | (29,340) | (533) | % | n/a | n/a | |||||||||||||||||||||||||||||||
| Depreciation and amortization | 14,098 | 15,072 | (974) | (6) | % | (762) | (212) | |||||||||||||||||||||||||||||||
| Interest expense | 10,780 | 10,680 | 100 | 1 | % | (590) | 690 | |||||||||||||||||||||||||||||||
| Equity in (loss) income of unconsolidated entities | (2,075) | 256 | (2,331) | (911) | % | — | (2,331) | |||||||||||||||||||||||||||||||
| Other interest income | 48 | 48 | — | — | % | n/a | n/a | |||||||||||||||||||||||||||||||
| (Loss) gain on real estate equity securities | (20,070) | 4,800 | (24,870) | (518) | % | — | (24,870) | |||||||||||||||||||||||||||||||
| Change in subordinated performance fee due upon termination to affiliate | — | 261 | (261) | (100) | % | n/a | n/a | |||||||||||||||||||||||||||||||
| (Loss) gain on sale of real estate | (175) | 31,148 | (31,323) | (101) | % | (31,323) | — | |||||||||||||||||||||||||||||||
| Gain on extinguishment of debt | — | 13 | (13) | 100 | % | n/a | n/a | |||||||||||||||||||||||||||||||
_____________________
(1) Represents the dollar amount increase (decrease) for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 related to real estate and real estate-related investments acquired or disposed on or after July 1, 2021.
(2) Represents the dollar amount increase (decrease) for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 with respect to real estate and real estate-related investments owned by us during the entirety of both periods presented.
32
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Rental income decreased from $32.7 million for the three months ended June 30, 2021 to $29.0 million for the three months ended June 30, 2022, primarily as a result of the disposition of City Tower on July 27, 2021, which accounted for $3.6 million of rental income during the three months ended June 30, 2021. There were no significant changes to the occupancy rate and annualized base rent per square foot of our office properties held throughout both periods. We expect rental income to increase in future periods as a result of leasing additional space and to the extent we acquire additional properties, but to decrease to the extent we dispose of properties.
Hotel revenues increased from $9.8 million for the three months ended June 30, 2021 to $12.9 million for the three months ended June 30, 2022, primarily as a result of the increase in occupancy from 71.1% to 74.5% and a slight increase in average daily rate for the Springmaid Beach Resort as well as the increase in occupancy from 41.7% to 70.3% and average daily rate from $127.54 to $221.37 for the Q&C Hotel.
Property operating costs were consistent for both of three months ended June 30, 2022 and 2021 with $0.8 million decrease due to the disposition of City Tower which was partially offset by an increase in legal fees related to various properties, and an increase in rental marketing efforts. Real estate taxes and insurance slightly decreased between the two periods. We expect property operating costs and real estate taxes and insurance to increase in future periods to the extent we acquire additional properties, increase occupancy of our real estate assets and due to general inflation, but to decrease to the extent we dispose of properties.
Hotel expenses increased from $5.8 million for the three months ended June 30, 2021 to $7.0 million for the three months ended June 30, 2022, primarily as a result of the increase in occupancy from 71.1% to 74.5% for the Springmaid Beach Resort as well as the increase in occupancy from 41.7% to 70.3% for the Q&C Hotel. We expect hotel expenses to vary in future periods based on occupancy rates.
Asset management fees slightly decreased from $3.5 million for the three months ended June 30, 2021 to $3.2 million for the three months ended June 30, 2022, primarily as a result of the disposition of City Tower, which attributed to $0.3 million of asset management fees during the three months ended June 30, 2021. We expect asset management fees to increase in future periods to the extent we acquire additional properties, but to decrease to the extent we dispose of properties.
We recognized a $23.8 million foreign currency transaction gain, net for the three months ended June 30, 2022 and $5.5 million of foreign currency transaction loss, net, for the three months ended June 30, 2021, related to the debentures in Israel. These debentures are denominated in Israeli new Shekels and we expect to recognize foreign transaction gains and losses based on changes in foreign currency exchange rates.
Depreciation and amortization decreased from $15.1 million for the three months ended June 30, 2021 to $14.1 million for the three months ended June 30, 2022, primarily as a result of the disposition of City Tower, which attributed to $0.7 million of depreciation and amortization expense. We expect depreciation and amortization to increase in future periods to the extent we acquire additional properties, but to decrease as a result of amortization of tenant origination costs related to lease expirations and disposition of properties.
Equity in income of unconsolidated entities decreased from gain of $0.3 million for the three months ended June 30, 2021 to a loss of $2.1 million for the three months ended June 30, 2022, primarily as a result of the allowance for credit losses for the 353 Sacramento joint venture for the three months ended June 30, 2022.
Gain on real estate equity securities decreased from $4.8 million for the three months ended June 30, 2021 to a $20.1 million loss for the three months ended June 30, 2022. We expect gains and losses on real estate equity securities to fluctuate in future periods as a result of changes in share prices of our investments in real estate equity securities.
During the three months ended June 30, 2021, we sold approximately 193 developable acres of Park Highlands undeveloped land that resulted in a gain on sale of $31.1 million. There were no dispositions during the three months ended June 30, 2022.
33
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Comparison of the six months ended June 30, 2022 versus the six months ended June 30, 2021
The following table provides summary information about our results of operations for the six months ended June 30, 2022 and 2021 (dollar amounts in thousands):
Six Months Ended June 30, | Increase (Decrease) | Percentage Change | $ Change Due to Acquisitions/ Dispositions (1) | $ Change Due to Investments Held Throughout Both Periods (2) | ||||||||||||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||||||||||||||||
| Rental income | $ | 58,360 | $ | 65,378 | $ | (7,018) | (11) | % | $ | (8,286) | $ | 1,268 | ||||||||||||||||||||||||||
| Hotel revenues | 18,771 | 12,424 | 6,347 | 51 | % | — | 6,347 | |||||||||||||||||||||||||||||||
| Other operating income | 1,728 | 2,124 | (396) | (19) | % | (525) | 129 | |||||||||||||||||||||||||||||||
| Dividend income from real estate equity securities | 3,206 | 3,504 | (298) | (9) | % | — | (298) | |||||||||||||||||||||||||||||||
| Operating, maintenance, and management | 20,218 | 20,775 | (557) | (3) | % | (2,120) | 1,563 | |||||||||||||||||||||||||||||||
| Real estate taxes and insurance | 10,103 | 10,688 | (585) | (5) | % | (1,047) | 462 | |||||||||||||||||||||||||||||||
| Hotel expenses | 12,109 | 9,233 | 2,876 | 31 | % | — | 2,876 | |||||||||||||||||||||||||||||||
| Asset management fees to affiliate | 6,315 | 7,380 | (1,065) | (14) | % | (598) | (467) | |||||||||||||||||||||||||||||||
| General and administrative expenses | 5,977 | 4,759 | 1,218 | 26 | % | n/a | n/a | |||||||||||||||||||||||||||||||
| Foreign currency transaction (gain) loss, net | (31,098) | (2,839) | (28,259) | 995 | % | n/a | n/a | |||||||||||||||||||||||||||||||
| Depreciation and amortization | 26,662 | 32,073 | (5,411) | (17) | % | (2,624) | (2,787) | |||||||||||||||||||||||||||||||
| Interest expense | 20,343 | 20,618 | (275) | (1) | % | (1,038) | 763 | |||||||||||||||||||||||||||||||
| Equity in (loss) income of unconsolidated entities | (2,754) | 425 | (3,179) | (748) | % | — | (3,179) | |||||||||||||||||||||||||||||||
| Other interest income | 94 | 94 | — | — | % | n/a | n/a | |||||||||||||||||||||||||||||||
| (Loss) gain on real estate equity securities | (27,591) | 15,553 | (43,144) | (277) | % | 225 | (43,369) | |||||||||||||||||||||||||||||||
| Change in subordinated performance fee due upon termination to affiliate | — | (200) | 200 | (100) | % | n/a | n/a | |||||||||||||||||||||||||||||||
| Gain on sale of real estate | 3,348 | 31,170 | (27,822) | (89) | % | (27,822) | — | |||||||||||||||||||||||||||||||
| Gain on extinguishment of debt | 2,367 | 13 | 2,354 | 100 | % | n/a | n/a | |||||||||||||||||||||||||||||||
_____________________
(1) Represents the dollar amount increase (decrease) for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 related to real estate and real estate-related investments acquired or disposed on or after July 1, 2021.
(2) Represents the dollar amount increase (decrease) for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 with respect to real estate and real estate-related investments owned by us during the entirety of both periods presented.
Rental income decreased from $65.4 million for the six months ended June 30, 2021 to $58.4 million for the six months ended June 30, 2022, primarily as a result of the disposition of City Tower, which accounted for $7.2 million of rental income during the six months ended June 30, 2021. There were no significant changes to the occupancy rate and annualized base rent per square foot of our office properties held throughout both periods. We expect rental income to increase in future periods as a result of leasing additional space and to the extent we acquire additional properties, but to decrease to the extent we dispose of properties.
Hotel revenues increased from $12.4 million for the six months ended June 30, 2021 to $18.8 million for the six months ended June 30, 2022, primarily as a result of the increase in occupancy from 49.1%% to 57.0% and average daily rate from $94.12 to $113.63 for the Springmaid Beach Resort as well as the increase in occupancy from 33.0% to 66.3% and average daily rate from $39.30 to $137.63 for the Q&C Hotel.
Property operating costs slightly decreased from $20.8 million for the six months ended June 30, 2022 to $20.2 million for the six months ended June 30, 2021, primarily due to a $1.6 million decrease due to the disposition of City Tower and partially offset by an increase in legal fees related to various properties and an increase in rental marketing efforts. Real estate taxes and insurance slightly decreased between the two periods. We expect property operating costs and real estate taxes and insurance to increase in future periods to the extent we acquire additional properties, increase occupancy of our real estate assets and due to general inflation, but to decrease to the extent we dispose of properties.
Hotel expenses increased from $9.2 million for the six months ended June 30, 2021 to $12.1 million for the six months ended June 30, 2022, primarily as a result of the increase in occupancy from 49.1%% to 57.0% for the Springmaid Beach Resort as well as the increase in occupancy from 33.0% to 66.3% for the Q&C Hotel. We expect hotel expenses to vary in future periods based on occupancy rates.
34
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Asset management fees decreased from $7.4 million for the six months ended June 30, 2021 to $6.3 million for the six months ended June 30, 2022, primarily as a result of the disposition of City Tower, which attributed to $0.6 million of asset management fees during the six months ended June 30, 2021. We expect asset management fees to increase in future periods to the extent we acquire additional properties, but to decrease to the extent we dispose of properties.
General and administrative expenses increased from $4.8 million for the six months ended June 30, 2021 to $6.0 million for the six months ended June 30, 2022, primarily due to increased accounting and advisory expenses. We expect general and administrative expenses to fluctuate in future periods based on investment and disposition activity as well as costs incurred to evaluate strategic transactions.
We recognized a $2.8 million foreign currency transaction gain, net for the six months ended June 30, 2021 and $31.1 million foreign currency transaction gain, net, for the six months ended June 30, 2022, related to the debentures in Israel. These debentures are denominated in Israeli new Shekels and we expect to recognize foreign transaction gains and losses based on changes in foreign currency exchange rates.
Depreciation and amortization decreased from $32.1 million for the six months ended June 30, 2021 to $26.7 million for the six months ended June 30, 2022, primarily as a result of the disposition of City Tower, which attributed to $2.4 million of depreciation and amortization expense. We expect depreciation and amortization to increase in future periods as a result of the extent we acquire additional properties, but to decrease as a result of amortization of tenant origination costs related to lease expirations and disposition of properties.
Equity in income of unconsolidated entities decreased from income of $0.4 million for the six months ended June 30, 2021 to loss of $2.8 million for the six months ended June 30, 2022, primarily as a result of the allowance for credit losses for the 353 Sacramento joint venture for the six months ended June 30, 2022.
Gain on real estate equity securities decreased from $15.6 million for the six months ended June 30, 2021 to a $27.6 million loss for the six months ended June 30, 2022. We expect gains and losses on real estate equity securities to fluctuate in future periods as a result of changes in share prices of our investments in real estate equity securities.
During the six months ended June 30, 2021, we sold approximately 193 developable acres of Park Highlands undeveloped land that resulted in a gain on sale of $31.1 million. During the six months ended June 30, 2022, we sold two office buildings related to the Richardson Portfolio and recognized a gain on sale of $3.5 million.
Funds from Operations, Modified Funds from Operations and Adjusted Modified Funds from Operations
We believe that funds from operations (“FFO”) is a beneficial indicator of the performance of an equity REIT. We compute FFO in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. FFO represents net income, excluding gains and losses from sales of real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), impairment losses on real estate assets, depreciation and amortization of real estate assets, and adjustments for unconsolidated partnerships and joint ventures. In addition, we elected the option to exclude mark-to-market changes in value recognized on equity securities in the calculation of FFO. We believe FFO facilitates comparisons of operating performance between periods and among other REITs. However, our computation of FFO may not be comparable to other REITs that do not define FFO in accordance with the NAREIT definition or that interpret the current NAREIT definition differently than we do. Our management believes that historical cost accounting for real estate assets in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and provides a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
35
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Changes in accounting rules have resulted in a substantial increase in the number of non-operating and non-cash items included in the calculation of FFO. As a result, our management also uses modified funds from operations (“MFFO”) as an indicator of our ongoing performance as well as our dividend sustainability. MFFO excludes from FFO: acquisition fees and expenses (to the extent that such fees and expenses have been recorded as operating expenses); adjustments related to contingent purchase price obligations; amounts relating to straight-line rents and amortization of above- and below-market intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; amortization of closing costs relating to debt investments; impairments of real estate-related investments; mark-to-market adjustments included in net income; and gains or losses included in net income for the extinguishment or sale of debt or hedges. We compute MFFO in accordance with the definition of MFFO included in the practice guideline issued by the Institute for Portfolio Alternatives (“IPA”) in November 2010 as interpreted by management. Our computation of MFFO may not be comparable to other REITs that do not compute MFFO in accordance with the current IPA definition or that interpret the current IPA definition differently than we do.
In addition, our management uses an adjusted MFFO (“Adjusted MFFO”) as an indicator of our ongoing performance, as well as our dividend sustainability. Adjusted MFFO provides adjustments to reduce MFFO related to operating expenses that are capitalized with respect to certain of our investments in undeveloped land.
We believe that MFFO and Adjusted MFFO are helpful as measures of ongoing operating performance because they exclude costs that management considers more reflective of investing activities and other non-operating items included in FFO. Management believes that excluding acquisition costs, prior to our early adoption of ASU No. 2017-01 on January 1, 2017, from MFFO and Adjusted MFFO provides investors with supplemental performance information that is consistent with management’s analysis of the operating performance of the portfolio over time, including periods after our acquisition stage. MFFO and Adjusted MFFO also exclude non-cash items such as straight-line rental revenue. Additionally, we believe that MFFO and Adjusted MFFO provide investors with supplemental performance information that is consistent with the performance indicators and analysis used by management, in addition to net income and cash flows from operating activities as defined by GAAP, to evaluate the sustainability of our operating performance. MFFO provides comparability in evaluating the operating performance of our portfolio with other non-traded REITs which typically have limited lives with short and defined acquisition periods and targeted exit strategies. MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes.
FFO, MFFO and Adjusted MFFO are non-GAAP financial measures and do not represent net income as defined by GAAP. Net income as defined by GAAP is the most relevant measure in determining our operating performance because FFO, MFFO and Adjusted MFFO include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization and the other items described above. Accordingly, FFO, MFFO and Adjusted MFFO should not be considered as alternatives to net income as an indicator of our current and historical operating performance. In addition, FFO, MFFO and Adjusted MFFO do not represent cash flows from operating activities determined in accordance with GAAP and should not be considered an indication of our liquidity. We believe FFO, MFFO and Adjusted MFFO, in addition to net income and cash flows from operating activities as defined by GAAP, are meaningful supplemental performance measures.
Although MFFO includes other adjustments, the exclusion of straight-line rent, the amortization of above- and below-market leases, mark to market foreign currency transaction adjustments and extinguishment of debt are the most significant adjustments for the periods presented. We have excluded these items based on the following economic considerations:
•Adjustments for straight-line rent. These are adjustments to rental revenue as required by GAAP to recognize contractual lease payments on a straight-line basis over the life of the respective lease. We have excluded these adjustments in our calculation of MFFO to more appropriately reflect the current economic impact of our in-place leases, while also providing investors with a useful supplemental metric that addresses core operating performance by removing rent we expect to receive in a future period or rent that was received in a prior period;
•Amortization of above- and below-market leases. Similar to depreciation and amortization of real estate assets and lease related costs that are excluded from FFO, GAAP implicitly assumes that the value of intangible lease assets and liabilities diminishes predictably over time and requires that these charges be recognized currently in revenue. Since market lease rates in the aggregate have historically risen or fallen with local market conditions, management believes that by excluding these charges, MFFO provides useful supplemental information on the realized economics of the real estate;
36
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
•Mark-to-market foreign currency transaction adjustments. The U.S. Dollar is our functional currency. Transactions denominated in currency other than our functional currency are recorded upon initial recognition at the exchange rate on the date of the transaction. After initial recognition, monetary assets and liabilities denominated in foreign currency are remeasured at each reporting date into the foreign currency at the exchange rate on that date. In addition, we have entered into foreign currency collars and foreign currency options that results in a foreign currency transaction adjustment. These amounts can increase or reduce net income. We exclude them from MFFO to more appropriately present the ongoing operating performance of our real estate investments on a comparative basis; and
•Loss or gain on extinguishment of debt. A loss or gain on extinguishment of debt, which includes prepayment fees related to the extinguishment of debt, represents the difference between the carrying value of any consideration transferred to the lender in return for the extinguishment of a debt and the net carrying value of the debt at the time of settlement. We have excluded the loss or gain from extinguishment of debt in our calculation of MFFO because these losses or gains do not impact the current operating performance of our investments and do not provide an indication of future operating performance.
Adjusted MFFO includes adjustments to reduce MFFO related to real estate taxes, property insurance and financing costs which are capitalized with respect to certain of our investments in undeveloped land. We have included adjustments for the costs incurred necessary to bring these investments to their intended use, as these costs are recurring operating costs that are capitalized in accordance with GAAP and not reflected in our net (loss) income, FFO and MFFO. In addition, adjusted MFFO includes an adjustment for casualty loss. We believe excluding this item appropriately presents the ongoing operating performance of our real estate investments on a comparative basis.
Our calculation of FFO, which we believe is consistent with the calculation of FFO as defined by NAREIT, is presented in the following table, along with our calculations of MFFO and Adjusted MFFO, for the three and six months ended June 30, 2022 and 2021 (in thousands). No conclusions or comparisons should be made from the presentation of these periods.
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Net (loss) income attributable to common stockholders | $ | (9,019) | $ | 21,675 | $ | (13,775) | $ | 28,187 | ||||||||||||||||||
| Depreciation of real estate assets | 8,368 | 8,871 | 16,662 | 18,120 | ||||||||||||||||||||||
| Amortization of lease-related costs | 5,730 | 6,201 | 10,000 | 13,953 | ||||||||||||||||||||||
Loss (gain) on sale of real estate (1) | 175 | (31,148) | (3,348) | (31,170) | ||||||||||||||||||||||
| Loss (gain) on real estate equity securities | 20,070 | (4,800) | 27,591 | (15,553) | ||||||||||||||||||||||
Adjustments for noncontrolling interests - consolidated entities (2) | (287) | (384) | (584) | (838) | ||||||||||||||||||||||
Adjustments for investments in unconsolidated entities (3) | 2,021 | (364) | 2,933 | 772 | ||||||||||||||||||||||
| FFO attributable to common stockholders | 27,058 | 51 | 39,479 | 13,471 | ||||||||||||||||||||||
| Straight-line rent and amortization of above- and below-market leases | (621) | (422) | (1,935) | (1,833) | ||||||||||||||||||||||
| Amortization of premium/discount on bond and notes payable, net | 1,477 | 963 | 2,255 | 1,445 | ||||||||||||||||||||||
| Gain on extinguishment of debt | — | (13) | (2,367) | (13) | ||||||||||||||||||||||
| Unrealized (gain) loss on interest rate caps | (215) | 3 | (270) | 16 | ||||||||||||||||||||||
| Mark-to-market foreign currency transaction (gain) loss, net | (23,833) | 5,507 | (31,098) | (2,839) | ||||||||||||||||||||||
Adjustments for noncontrolling interests - consolidated entities (2) | (42) | (47) | (82) | (98) | ||||||||||||||||||||||
Adjustments for investments in unconsolidated entities (3) | 3,166 | 1,782 | 2,901 | 1,647 | ||||||||||||||||||||||
| MFFO attributable to common stockholders | 6,990 | 7,824 | 8,883 | 11,796 | ||||||||||||||||||||||
Other capitalized operating expenses (4) | (638) | (651) | (1,211) | (1,329) | ||||||||||||||||||||||
| Change in subordinated performance fee due upon termination to affiliate | — | (261) | — | 200 | ||||||||||||||||||||||
| Adjusted MFFO attributable to common stockholders | $ | 6,352 | $ | 6,912 | $ | 7,672 | $ | 10,667 | ||||||||||||||||||
_____________________
(1) Reflects an adjustment to eliminate gain on sale of real estate.
(2) Reflects adjustments to eliminate the noncontrolling interest holders’ share of the adjustments to convert our net (loss) income attributable to common stockholders to FFO, MFFO and Adjusted MFFO.
(3) Reflects adjustments to add back our noncontrolling interest share of the adjustments to convert our net (loss) income attributable to common stockholders to FFO, MFFO and Adjusted MFFO for our equity investments in unconsolidated joint ventures.
37
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
(4) Reflects real estate taxes, property insurance and financing costs that are capitalized with respect to certain of our investments in undeveloped land and unconsolidated entity. During the periods in which we are incurring costs necessary to bring these investments to their intended use, certain normal recurring operating costs are capitalized in accordance with GAAP and not reflected in our net (loss) income, FFO and MFFO.
FFO, MFFO and Adjusted MFFO may also be used to fund all or a portion of certain capitalizable items that are excluded from FFO, MFFO and Adjusted MFFO, such as tenant improvements, building improvements and deferred leasing costs. We expect FFO, MFFO and Adjusted MFFO to improve in future periods to the extent that we continue to lease up vacant space and acquire additional assets. We expect FFO, MFFO and Adjusted MFFO to decrease as a result of dispositions.
Distributions
There were no distributions declared for the six months ended June 30, 2022. Our net loss attributable to common stockholders for the six months ended June 30, 2022 was $13.8 million and our cash flows provided by operations were $12.3 million. Our cumulative distributions paid and net income attributable to common stockholders from inception through June 30, 2022 were $464.5 million. We have funded our cumulative distributions paid, which includes net cash distributions and distributions reinvested by stockholders, with prior period cash flow from operating activities in excess of distributions paid and with cash from gains realized from the disposition of properties. To the extent that we pay distributions from sources other than our cash flow from operations or gains from asset sales, we will have fewer funds available for investment in real estate-related loans, opportunistic real estate, real estate-related debt securities, real estate equity securities and other real estate-related investments, the overall return to our stockholders may be reduced and subsequent investors may experience dilution.
Critical Accounting Policies
Our consolidated interim financial statements have been prepared in accordance with GAAP and in conjunction with the rules and regulations of the SEC. The preparation of our financial statements requires significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments will affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. A discussion of the accounting policies that management considers critical in that they involve significant management judgments, assumptions and estimates is included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC. There have been no significant changes to our policies during 2022.
Subsequent Events
We evaluate subsequent events up until the date the consolidated financial statements are issued.
PORT II Reconsideration
On July 1, 2022, we, through our subsidiary, made a tender offer to purchase 76,735 shares of PORT II common stock held by unrelated parties for a price of $14.66 per share. As a result, we determined that we became the primary beneficiary of PORT II, which resulted in the consolidation of PORT II into our consolidated financial statements. On July 29, 2022, we consummated the transactions with the unrelated parties and owned 100% of PORT II. We are in the process of assessing the fair value of the assets and liabilities to be consolidated. Our preliminary fair values are: $135.1 million of 588 single-family homes and $82.6 million to the notes payable. There are no liquidity arrangements or agreements to fund capital or purchase assets that could require us to provide financial support to PORT II. We and the aforementioned unrelated parties did not guarantee any debt in connection with the transaction. Please refer to Notes 8 and 9 for additional details.
In July 2022, we, through our subsidiary, made a tender offer to purchase 76,735 of PORT II common stock held by unrelated parties for a price of $14.66 per share. As a result, we determined that we became the primary beneficiary of PORT II, which resulted in the consolidation of PORT II into our consolidated financial statements. We are in the process of assessing the fair value of the assets and liabilities to be consolidated. Our preliminary fair values are: $135.1 million of 588 single-family homes and $82.6 million to the notes payable. There are no liquidity arrangements or agreements to fund capital or purchase assets that could require us to provide financial support to PORT II. We and the aforementioned unrelated parties did not guarantee any debt in connection with the transaction.
38
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
Springmaid Beach Resort Purchase and Sale Contract
On July 14, 2022, our board of directors committed to a plan to sell the Springmaid Beach Resort to an unrelated party. On July 15, 2022, we, through an indirect wholly owned subsidiary, entered into an amended purchase and sale agreement, to sell the Springmaid Beach Resort for $91.0 million, before closing costs and credits. The mortgage loan secured by the property had an outstanding principal balance of $53.1 million as of July 15, 2022. The due diligence period has expired and the buyer’s deposit of $2.0 million is no longer refundable. We expect to close the transaction in the third quarter of 2022, but can give no assurances that the sale will be completed.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Generally, the composition of our investments is such that declining interest rates will increase our net income, while rising interest rates will decrease our net income. Recently, interest rates have remained at relatively low levels on a historical basis and the Federal Reserve maintained the federal funds target range at 0.0% to 0.25% for much of 2021. However, in March 2022, the Federal Reserve approved a 0.25% rate increase and additionally approved 0.75% rate increases in both June and July 2022. The Federal Reserve has indicated that it foresees further increases in interest rates throughout the year and into 2023 and 2024, considering the current inflationary environment.
We are exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity, fund distributions and to fund the refinancing of our real estate investment portfolio and operations. We may also be exposed to the effects of changes in interest rates as a result of the acquisition and origination of mortgage, mezzanine, bridge and other loans and the acquisition of real estate securities. We are also exposed to the effects of foreign currency changes in Israel with respect to the 3.93% Series B Debentures issued to investors in Israel. Our profitability and the value of our investment portfolio may be adversely affected during any period as a result of interest rate changes and foreign currency changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs. We may manage interest rate risk by maintaining a ratio of fixed rate, long-term debt such that floating rate exposure is kept at an acceptable level. In addition, we may utilize a variety of financial instruments, including interest rate caps, floors, and swap agreements, in order to limit the effects of changes in interest rates on our operations. In order to limit the effects of changes in foreign currency on our operations, we may utilize a variety of foreign currency hedging strategies such as cross currency swaps, forward contracts, puts or calls. When we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and the risk that the losses may exceed the amount we invested in the instruments. Additionally, certain of these strategies may cause us to fund a margin account periodically to offset changes in foreign currency rates which may also reduce the funds available for payments to holders of our common stock.
As of June 30, 2022, we held 195.4 million Israeli new Shekels and 24.6 million Israeli new Shekels in cash and restricted cash, respectively. In addition, as of June 30, 2022, we had bonds outstanding and the related interest payable in the amounts of 1.2 billion Israeli new Shekels and 15.9 million Israeli new Shekels, respectively. Foreign currency exchange rate risk is the possibility that our financial results could be better or worse than planned because of changes in foreign currency exchange rates. Based solely on the remeasurement for the six months ended June 30, 2022, if foreign currency exchange rates were to increase or decrease by 10%, our net income would increase or decrease by approximately $25.0 million and $30.5 million, respectively, for the same period.
We borrow funds at a combination of fixed and variable rates. Interest rate fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt unless such instruments mature or are otherwise terminated. However, interest rate changes will affect the fair value of our fixed rate instruments. As of June 30, 2022, the fair value of our Pacific Oak SOR BVI Series B Debentures was $314.5 million and the outstanding principal balance was $333.4 million. As of June 30, 2022, excluding the Pacific Oak SOR BVI Series B Debentures, the fair value of our fixed rate debt was $134.3 million and the outstanding principal balance of our fixed rate debt was $139.4 million. The fair value estimate of our Pacific Oak SOR BVI Series B Debentures were calculated using the quoted bond price as of June 30, 2022 on the Tel Aviv Stock Exchange of 95.99 Israeli new Shekels. The fair value estimate of our fixed rate debt was calculated using a discounted cash flow analysis utilizing rates we would expect to pay for debt of a similar type and remaining maturity if the loans were originated as of June 30, 2022. As we expect to hold our fixed rate instruments to maturity and the amounts due under such instruments would be limited to the outstanding principal balance and any accrued and unpaid interest, we do not expect that fluctuations in interest rates, and the resulting changes in fair value of our fixed rate instruments, would have a significant impact on our operations.
39
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 3. Quantitative and Qualitative Disclosures about Market Risk (continued)
Conversely, movements in interest rates on variable rate debt would change our future earnings and cash flows, but would not significantly affect the fair value of those instruments. However, changes in required risk premiums would result in changes in the fair value of floating rate instruments. As of June 30, 2022, we had entered into three separate interest rate caps with an aggregate notional of $181.0 million which effectively limits our exposure to increases in one-month LIBOR and SOFR above certain thresholds. Based on interest rates as of June 30, 2022, if interest rates were 100 basis points higher or lower during the 12 months ending June 30, 2022, interest expense on our variable rate debt would increase or decrease by $5.3 million and $4.4 million, respectively.
The weighted-average interest rates of our fixed rate debt and variable rate debt as of June 30, 2022 were 4.1% and 3.9%, respectively. The interest rate and weighted-average interest rate represent the actual interest rate in effect as of June 30, 2022 (consisting of the contractual interest rate and the effect of contractual floor rates, if applicable), using interest rate indices as of June 30, 2022 where applicable.
We are exposed to financial market risk with respect to our real estate equity securities. Financial market risk is the risk that we will incur economic losses due to adverse changes in our real estate equity security prices. Our exposure to changes in real estate equity security prices is a result of our investment in these types of securities. Market prices are subject to fluctuation and, therefore, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market prices of a real estate equity security may result from any number of factors, including perceived changes in the underlying fundamental characteristics of the issuer, the relative price of alternative investments, interest rates, default rates and general market conditions. In addition, amounts realized in the sale of a particular security may be affected by the relative quantity of the real estate equity security being sold. We do not currently engage in derivative or other hedging transactions to manage our real estate equity security price risk. As of June 30, 2022, we owned real estate equity securities with a book value of $84.5 million. Based solely on the prices of real estate equity securities as of June 30, 2022, if prices were to increase or decrease by 10%, our net income would increase or decrease by approximately $8.5 million.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2021 and Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended March 31, 2022, each as filed with the SEC.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
a)During the period covered by this Form 10-Q, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended.
b)Not applicable.
c)We have adopted a share redemption program that may enable stockholders to sell their shares to us in limited circumstances.
Pursuant to the share redemption program there are several limitations on our ability to redeem shares:
•Unless the shares are being redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined under the share redemption program), we may not redeem shares until the stockholder has held the shares for one year.
•During any calendar year, we may redeem no more than 5% of the weighted-average number of shares outstanding during the prior calendar year.
•We have no obligation to redeem shares if the redemption would violate the restrictions on distributions under Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency.
•During any calendar year, we may redeem only the number of shares that we can purchase with the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year; provided, however, that this limit may be increased or decreased by us upon ten business days’ notice to our stockholders. To the extent that we redeem less than the number of shares that we can purchase in any calendar year with the amount of net proceeds from the sale of shares under our dividend reinvestment plan during the prior calendar year plus any additional funds approved by us, such excess capacity to redeem shares during any calendar year shall be added to our capacity to otherwise redeem shares during the subsequent calendar year. Furthermore, during any calendar year, once we have received requests for redemptions, whether in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence”, or otherwise, that if honored, and when combined with all prior redemptions made during the calendar year, would result in the amount of remaining funds available for the redemption of additional shares in such calendar year being $1.0 million or less, the last $1.0 million of available funds shall be reserved exclusively for shares being redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence.” To the extent that, in the last month of any calendar year, the amount of redemption requests in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” is less than the amount of available funds reserved for such redemptions in accordance with the previous sentence, any excess funds may be used to redeem shares not in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence” during such month.
41
PART II. OTHER INFORMATION (CONTINUED)
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds (Continued)
•We may not redeem more than $3.0 million of shares in a given quarter (excluding shares redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence”). To the extent that, in a given fiscal quarter, we redeem less than the sum of (a) $3.0 million of shares (excluding shares redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence”) and (b) any excess capacity carried over to such fiscal quarter from a prior fiscal quarter as described below, any remaining excess capacity to redeem shares in such fiscal quarter will be added to our capacity to otherwise redeem shares (excluding shares redeemed in connection with a stockholder’s death, “qualifying disability” or “determination of incompetence”) during succeeding fiscal quarter. We may increase or decrease this limit upon ten business days’ notice to stockholders.
We may amend, suspend or terminate the program upon ten business days’ notice to our stockholders. We may provide notice to our stockholders by including such information in a Current Report on Form 8-K or in our annual or quarterly reports, all publicly filed with the SEC, or by a separate mailing to our stockholders.
•Separate from the funding described in the first bullet above, on March 10, 2022 and July 22, 2022, our board of directors made available a total of $3.0 million and $2.5 million, respectively for redemptions in connection with a stockholder's death, “qualifying disability”, or “determination of incompetence” and that will carry forward until depleted. As of June 30, 2022, $1.4 million remained available.
During the six months ended June 30, 2022, we fulfilled redemption requests eligible for redemption under our share redemption program and received in good order and funded redemptions under our share redemption program with the net proceeds from our dividend reinvestment plan and cash on hand. We redeemed shares pursuant to our share redemption program as follows:
| Month | Total Number of Shares Redeemed | Average Price Paid Per Share (1) | Approximate Dollar Value of Shares Available That May Yet Be Redeemed Under the Program | |||||||||||||||||
January 2022 | — | $ | — | (2) | ||||||||||||||||
February 2022 | 42,430 | $ | 9.51 | (2) | ||||||||||||||||
March 2022 | 22,735 | $ | 9.51 | (2) | ||||||||||||||||
April 2022 | 75,875 | $ | 9.51 | (2) | ||||||||||||||||
May 2022 | 62,376 | $ | 9.51 | (2) | ||||||||||||||||
June 2022 | 38,920 | $ | 9.51 | (2) | ||||||||||||||||
| Total | 242,336 | |||||||||||||||||||
_____________________
(1) On January 26, 2022, our board of directors approved an estimated value per share of our common stock of $9.51. The change in the redemption price became effective for the January 2022 redemption date and is effective until the estimated value per share is updated. We expect to update our estimated value per share no later than December 2022.
(2) We limit the dollar value of shares that may be redeemed under the program as described above. During the six months ended June 2022, we redeemed $2.3 million of common stock under the program, which represented all redemption requests received in good order and eligible for redemption through the June 2022 redemption date, except for the $133.7 million of shares in connection with redemption requests not made upon a stockholder’s death, “qualifying disability” or “determination of incompetence,” which redemption requests will be fulfilled subject to the limitations described above. Based on the Twelfth SRP, we had $1.4 million available for redemptions in the remainder of 2022 as of June 2022, all of which are in connection with a stockholders’ death, “qualifying disability” or “determination of incompetence,” subject to the limitations described above.
Item 3. Defaults upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
None.
42
PART II. OTHER INFORMATION (CONTINUED)
Item 6. Exhibits
| Ex. | Description | |||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 3.4 | ||||||||
| 4.1 | ||||||||
| 4.2 | ||||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 32.2 | ||||||||
| 99.1 | ||||||||
| 99.2 | ||||||||
| 101.INS | Inline XBRL Instance Document | |||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema | |||||||
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase | |||||||
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase | |||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase | |||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase | |||||||
| 104 | Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101). | |||||||
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC. | |||||||||||
| Date: | August 12, 2022 | By: | /S/ KEITH D. HALL | ||||||||
| Keith D. Hall | |||||||||||
| Chief Executive Officer and Director | |||||||||||
| (principal executive officer) | |||||||||||
| Date: | August 12, 2022 | By: | /S/ MICHAEL A. BENDER | ||||||||
| Michael A. Bender | |||||||||||
| Chief Financial Officer | |||||||||||
| (principal financial officer) | |||||||||||
44
Exhibit 31.1
Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Keith D. Hall, certify that:
1.I have reviewed this quarterly report on Form 10-Q of Pacific Oak Strategic Opportunity REIT, Inc.;
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
| Date: | August 12, 2022 | By: | /s/ Keith D. Hall | ||||||||
| Keith D. Hall | |||||||||||
| Chief Executive Officer and Director | |||||||||||
| (principal executive officer) | |||||||||||
Exhibit 31.2
Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Michael A. Bender, certify that:
1.I have reviewed this quarterly report on Form 10-Q of Pacific Oak Strategic Opportunity REIT, Inc.;
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
| Date: | August 12, 2022 | By: | /s/ Michael A. Bender | ||||||||
| Michael A. Bender | |||||||||||
| Chief Financial Officer | |||||||||||
| (principal financial officer) | |||||||||||
Exhibit 32.1
Certification pursuant to 18 U.S.C. Section 1350,
as Adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report on Form 10-Q of Pacific Oak Strategic Opportunity REIT, Inc. (the “Registrant”) for the quarter ended June 30, 2022, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Keith D. Hall, Chief Executive Officer and Director of the Registrant, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge and belief:
1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| Date: | August 12, 2022 | By: | /s/ Keith D. Hall | ||||||||
| Keith D. Hall | |||||||||||
| Chief Executive Officer and Director | |||||||||||
| (principal executive officer) | |||||||||||
Exhibit 32.2
Certification pursuant to 18 U.S.C. Section 1350,
as Adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
In connection with the Quarterly Report on Form 10-Q of Pacific Oak Strategic Opportunity REIT, Inc. (the “Registrant”) for the quarter ended June 30, 2022, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Michael A. Bender, the Chief Financial Officer of the Registrant, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge and belief:
1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
| Date: | August 12, 2022 | By: | /s/ Michael A. Bender | ||||||||
| Michael A. Bender | |||||||||||
| Chief Financial Officer | |||||||||||
| (principal financial officer) | |||||||||||
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