UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________
FORM 10-Q
____________
☒ Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2020
☐ Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 000-53912
__________
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC.
(Exact name of registrant as specified in its charter)
Maryland | 26-3455189 | ||||
(State of Organization) | (I.R.S. Employer Identification Number) | ||||
2909 Hillcroft | |||||
Suite 420 | |||||
Houston | |||||
Texas | 77057 | ||||
(Address of principal executive offices) | (Zip Code) |
_______________
(713) 467-2222
(Registrant’s telephone number, including area code)
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☒ Smaller reporting company ☒ Emerging Growth Company ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
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. ☒
As of June 1, 2020, there were 18,417,687 shares of the Registrant’s common stock issued and outstanding, 19,000 of which were held by an affiliate of the Registrant.
Hartman Short Term Income Properties XX, Inc. and Subsidiaries
Table of Contents
PART I FINANCIAL INFORMATION | |||||||||||
Item 1. | |||||||||||
Item 2. | |||||||||||
Item 3. | |||||||||||
Item 4. | |||||||||||
PART II OTHER INFORMATION | |||||||||||
Item 1. | |||||||||||
Item 1A. | |||||||||||
Item 2. | |||||||||||
Item 3. | |||||||||||
Item 4. | |||||||||||
Item 5. | |||||||||||
Item 6. | |||||||||||
SIGNATURES |
EXPLANATORY NOTE:
Reliance on Securities and Exchange Commission Order
Hartman Short Term Income Properties XX, Inc. and Subsidiaries (the “Company”) is filing its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020 (the “Report”) pursuant to the Securities and Exchange Commission (the “SEC”) Order dated March 4, 2020 (Release No. 34-88318) under Section 36 of the Exchange Act Granting Exemptions from Specified Provisions of the Exchange Act and Certain Rules Thereunder, as superseded by SEC Order Modifying Exemptions from the Reporting and Proxy Delivery Requirements for Public Companies dated March 25, 2020 (Release No. 34-88465) (together, the “Order”) to delay the filing of the Report due to circumstances related to the coronavirus pandemic (“COVID-19”). On May 14, 2020, the Company filed a Current Report on Form 8-K stating that it is relying on the Order to delay the filing of the Report by up to 45 days. As result of the global outbreak of the COVID-19 virus and out of an abundance of caution, members of the Company’s advisor, property manager and certain other employees, including financial reporting staff, began working remotely on or about March 17, 2020. The Company has been following the recommendations of local government and health authorities to minimize exposure risk for its employees, including the temporary closures of some of its offices and having employees work remotely. The Company’s operations and business have experienced disruption due to the unprecedented conditions surrounding the COVID-19 pandemic that has spread throughout the United States and the world. The Company’s business was abruptly and dramatically impacted by the COVID-19 pandemic as the Company’s commercial real estate properties, headquarters, property management operations and other services offices located in Texas counties, which were under stay-at-home orders resulting in staffing and work-from-home challenges which caused significant disruptions in communications and delayed completion of the audit. These disruptions to the process of preparing the Company’s financial statements as a result of the COVID-19 virus, are causing the Company’s Form 10-Q for the quarterly period ended March 31, 2020 which was due on May 15, 2020 to be delayed. Consequently, the Company was unable to timely file the Report without the extension provided for by the Order.
1
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES | ||||||||||||||||||||
CONSOLIDATED BALANCE SHEETS | ||||||||||||||||||||
(in thousands, except share data) | ||||||||||||||||||||
March 31, 2020 | December 31, 2019 | |||||||||||||||||||
(Unaudited) | ||||||||||||||||||||
ASSETS | ||||||||||||||||||||
Real estate assets, at cost | $ | 597,501 | $ | 594,569 | ||||||||||||||||
Accumulated depreciation and amortization | (124,634) | (117,652) | ||||||||||||||||||
Real estate assets, net | 472,867 | 476,917 | ||||||||||||||||||
Cash and cash equivalents | 35 | 1,033 | ||||||||||||||||||
Restricted cash | 18,400 | 26,078 | ||||||||||||||||||
Accrued rent and accounts receivable, net | 14,232 | 12,576 | ||||||||||||||||||
Notes receivable - related party | 16,538 | 17,288 | ||||||||||||||||||
Deferred leasing commission costs, net | 11,448 | 10,790 | ||||||||||||||||||
Goodwill | 250 | 250 | ||||||||||||||||||
Prepaid expenses and other assets | 392 | 735 | ||||||||||||||||||
Due from related parties | 3,409 | 2,130 | ||||||||||||||||||
Investment in affiliate | 8,978 | 8,978 | ||||||||||||||||||
Total assets | $ | 546,549 | $ | 556,775 | ||||||||||||||||
LIABILITIES AND EQUITY | ||||||||||||||||||||
Liabilities: | ||||||||||||||||||||
Notes payable, net | $ | 306,682 | $ | 303,039 | ||||||||||||||||
Accounts payable and accrued expenses | 12,982 | 23,444 | ||||||||||||||||||
Tenants' security deposits | 5,356 | 5,286 | ||||||||||||||||||
Total liabilities | 325,020 | 331,769 | ||||||||||||||||||
Commitments and contingencies | ||||||||||||||||||||
Stockholders' equity: | ||||||||||||||||||||
Preferred stock, $0.001 par value, 200,000,000 convertible, non-voting shares authorized, 1000 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively | — | — | ||||||||||||||||||
Common stock, $0.001 par value, 750,000,000 authorized, 18,417,687 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively | 18 | 18 | ||||||||||||||||||
Additional paid-in capital | 174,019 | 174,019 | ||||||||||||||||||
Accumulated distributions and net loss | (111,461) | (109,406) | ||||||||||||||||||
Total stockholders' equity | 62,576 | 64,631 | ||||||||||||||||||
Noncontrolling interests in subsidiary | 158,953 | 160,375 | ||||||||||||||||||
Total equity | 221,529 | 225,006 | ||||||||||||||||||
Total liabilities and equity | $ | 546,549 | $ | 556,775 |
The accompanying notes are an integral part of these consolidated financial statements.
2
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES | ||||||||||||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF OPERATIONS | ||||||||||||||||||||||||||||||||
(Unaudited, in thousands, except per share data) | ||||||||||||||||||||||||||||||||
Three Months Ended March 31, | ||||||||||||||||||||||||||||||||
2020 | 2019 | |||||||||||||||||||||||||||||||
Revenues | ||||||||||||||||||||||||||||||||
Rental revenues | $ | 18,720 | $ | 18,229 | ||||||||||||||||||||||||||||
Tenant reimbursements and other revenues | 4,419 | 5,080 | ||||||||||||||||||||||||||||||
Total revenues | 23,139 | 23,309 | ||||||||||||||||||||||||||||||
Expenses (income) | ||||||||||||||||||||||||||||||||
Property operating expenses | 6,945 | 7,751 | ||||||||||||||||||||||||||||||
Asset management fees | 440 | 440 | ||||||||||||||||||||||||||||||
Real estate taxes and insurance | 3,170 | 3,157 | ||||||||||||||||||||||||||||||
Depreciation and amortization | 6,982 | 7,030 | ||||||||||||||||||||||||||||||
General and administrative | 1,177 | 1,177 | ||||||||||||||||||||||||||||||
Interest expense | 3,018 | 3,669 | ||||||||||||||||||||||||||||||
Interest and dividend income | (477) | (275) | ||||||||||||||||||||||||||||||
Total expenses, net | 21,255 | 22,949 | ||||||||||||||||||||||||||||||
Net Income | 1,884 | 360 | ||||||||||||||||||||||||||||||
Net Income attributable to noncontrolling interests | 716 | 25 | ||||||||||||||||||||||||||||||
Net Income attributable to common stockholders | $ | 1,168 | $ | 335 | ||||||||||||||||||||||||||||
Net Income attributable to common stockholders per share | $ | 0.06 | $ | 0.02 | ||||||||||||||||||||||||||||
Weighted average number of common shares outstanding, basic and diluted | 18,418 | 17,837 | ||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements. |
3
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF EQUITY | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Unaudited, in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Preferred Stock | Common Stock | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Additional Paid-In Capital | Accumulated Distributions and Net Loss | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
Balance, December 31, 2018 | 1 | $ | — | 17,712 | $ | 18 | $ | 165,084 | $ | (95,162) | $ | 69,940 | $ | 178,541 | $ | 248,481 | ||||||||||||||||||||||||||||||||||||||||
Issuance of common shares | — | — | 6 | — | 76 | — | 76 | — | 76 | |||||||||||||||||||||||||||||||||||||||||||||||
Purchase of non-controlling interest | — | — | 700 | — | 8,896 | 8,896 | (8,858) | 38 | ||||||||||||||||||||||||||||||||||||||||||||||||
Dividends and distributions (cash) | — | — | — | — | — | (3,141) | (3,141) | (2,147) | (5,288) | |||||||||||||||||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | 335 | 335 | 25 | 360 | |||||||||||||||||||||||||||||||||||||||||||||||
Balance, March 31, 2019 | 1 | — | 18,418 | 18 | 174,056 | (97,968) | 76,106 | 167,561 | 243,667 | |||||||||||||||||||||||||||||||||||||||||||||||
Preferred Stock | Common Stock | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Additional Paid-In Capital | Accumulated Distributions and Net Loss | Total Stockholders' Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||||||||||||||
Balance, December 31, 2019 | 1 | $ | — | 18,418 | $ | 18 | $ | 174,019 | $ | (109,406) | $ | 64,631 | $ | 160,375 | $ | 225,006 | ||||||||||||||||||||||||||||||||||||||||
Dividends and distributions (cash) | — | — | — | — | — | (3,223) | (3,223) | (2,138) | (5,361) | |||||||||||||||||||||||||||||||||||||||||||||||
Net income | — | — | — | — | — | 1,168 | 1,168 | 716 | 1,884 | |||||||||||||||||||||||||||||||||||||||||||||||
Balance, March 31, 2020 | 1 | $ | — | 18,418 | $ | 18 | $ | 174,019 | $ | (111,461) | $ | 62,576 | $ | 158,953 | $ | 221,529 |
The accompanying notes are an integral part of these consolidated financial statements.
4
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES | ||||||||||||||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||||||||||||||
(Unaudited, in thousands) | ||||||||||||||||||||
Three Months Ended March 31, | ||||||||||||||||||||
2020 | 2019 | |||||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||
Net income (Loss) | $ | 1,884 | $ | 360 | ||||||||||||||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||||||||||||||
Stock based compensation | 19 | 19 | ||||||||||||||||||
Depreciation and amortization | 6,982 | 7,030 | ||||||||||||||||||
Deferred loan and lease commission costs amortization | 609 | 885 | ||||||||||||||||||
Bad debt provision, net | 44 | 775 | ||||||||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||||||
Accrued rent and accounts receivable | (1,700) | (3,163) | ||||||||||||||||||
Deferred leasing commissions | (1,013) | (951) | ||||||||||||||||||
Prepaid expenses and other assets | 343 | (1,654) | ||||||||||||||||||
Accounts payable and accrued expenses | (10,481) | (10,643) | ||||||||||||||||||
Due to/from related parties | (1,279) | 1,221 | ||||||||||||||||||
Tenants' security deposits | 70 | 43 | ||||||||||||||||||
Net cash used in operating activities | (4,522) | (6,078) | ||||||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Acquisition deposits | — | 529 | ||||||||||||||||||
Repayment of note receivable from affiliate | 750 | — | ||||||||||||||||||
Investment in affiliate - related party | — | (10,546) | ||||||||||||||||||
Lender required reserves | — | 10,273 | ||||||||||||||||||
Additions to real estate | (2,932) | (2,753) | ||||||||||||||||||
Net cash used in investing activities | (2,182) | (2,497) | ||||||||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||
Distributions to common stockholders | (3,223) | (3,141) | ||||||||||||||||||
Distributions to non-controlling interest | (2,138) | (2,147) | ||||||||||||||||||
Borrowing from affiliate | 3,800 | — | ||||||||||||||||||
Repayments under term loan notes | (411) | (7,492) | ||||||||||||||||||
Borrowings under insurance premium finance note | — | 1,421 | ||||||||||||||||||
Payments of deferred loan costs | — | (71) | ||||||||||||||||||
Net cash used in financing activities | (1,972) | (11,430) | ||||||||||||||||||
Net change in cash and cash equivalents and restricted cash | (8,676) | (20,005) | ||||||||||||||||||
Cash and cash equivalents and restricted cash, beginning of period | 27,111 | 51,477 | ||||||||||||||||||
Cash and cash equivalents and restricted cash, end of period | $ | 18,435 | $ | 31,472 | ||||||||||||||||
Supplemental cash flow information: | ||||||||||||||||||||
Cash paid for interest | $ | 2,960 | $ | 3,322 | ||||||||||||||||
Supplemental disclosures of non-cash investing and financing activities: | ||||||||||||||||||||
Value of director's stock compensation shares issued | $ | — | $ | 76 | ||||||||||||||||
Value of common shares issued to acquire non-controlling interest | $ | — | $ | 8,896 | ||||||||||||||||
Acquisition of non-controlling interest | $ | — | $ | (8,858) | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements. |
5
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Organization and Business
Hartman Short Term Income Properties XX, Inc. (the “Company”), is a Maryland corporation formed on February 5, 2009. The Company elected to be treated as a real estate investment trust (“REIT”) beginning with the taxable year ending December 31, 2011. As used herein, the “Company,” “we,” “us,” or “our”refer to Hartman Short Term Income Properties XX, Inc. and its consolidated subsidiaries, including Hartman XX Limited Partnership, a Texas limited partnership (the “Operating Partnership”), except where context otherwise requires.
On July 19, 2018, we entered into a limited liability company agreement with our affiliates Hartman Income REIT, Inc. (“HIREIT”), Hartman Short Term Income Properties XIX, Inc. (“Hartman XIX”) and Hartman vREIT XXI, Inc. (“vREIT XXI”) to form Hartman SPE, LLC ("SPE LLC"), a special purpose entity.
On October 1, 2018, SPE LLC, as borrower, and Goldman Sachs Mortgage Company entered into a term loan agreement pursuant to which the lender made a term loan to SPE LLC in the principal amount of $259,000,000.
Contemporaneously therewith and together with our affiliates HIREIT, Hartman XIX and vREIT XXI, we contributed a total of 39 commercial real estate properties ("Properties") to SPE, LLC, subject to the then existing mortgage indebtedness encumbering the Properties, in exchange for membership interests in SPE LLC. Proceeds of the Loan were immediately used to extinguish the existing mortgage indebtedness encumbering the Properties.
Substantially all of our business is conducted through our wholly owned subsidiary, the Operating Partnership, and SPE LLC. Our wholly-owned subsidiary, Hartman XX REIT GP LLC, a Texas limited liability company, is the sole general partner of the Operating Partnership. We are the sole limited partner of the Operating Partnership. Our wholly-owned subsidiary, Hartman SPE Management, LLC ("SPE Management") is the manager of SPE LLC. Our single member interests in our limited liability company subsidiaries are owned by the Operating Partnership or its wholly owned subsidiaries.
Subject to certain restrictions and limitations, Hartman Advisors LLC ("Advisor") is responsible for managing our affairs on a day-to-day basis and for identifying and making acquisitions and investments on our behalf pursuant to an advisory agreement (the “Advisory Agreement”) by and among the Company and Advisor. Management of the Company’s properties and the Properties, is provided pursuant to property management agreements with Hartman Income REIT Management, Inc. (the "Property Manager"), a wholly-owned subsidiary of HIREIT.
As of March 31, 2020 and 2019, the Company owned 43 commercial properties comprising approximately 6.7 million square feet plus 3 pad sites, all located in Texas. As of March 31, 2020 and 2019, the Company owned 15 properties located in Richardson, Arlington and Dallas, Texas, 25 properties located in Houston, Texas and 3 properties located in San Antonio, Texas.
On July 21, 2017, the Company and Hartman Short Term Income Properties XIX, Inc. (“Hartman XIX”), entered into an agreement and plan of merger (the “XIX Merger Agreement”). On July 21, 2017, as subsequently modified on May 8 2018, the Company, the Operating Partnership, Hartman Income REIT, Inc. (“HIREIT”) and Hartman Income REIT Operating Partnership LP, the operating partnership of HIREIT, (“HIROP”), entered into an agreement and plan of merger (the “HIREIT Merger Agreement,” and together with the XIX Merger Agreement, the “Merger Agreements”).
On May 14, 2020, the Merger Agreements were approved by the respective company shareholders. The effective date of the Mergers is expected to be July 1, 2020.
6
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 2 — Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements included in this report are unaudited; however, amounts presented in the consolidated balance sheet as of December 31, 2019 are derived from our audited consolidated financial statements as of that date. The unaudited consolidated financial statements as of March 31, 2020 have been prepared by the Company in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission, including Form 10-Q and Regulation S-X, on a basis consistent with the annual audited consolidated financial statements. The consolidated financial statements presented herein reflect all adjustments (consisting of normal recurring accruals and adjustments), which are, in the opinion of management, necessary to fairly present the financial position of the Company as of March 31, 2020, and the results of consolidated operations for the three months ended March 31, 2020 and 2019, the consolidated statements of stockholders’ equity for the three months ended March 31, 2020 and 2019 and the consolidated statements of cash flows for the three months ended March 31, 2020 and 2019. The results of the three months ended March 31, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, 2020.
The consolidated financial statements herein are condensed and should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
These unaudited consolidated financial statements include the accounts of the Company, the Operating Partnership and its subsidiaries, and Hartman SPE, LLC. All significant intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents on the accompanying consolidated balance sheets include all cash and liquid investments with maturities of three months or less. Cash and cash equivalents as of March 31, 2020 and December 31, 2019 consisted of demand deposits at commercial banks. We maintain accounts which may from time to time exceed federally insured limits. We have not experienced any losses in these accounts and believe that the Company is not exposed to any significant credit risk and regularly monitors the financial stability of these financial institutions.
Restricted Cash
Restricted cash on the accompanying consolidated balance sheets consists of amounts escrowed for future real estate taxes, insurance, capital expenditures and debt service, as required by certain of our mortgage debt agreements.
Financial Instruments
The accompanying consolidated balance sheets include the following financial instruments: cash and cash equivalents, accrued rent and accounts receivable, accounts payable and accrued expenses and balances due to/due from related parties, as well as related party notes receivable. The Company considers the carrying value of these financial instruments to approximate their respective fair values due to their short-term nature. Disclosure about the fair value of financial instruments is based on relevant information available as of March 31, 2020 and December 31, 2019.
7
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Revenue Recognition
The Company’s leases are accounted for as operating leases. Certain leases provide for tenant occupancy during periods for which no rent is due and/or for increases or decreases in the minimum lease payments over the terms of the leases. Revenue is recognized on a straight-line basis over the terms of the individual leases. Revenue recognition under a lease begins when the tenant takes possession of or controls the physical use of the leased space. When the Company acquires a property, the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. The Company’s accrued rents are included in accrued rent and accounts receivable, net. The Company will defer the recognition of contingent rental income, such as percentage rents, until the specific target that triggers the contingent rental income is achieved. Additionally, cost recoveries from tenants are included in the tenant reimbursements and other revenues line item in the consolidated statements of operations in the period the related costs are incurred.
Allocation of Purchase Price of Acquired Assets
Upon the acquisition of real properties, it is the Company’s policy to allocate the purchase price of properties to acquired tangible assets, consisting of land and buildings, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of in-place leases and leasehold improvements and value of tenant relationships, based in each case on their fair values. The Company utilizes internal valuation methods to determine the fair values of the tangible assets of an acquired property (which includes land and buildings).
The fair values of above-market and below-market in-place lease values, including below-market renewal options for which renewal has been determined to be reasonably assured, are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (a) the contractual amounts to be paid pursuant to the in-place leases and (b) an estimate of fair market lease rates for the corresponding in-place leases and below-market renewal options, which is generally obtained from independent appraisals, measured over a period equal to the remaining non-cancelable term of the lease. The above-market and below-market lease and renewal option values are capitalized as intangible lease assets or liabilities and amortized as an adjustment to rental revenues over the remaining expected terms of the respective leases.
The fair values of in-place leases include direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals which are avoided by acquiring an in-place lease, and tenant relationships. Direct costs associated with obtaining a new tenant include commissions, tenant improvements, and other direct costs and are estimated based on independent appraisals and management’s consideration of current market costs to execute a similar lease. These direct costs are included in intangible lease assets and are amortized to expense over the remaining terms of the respective leases. The value of opportunity costs is calculated using the contractual amounts to be paid pursuant to the in-place leases over a market absorption period for a similar lease. Customer relationships are valued based on expected renewal of a lease or the likelihood of obtaining a particular tenant for other locations. These intangibles are included in real estate assets in the consolidated balance sheets and are being amortized to expense over the remaining term of the respective leases.
The determination of the fair values of the assets and liabilities acquired requires the use of significant assumptions with regard to the current market rental rates, rental growth rates, discount rates and other variables. The use of inappropriate estimates would result in an incorrect assessment of the purchase price allocations, which could impact the amount of the Company’s reported net loss.
Real Estate Joint Ventures and Partnerships
To determine the method of accounting for partially owned real estate joint ventures and partnerships, management determines whether an entity is a VIE and, if so, determines which party is the primary beneficiary by analyzing whether we have both the power to direct the entity’s significant economic activities and the obligation to absorb potentially significant losses or receive potentially significant benefits. Significant judgments and assumptions inherent in this analysis include the design of the entity structure, the nature of the entity’s operations, future cash flow projections, the entity’s financing and capital structure, and contractual relationships and terms. We consolidate a VIE when we have determined that we are the primary beneficiary.
Primary risks associated with our involvement with our VIEs include the potential funding of the entities’ debt obligations or making additional contributions to fund the entities’ operations or capital activities.
8
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Partially owned, non-variable interest real estate joint ventures and partnerships over which we have a controlling financial interest are consolidated in our consolidated financial statements. In determining if we have a controlling financial interest, we consider factors such as ownership interest, authority to make decisions, kick-out rights and substantive participating rights. Partially owned real estate joint ventures and partnerships where we do not have a controlling financial interest, but have the ability to exercise significant influence, are accounted for using the equity method.
Management continually analyzes and assesses reconsideration events, including changes in the factors mentioned above, to determine if the consolidation or equity method treatment remains appropriate.
Depreciation and amortization
Depreciation is computed using the straight-line method over the estimated useful lives of 5 to 39 years for buildings and improvements. Tenant improvements are depreciated using the straight-line method over the lesser of the life of the improvement or the remaining term of the lease. In-place leases are amortized using the straight-line method over the weighted average years’ remaining calculated on terms of all of the leases in-place when acquired.
Impairment
The Company reviews its real estate assets for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. The Company determines whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the estimated residual value of the property, with the carrying cost of the property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the property exceeds its fair value. Management has determined that there is 0 impairment indicated in the carrying value of our real estate assets as of March 31, 2020 and December 31, 2019.
Accrued Rent and Accounts Receivable
Accrued rent and accounts receivable include base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis. An allowance for the uncollectible portion of accrued rent and accounts receivable is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends.
Deferred Leasing Commission Costs
Leasing commissions are amortized using the straight-line method over the term of the related lease agreements.
Goodwill
GAAP requires the Company to test goodwill for impairment at least annually or more frequently whenever events or circumstances occur indicating goodwill might be impaired. The Company applies a one-step quantitative test to determine if the estimated fair value is less than the carrying amount. If the carrying amount exceeds the estimated fair value, the Company will record a goodwill impairment equal to such excess, not to exceed the total amount of goodwill. NaN goodwill impairment has been recognized in the accompanying consolidated financial statements.
Noncontrolling Interests
Noncontrolling interests is the portion of equity in a subsidiary not attributable to a parent. The ownership interests not held by the parent are considered noncontrolling interests. Accordingly, the Company has reported noncontrolling interests in equity on the consolidated balance sheets but separate from the Company's equity. On the consolidated statements of operations, subsidiaries are reported at the consolidated amount, including both the amount attributable to the Company and noncontrolling interests.
9
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Stock-Based Compensation
The Company follows Accounting Standards Codification ("ASC") 718 - Compensation - Stock Compensation, with regard to issuance of stock in payment of services. ASC 718 requires that compensation cost relating to share-based payment transactions be recognized in the consolidated financial statements. The compensation cost is measured based on the estimated grant date fair value, as of the grant date of the Company’s common stock, of the equity or liability instruments issued. Stock-based compensation expense are recorded over the vesting period and is included in general and administrative expense in the accompanying consolidated statements of operations.
Income Taxes
The Company has elected to be treated as a REIT under the Internal Revenue Code of 1986, as amended, beginning with its taxable year ended December 31, 2011. To qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company’s annual REIT taxable income to stockholders (which is computed without regard to the dividends-paid deduction or net capital gain and which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax on income that it distributes as dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost, unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially and adversely affect the Company’s net income and net cash available for distribution to stockholders. However, the Company believes that it is organized and will continue to operate in such a manner as to qualify for treatment as a REIT.
For the three months ended March 31, 2020 and 2019, the Company incurred net income of $1,884,000 and $360,000. The Company formed a taxable REIT subsidiary which may generate future taxable income which may be offset by the net loss carry forward. The Company considers that any deferred tax benefit and corresponding deferred tax asset which may be recorded in light of the net loss carry forward would be properly offset by an equal valuation allowance. Accordingly, no deferred tax benefit or deferred tax asset has been recorded in the consolidated financial statements.
The Company is required to recognize in its consolidated financial statements the financial effects of a tax position only if it is determined that it is more likely than not that the tax position will not be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Management has reviewed the Company’s tax positions and is of the opinion that material positions taken by the Company would more likely than not be sustained upon examination. Accordingly, the Company has not recognized a liability related to uncertain tax positions.
Income Per Share
The computations of basic and diluted income per common share are based upon the weighted average number of common shares outstanding and potentially dilutive securities. The Company’s potentially dilutive securities include preferred shares that are convertible into the Company’s common stock. As of March 31, 2020 and 2019, there were no shares issuable in connection with these potentially dilutive securities. These potentially dilutive securities were excluded from the computations of diluted net income per share for the three months ended March 31, 2020 and 2019 because no shares are issuable.
Concentration of Risk
The geographic concentration of the Company’s real estate assets makes it susceptible to adverse economic developments in the State of Texas. Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, relocation of businesses, increased competition or any other changes, could adversely affect the Company’s operating results and its ability to make distributions to stockholders.
Going Concern Evaluation
Pursuant to ASU 2014-15, “Presentation of Financial Statements – Going Concern,” management is required to evaluate the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are issued. The Hartman SPE, LLC loan agreement (the “SASB Loan”) has an initial maturity date of October 9, 2020. The SASB Loan provides for 3 successive one-year maturity date extensions. In order to exercise each successive one-year
10
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
extension options, the Hartman SPE, LLC must meet five conditions in order to extend the maturity date without any further qualification. One of the five conditions is that Hartman SPE must have a debt yield, as defined, of 12.5% or greater as of June 30, 2020.
As of December 31, 2019 and March 31, 2020, Hartman SPE has a debt yield of 13.29% and 12.95%, respectively. Management has concluded that there is substantial doubt about the Company's ability to continue as a going concern within one year of the issuance date of these consolidated financial statements due to the fact of the uncertainty regarding the loan maturity of the SPE Loan. Management believes that Hartman SPE will be able to extend the maturity date for one year which will mitigate the maturity date issue within one year of the issuance date of these consolidated financial statements.
Reclassification
Certain items in the comparative consolidated financial statements have been reclassified to conform to the presentation adopted in the current period. The Consolidated Statement of Cash Flows presented for the three months ended March 31, 2019 was adjusted to present cash and cash equivalents and restricted cash, as restricted cash was previously reported as part of prepaid expenses and other assets.
Recent Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The updated guidance requires measurement and recognition of expected credit losses for financial assets, including trade and other receivables, held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This is different from the current guidance as this will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets. Generally, the pronouncement requires a modified retrospective method of adoption. This guidance is effective for fiscal years and interim periods within those years beginning after January 2023, with early adoption permitted. The Company is currently evaluating the impact this guidance will have on the consolidated financial statements when adopted.
Note 3 — Real Estate
The Company’s real estate assets consisted of the following, in thousands:
March 31, 2020 | December 31, 2019 | ||||||||||
Land | $ | 145,050 | $ | 145,050 | |||||||
Buildings and improvements | 351,661 | 348,729 | |||||||||
In-place lease value intangible | 100,790 | 100,790 | |||||||||
597,501 | 594,569 | ||||||||||
Less: accumulated depreciation and amortization | (124,634) | (117,652) | |||||||||
Total real estate assets | $ | 472,867 | $ | 476,917 |
Depreciation expense for the three months ended March 31, 2020 and 2019 was $4,317,000 and $4,313,000, respectively. Amortization expense of in-place lease value intangible was $2,665,000 and $2,717,000 for the three months ended March 31, 2020 and 2019, respectively.
The Company identifies and records the value of acquired lease intangibles at the property acquisition date. Such intangibles include the value of acquired in-place leases and above and below-market leases. Acquired lease intangibles are amortized over the leases' remaining terms. With respect to all properties owned by the Company, we consider all of the in-place leases to be market rate leases.
The amount of total in-place lease intangible asset and the respective accumulated amortization are as follows, in thousands:
March 31, 2020 | December 31, 2019 | ||||||||||
In-place lease value intangible | $ | 100,790 | $ | 100,790 | |||||||
In-place leases – accumulated amortization | (71,549) | (68,884) | |||||||||
Acquired lease intangible assets, net | $ | 29,241 | $ | 31,906 |
11
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
As of March 31, 2020 and December 31, 2019, the Company owned 43 commercial properties comprising approximately 6.7 million square feet plus 3 pad sites, all located in Texas. As of March 31, 2020, the Company owned 15 properties located in Richardson, Arlington and Dallas, Texas, 25 properties located in Houston, Texas and 3 properties located in San Antonio, Texas.
Asset management fees incurred and paid to Advisor were $440,000 for the three months ended March 31, 2020 and 2019, respectively. Asset management and acquisition fees are captioned as such in the accompanying consolidated statements of operations.
Note 4 - Accrued Rent and Accounts Receivable, net
Accrued rent and accounts receivable, net, consisted of the following, in thousands:
March 31, 2020 | December 31, 2019 | ||||||||||
Tenant receivables | $ | 7,126 | $ | 5,929 | |||||||
Accrued rent | 9,747 | 9,244 | |||||||||
Allowance for uncollectible accounts | (2,641) | (2,597) | |||||||||
Accrued rents and accounts receivable, net | $ | 14,232 | $ | 12,576 |
As of March 31, 2020 and December 31, 2019, the Company had an allowance for uncollectible accounts of $2,641,000 and $2,597,000, respectively. For the three months ended March 31, 2020 and 2019, the Company recorded bad debt expense in the amount of $44,000 and $775,000, respectively, related to tenant receivables that we have specifically identified as potentially uncollectible based on our assessment of each tenant’s credit-worthiness. For the three months ended March 31, 2020 and 2019, the Company did 0t record any write-offs. Bad debt expense and any related recoveries are included in property operating expenses in the accompanying consolidated statements of operations.
Note 5 — Deferred Leasing Commission Costs, net
Costs which have been deferred consist of the following, in thousands:
March 31, 2020 | December 31, 2019 | ||||||||||
Deferred leasing commissions costs | $ | 18,633 | $ | 17,620 | |||||||
Less: accumulated amortization | (7,185) | (6,830) | |||||||||
Deferred leasing commission costs, net | $ | 11,448 | $ | 10,790 |
Note 6 — Future Minimum Rents
The Company leases the majority of its properties under noncancellable operating leases which provide for minimum base rentals. A summary of minimum future rentals to be received (exclusive of renewals, tenant reimbursements, and contingent rentals) under noncancellable operating leases in existence at March 31, 2020 is as follows, in thousands:
March 31, | Minimum Future Rents | ||||
2020 | $ | 70,520 | |||
2021 | 62,071 | ||||
2022 | 49,589 | ||||
2023 | 38,112 | ||||
2024 | 26,036 | ||||
Thereafter | 39,345 | ||||
Total | $ | 285,673 |
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HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 7 — Notes Payable
The Operating Partnership is a party to 4, cross-collateralized, term loan agreements with an insurance company. The term loans are secured by the Richardson Heights Property, the Cooper Street Property, the Bent Tree Green Property and the Mitchelldale Property. The loans require monthly payments of principal and interest due and payable on the first day of each month. Monthly payments are based on a 27-year loan amortization. Each of the loan agreements are subject to customary covenants, representations and warranties which must be maintained during the term of the loan agreements. Each of the loan agreements provides for a fixed interest rate of 4.61%. As of March 31, 2020, the Company was in compliance with all loan covenants, with respect to the loans above. Each of the loan agreements is secured by a deed of trust, assignment of licenses, permits and contracts, assignment and subordination of the management agreements and assignment of rents. The terms of the security instruments provide for the cross collateralization/cross default of the each of the loans. The outstanding balance of the 4 loans was $42,982,000 and $43,393,000 as of March 31, 2020 and December 31, 2019, respectively.
On October 1, 2018, the Company through Hartman SPE, LLC and Goldman Sachs Mortgage Company entered into a $259,000,000 term loan agreement (the "SASB Loan"). The Company together with its affiliates HIREIT, Hartman XIX and vREIT XXI, contributed a total of 39 commercial real estate properties to Hartman SPE, LLC in exchange for membership interests in Hartman SPE, LLC.
The term of the SASB Loan is five years, comprised of an initial two-year term with 3 one-year extension options. Each extension option shall be subject to certain conditions precedent including (i) no default then outstanding, (ii) 30 days prior written notice, (iii) the properties must have a specified in-place net operating income debt yield and (iv) purchase of an interest rate cap as described below for the exercised option term or terms.
The outstanding principal of the SASB Loan bears interest at the one-month LIBOR rate plus 1.8%. The SASB Loan is subject to an interest rate cap arrangement which caps LIBOR at 3.75% during the initial term of the SASB Loan.
The SASB Loan contains various customary covenants, including but not limited to financial covenants, covenants requiring monthly deposits in respect of certain property costs, such as taxes, insurance, tenant improvements, and leasing commissions, covenants imposing restrictions on indebtedness and liens, and restrictions on investments and participation in other asset disposition, merger or business combination or dissolution transactions.
The SASB Loan is secured by, among other things, mortgages on the properties. The Company, HIREIT and Hartman XIX, entered into a guaranty agreement in favor of the lender, whereby each guarantor unconditionally guaranties the full and timely performance of the obligations set forth in the loan agreement and all other loan documents, including the payment of all indebtedness and obligations due under the loan agreement.
The following is a summary of the Company’s notes payable, in thousands:
Property/Facility | Payment (1) | Maturity Date | Rate | March 31, 2020 | December 31, 2019 | ||||||||||||||||||||||||
Richardson Heights (2) | P&I | July 1, 2041 | 4.61 | % | $ | 17,087 | $ | 17,260 | |||||||||||||||||||||
Cooper Street (2) | P&I | July 1, 2041 | 4.61 | % | 7,367 | 7,435 | |||||||||||||||||||||||
Bent Tree Green (2) | P&I | July 1, 2041 | 4.61 | % | 7,367 | 7,435 | |||||||||||||||||||||||
Mitchelldale (2) | P&I | July 1, 2041 | 4.61 | % | 11,161 | 11,263 | |||||||||||||||||||||||
Hartman SPE LLC | IO | October 9, 2020 | 2.79 | % | 259,000 | 259,000 | |||||||||||||||||||||||
Hartman XXI | IO | March 31, 2021 | 10.00 | % | 8,200 | 4,400 | |||||||||||||||||||||||
310,182 | 306,793 | ||||||||||||||||||||||||||||
Less: unamortized deferred loan costs | (3,500) | (3,754) | |||||||||||||||||||||||||||
$ | 306,682 | $ | 303,039 |
(1) Principal and interest (P&I) or interest only (IO).
(2) Each promissory note contains a call option wherein the holder of the promissory note may declare the outstanding balance due and payable on either July 1, 2024, July 1, 2029, July 1, 2034, or July 1, 2039.
The Company's loan costs are amortized using the straight-line method over the terms of the loans, which approximates the interest method. Costs which have been deferred consist of the following, in thousands:
13
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 2020 | December 31, 2019 | ||||||||||
Deferred loan costs | $ | 7,155 | $ | 7,155 | |||||||
Less: deferred loan cost accumulated amortization | (3,655) | (3,401) | |||||||||
Total cost, net of accumulated amortization | $ | 3,500 | $ | 3,754 |
Interest expense incurred for the three months ended March 31, 2020 and 2019 was $3,018,000 and $3,669,000, respectively, which includes amortization expense of deferred loan costs. Interest expense of $320,000 and $516,000 was payable as of March 31, 2020 and December 31, 2019, respectively, and is included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.
The Company is required to provide audited financial statements for Hartman SPE, LLC within 120 days after the end of its fiscal year, which is December 31. The servicer for the lender has extended the time for delivery of the Hartman SPE, LLC audited annual financial statements.
Fair Value of Debt
The fair value of the Company’s fixed rate notes payable, variable rate notes payable and secured revolving credit facilities aggregates to $315,637,000 and $308,671,000 as compared to book value of $310,182,000 and $306,793,000 as of March 31, 2020 and December 31, 2019, respectively. The fair value of our debt instruments is estimated on a Level 2 basis, as provided by ASC 820, using a discounted cash flow analysis based on the borrowing rates currently available to the Company for loans with similar terms and maturities, discounting the future contractual interest and principal payments. Disclosure about the fair value of notes payable is based on relevant information available as of March 31, 2020 and December 31, 2019.
Note 8 — Income Per Share
Basic income per share is computed using net income attributable to common stockholders and the weighted average number of common shares outstanding. Diluted weighted average shares outstanding reflect common shares issuable from the assumed conversion of convertible preferred stock into common shares. Only those items that have a dilutive impact on basic earnings per share are included in the diluted earnings per share.
Three months ended March 31, | |||||||||||
2020 | 2019 | ||||||||||
Numerator: | |||||||||||
Net income attributable to common stockholders (in thousands) | $ | 1,168 | $ | 335 | |||||||
Denominator: | |||||||||||
Weighted average number of common shares outstanding, basic and diluted (in thousands) | 18,418 | 17,837 | |||||||||
Basic and diluted income per common share: | $ | 0.06 | $ | 0.02 |
Note 9 — Income Taxes
Federal income taxes are not provided for because we qualify as a REIT under the provisions of the Internal Revenue Code and because we have distributed and intend to continue to distribute all of our taxable income to our stockholders. Our stockholders include their proportionate taxable income in their individual tax returns. As a REIT, we must distribute at least 90% of our real estate investment trust taxable income to our stockholders and meet certain income sources and investment restriction requirements. In addition, REITs are subject to a number of organizational and operational requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates. The Company’s federal income tax returns for the years ended December 31, 2015, 2016, 2017, 2018 and 2019 have not been examined by the Internal Revenue Service.The Company’s federal income tax return for the year ended December 31, 2015 may be examined on or before September 15, 2020.
The Company has formed a taxable REIT subsidiary which may generate future taxable income, which may be offset by the net loss carry forward. The Company considers that any deferred tax benefit and corresponding deferred tax asset which may be recorded in light of the net loss carry forward would be properly offset by an equal valuation allowance. Accordingly, 0 deferred tax benefit or deferred tax asset has been recorded in the accompanying consolidated financial statements.
14
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company is required to recognize in its consolidated financial statements the financial effects of a tax position only if it is determined that it is more likely than not that the tax position will not be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Management has reviewed the Company’s tax positions and is of the opinion that material positions taken by the Company would more likely than not be sustained upon examination. Accordingly, the Company has not recognized a liability related to uncertain tax positions.
Taxable income (loss) differs from net income (loss) for financial reporting purposes principally due to differences in the timing of recognition of interest, real estate taxes, depreciation and amortization and rental revenue.
Note 10 — Related Party Transactions
Hartman Advisors LLC, is a Texas limited liability company owned 70% by Allen R. Hartman individually and 30% by the Property Manager. The Property Manager is a wholly owned subsidiary of Hartman Income REIT Management, LLC, which is wholly owned by Hartman Income REIT, Inc. and Subsidiaries of which approximately 20% is owned by Allen R. Hartman who is the Chief Executive Officer and Chairman of the Board of Directors.
The Company pays acquisition fees and asset management fees to the Advisor in connection with the acquisition of properties and management of the Company. The Company pays property management and leasing commissions to the Property Manager in connection with the management and leasing of the Company’s properties. For the three months ended March 31, 2020 and 2019, the Company incurred property management fees and reimbursements of $2,069,000 and $1,953,000, respectively, and $1,013,000 and $950,000, respectively for leasing commissions owed to our Property Manager. We incurred asset management fees of $440,000 and $440,000, respectively, owed to the Advisor. These fees are monthly fees equal to one-twelfth of 0.75% of the sum of the higher of the cost or value of each asset. The asset management fee will be based only on the portion of the cost or value attributable to the Company’s investment in an asset, if the Company does not own all or a majority of an asset. There were no acquisition fees incurred to the Advisor for the three months ended March 31, 2020 and 2019, respectively. Property management fees and reimbursements are included in property operating expense in the accompanying consolidated statements of operations. Asset management fees are captioned as such in the accompanying consolidated statements of operations.
The Company also pays construction management fees for the Property Manager in connection with the construction management of the Company's properties. For the three months ended March 31, 2020 and 2019, the Company incurred construction management fees of $166,000 and $267,000, respectively. Construction management fees are capitalized and included in real estate assets in the consolidated balance sheets.
The Company had a balance due to the Property Manager of $843,000 and $1,168,000 as of March 31, 2020 and December 31, 2019, respectively. The Company owed the Advisor $1,966,000 and $2,077,000 for asset management fees as of March 31, 2020 and December 31, 2019, respectively. The Company had a net balance due from other related parties of $8,125,000 and $5,375,000 as of March 31, 2020 and December 31, 2019, respectively.
The Company owns 1,561,523 shares of the common stock of HIREIT which it acquired for cash consideration of $8,978,000. The Company’s investment in HIREIT is accounted for under the cost method. The Company’s approximate 11% ownership interest in HIREIT is less than a controlling stake, and is reflected as “Investment in Affiliate” on the accompanying consolidated balance sheets. The Company received dividend distributions from HIREIT of $106,000 and $106,000 for the three months ended March 31, 2020 and 2019, respectively, which is included in interest and dividend income in the accompanying consolidated statements of operations.
During the fourth quarter of 2019, the Company borrowed under an unsecured promissory note payable to Hartman vREIT XXI, Inc., an affiliate of the Advisor and the Property Manager, in the face amount of $4,400,000. This note payable had an outstanding balance of $8,200,000 and $4,400,000 as of March 31, 2020 and December 31, 2019, respectively, which is included in Notes payable, net in the accompanying consolidated balance sheets. Interest has been accrued on the loan amount at an annual rate of 10%. The Company recognized interest expense on the affiliate note in the amount of $110,000 for the three months ended March 31, 2020, which is included in interest expense in the accompanying consolidated statements of operations.
In May 2016, the Company, through its taxable REIT subsidiary, Hartman TRS, Inc. (“TRS”), loaned $7,231,000 pursuant to a promissory note in the face amount of up to $8,820,000 to Hartman Retail II Holdings Company, Inc. (“Retail II Holdings”), an affiliate of the Advisor and the Property Manager, in connection with the acquisition of a retail shopping center
15
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
by Hartman Retail II DST, a Delaware statutory trust sponsored by the Property Manager. Pursuant to the terms of the promissory note, TRS received a two percent (2%) origination fee of amounts advanced under the promissory note, and interest at ten percent (10%) per annum on the outstanding principal balance. The outstanding principal balance of the promissory note will be repaid as investor funds are raised by Hartman Retail II DST. The maturity date of the promissory note, as amended is December 31, 2020. This note receivable had an outstanding balance of $1,726,000 and $2,476,000 as of March 31, 2020 and December 31, 2019, respectively, which is included in Notes receivable – related party in the accompanying consolidated balance sheets. For the three months ended March 31, 2020 and 2019, respectively, the Company recognized interest income on this affiliate note in the amount of $43,000 and $61,000, respectively, which is included in interest and dividend income in the accompanying consolidated statements of operations.
The Company had a note receivable due from an affiliate, Hartman Short Term Income Properties XIX, Inc. (“Hartman XIX”), of $4,200,000 as of March 31, 2020 and December 31, 2019, respectively, which is included in Notes receivable - related party in the accompanying consolidated balance sheets. The face amount of the promissory note is $4,500,000. Interest has been accrued on the loan amount at an annual rate of six percent (6%). The Company recognized interest income on the affiliate note in the amount of $63,000 for the three months ended March 31, 2020 and 2019, respectively, which is included in interest and dividend income in the accompanying consolidated statements of operations.
In February 2019, the Company through TRS, loaned $6,782,455 pursuant to a promissory note in the face amount of up to $7,500,000 to Hartman Retail III Holdings Company, Inc. (“Retail III Holdings”), an affiliate of the Advisor and the Property Manager, in connection with the acquisition of a retail shopping center by Hartman Retail III DST, a Delaware statutory trust sponsored by the Advisor. This note receivable had an outstanding balance of $6,782,000 as of March 31, 2020 and December 31, 2019, respectively, which is included in Notes receivable – related party in the accompanying consolidated balance sheets. Pursuant to the terms of the promissory note, TRS receives a two percent (2%) origination fee of amounts advanced under the promissory note, and interest at ten percent (10%) per annum on the outstanding principal balance. The outstanding principal balance of the promissory note will be repaid as investor funds are raised by Hartman Retail III DST. The maturity date of the promissory note is February 29, 2021. The Company recognized interest income on this affiliate note in the amount of $169,000 for the three months ended March 31, 2020, which is included in interest and dividend income in the accompanying consolidated statements of operations.
In March 2019, the Company through TRS, loaned $3,829,711 pursuant to a promissory note in the face amount of up to $3,500,000 to Hartman Ashford Bayou, LLC (“Ashford Bayou”), an affiliate of the Advisor and the Property Manager, in connection with the acquisition of office building by Ashford Bayou, a wholly owned subsidiary of Hartman Total Return, Inc. This note receivable had an outstanding balance of $3,830,000 as of March 31, 2020 and December 31, 2019, respectively, which is included in Notes receivable – related party in the accompanying consolidated balance sheets. Pursuant to the terms of the promissory note, TRS receives a two percent (2%) origination fee of amounts advanced under the promissory note, and interest at ten percent (10%) per annum on the outstanding principal balance. The outstanding principal balance of the promissory note will be repaid as investor funds are raised by Hartman Total Return, Inc. The maturity date of the promissory note is March 31, 2021. The Company recognized interest income on this affiliate note in the amount of 95,000 for the three months ended March 31, 2020, which is included in interest and dividend income in the accompanying consolidated statements of operations.
Variable interest entities (“VIEs”) are defined as entities with a level of invested equity that is not sufficient to fund future operations on a stand-alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. For identified VIEs, an assessment must be made to determine which party to the VIE, if any, has both the power to direct the activities of the VIE that most significantly impacts the performance of the VIE and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.
The Company is not deemed to be the primary beneficiary of Retail II Holdings, Retail III Holdings or Ashford Bayou, each of which qualifies as a VIE. Accordingly, the assets and liabilities and revenues and expenses of Retail II Holdings , Retail III Holdings and Ashford Bayou have not been included in the accompanying consolidated financial statements.
The Board of Directors voted to acquire an additional 3.42% ownership interest of Hartman SPE, LLC from Hartman vREIT XXI, Inc. in exchange for 700,302 shares of the Company’s common stock with a total value of $8,858,826 ($12.65 per share). The exchange increased the Company’s ownership interest in Hartman SPE, LLC from 32.74% to 36.16%. The transaction was effective March 1, 2019.
16
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 11 - Stockholders’ Equity
Under the Company’s articles of incorporation, the Company has authority to issue 750,000,000 shares of common stock, $0.001 par value per share, and 200,000,000 shares of preferred stock, $0.001 par value per share.
Common Stock
Shares of common stock entitle the holders to 1 vote per share on all matters which stockholders are entitled to vote, to receive dividends and other distributions as authorized by the Company’s board of directors in accordance with the Maryland General Corporation Law and to all rights of a stockholder pursuant to the Maryland General Corporation Law. The common stock has no preferences or preemptive, conversion or exchange rights.
Preferred Stock
Under the Company’s articles of incorporation, the Company’s board of directors has the authority to issue one or more classes or series of preferred stock, and prior to the issuance of such stock, the board of directors has the power to classify or reclassify, in one or more series, any unissued shares and designate the preferences, rights and privileges of such shares. As of March 31, 2020, and December 31, 2019, respectively, the Company has issued 1,000 shares of convertible preferred stock to the Advisor at a price of $10.00 per share.
Common Stock Issuable Upon Conversion of Convertible Preferred Stock
The convertible preferred stock issued to the Advisor will convert to shares of the Company’s common stock if (1) the Company has made total distributions on then outstanding shares of the Company’s common stock equal to the issue price of those shares plus a 6% cumulative, non-compounded, annual return on the issue price of those outstanding shares, (2) the Company lists its common stock for trading on a national securities exchange if the sum of prior distributions on then outstanding shares of the Company’s common stock plus the aggregate market value of the Company’s common stock (based on the 30-day average closing meets the same 6% performance threshold, or (3) the Company’s advisory agreement with the Advisor expires without renewal or is terminated (other than because of a material breach by the Advisor), and at the time of such expiration or termination the Company is deemed to have met the foregoing 6% performance threshold based on the Company’s enterprise value and prior distributions and, at or subsequent to the expiration or termination, the stockholders actually realize such level of performance upon listing or through total distributions. In general, the convertible stock will convert into shares of common stock with a value equal to 15% of the excess of the Company’s enterprise value plus the aggregate value of distributions paid to date on then outstanding shares of common stock over the aggregate issue price of those outstanding shares plus a 6% cumulative, non-compounded, annual return on the issue price of those outstanding shares. With respect to conversion in connection with the termination of the advisory agreement, this calculation is made at the time of termination even though the actual conversion may occur later, or not at all.
Stock-Based Compensation
The Company awards shares of restricted common stock to non-employee directors as compensation in part for their service as members of the board of directors of the Company. These shares are fully vested when granted. These shares may not be sold while an independent director is serving on the board of directors. For the three months ended March 31, 2020 and 2019, respectively, the Company granted 1,500 shares of restricted common stock to independent directors as compensation for services and recognized $19,000 as stock-based compensation expense for each period. Share based compensation expense is based upon the estimated fair value per share. Stock-based compensation expense is included in general and administrative expenses in the accompanying consolidated statements of operations.
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HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Distributions
The following table reflects the total distributions the Company has paid, including the total amount paid, thousands, and amount paid per common share, in each indicated quarter:
Quarter Paid | Distributions per Common Share | Total Distributions | |||||||||
2020 | |||||||||||
1st Quarter | 0.175 | 3,223 | |||||||||
Total 2020 year to date | $ | 0.175 | $ | 3,223 | |||||||
2019 | |||||||||||
4th Quarter | $ | 0.175 | $ | 3,223 | |||||||
3rd Quarter | 0.175 | 3,224 | |||||||||
2nd Quarter | 0.175 | 3,223 | |||||||||
1st Quarter | 0.171 | 3,141 | |||||||||
Total 2019 | $ | 0.696 | $ | 12,811 |
Mergers
Subject to the terms and conditions of the XIX Merger Agreement, including the satisfaction of all closing conditions set forth in the Merger Agreements, Hartman XIX will merge with and into the Company, with the Company surviving the merger (the “Hartman XIX Merger”). Subject to the terms and conditions of the HIREIT Merger Agreement, (i) HIREIT will merge with and into the Company, with the Company surviving the merger (the “HIREIT Merger,” and together with the Hartman XIX Merger, the “REIT Mergers”), and (ii) HIROP will merge and with and into the Operating Partnership, with the Operating Partnership surviving the merger (the “Partnership Merger,” and together with the REIT Mergers, the “Mergers”). The REIT Mergers are intended to qualify as a “reorganization” under, and within the meaning of, Section 368(a) of the Internal Revenue Code of 1986, as amended (the “Code”), and the Partnership Merger is intended to be treated as a tax-deferred exchange under Section 721 of the Code.
Subject to the terms and conditions of the XIX Merger Agreement, (i) each share of common stock of Hartman XIX (the “XIX Common Stock”) issued and outstanding immediately prior to the Effective Time (as defined in the XIX Merger Agreement) will be automatically cancelled and retired and converted into the right to receive 9,171.98 shares of common stock, $0.01 par value per share, of the Company (“Company Common Stock”), (ii) each share of 8% cumulative preferred stock of Hartman XIX issued and outstanding immediately prior to the Effective Time will be automatically cancelled and retired and converted into the right to receive 1.238477 shares of Company Common Stock, and (iii) each share of 9% cumulative preferred stock of Hartman XIX issued and outstanding immediately prior to the Effective Time will be automatically cancelled and retired and converted into the right to receive 1.238477 shares of Company Common Stock.
Subject to the terms and conditions of the HIREIT Merger Agreement, (a) in connection with the HIREIT Merger, (i) each share of common stock of HIREIT (the “HIREIT Common Stock”) issued and outstanding immediately prior to the REIT Merger Effective Time (as defined in the HIREIT Merger Agreement) will be automatically cancelled and retired and converted into the right to receive 0.752222 shares of Company Common Stock, and (ii) each share of subordinate common stock of HIREIT will be automatically cancelled and retired and converted into the right to receive 0.863235 shares of Company Common Stock, and (b) in connection with the Partnership Merger, each unit of limited partnership interest in HIREIT Operating Partnership (“HIREIT OP Units”) issued and outstanding immediately prior to the Partnership Merger Effective Time (as defined in the HIREIT Merger Agreement) (other than any HIREIT OP Units held by HIREIT) will be automatically cancelled and retired and converted into the right to receive 0.752222 validly issued, fully paid and non-assessable units of limited partnership interests in XX Operating Partnership.
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HARTMAN SHORT TERM INCOME PROPERTIES XX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 12 - Incentive Award Plan
The Company has adopted an incentive plan (the “Omnibus Stock Incentive Plan” or the “Incentive Plan”) that provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, deferred stock awards, restricted stock awards, dividend equivalent rights and other stock-based awards within the meaning of Internal Revenue Code Section 422, or any combination of the foregoing. The Company has initially reserved 5,000,000 shares of the Company’s common stock for the issuance of awards under the Company’s stock incentive plan, but in no event more than ten (10%) percent of the Company’s issued and outstanding shares. The number of shares reserved under the Company’s stock incentive plan is also subject to adjustment in the event of a stock split, stock dividend or other change in the Company’s capitalization. Generally, shares that are forfeited or canceled from awards under the Company’s stock incentive plan also will be available for future awards.
Incentive Plan compensation expense is included in general and administrative expenses in the accompanying consolidated statements of operations.
Note 13 - Commitments and Contingencies
Economic Dependency
The Company is dependent on the Property Manager and the Advisor for certain services that are essential to the Company, including the identification, evaluation, negotiation, purchase and disposition of properties, management of the daily operations of the Company’s real estate portfolio, and other general and administrative responsibilities. In the event that these companies are unable to provide the respective services, the Company will be required to obtain such services from other providers.
Litigation
The Company is subject to various claims and legal actions that arise in the ordinary course of business. Management of the Company believes that the final disposition of such matters will not have a material adverse effect on the financial position of the Company.
Note 14 - Subsequent Events
On May 14, 2020, the shareholders of the Company, Hartman XIX and HIREIT approved the previously proposed Merger Agreements. The target effective date of the mergers is July 1, 2020. Results of the special shareholder meetings was reported by the Company on its Current Report on Form 8-K filed with the SEC on May 20, 2020.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise requires, all references in this report to the “Company,” “we,” “us” or “our” are to Hartman Short Term Income Properties XX, Inc.
Forward-Looking Statements
Certain statements included in this quarterly report on Form 10-Q (this “Quarterly Report”) that are not historical facts (including statements concerning investment objectives, other plans and objectives of management for future operations or economic performance, or assumptions, or forecasts related thereto) are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. These statements are only predictions. We caution that forward-looking statements are not guarantees. Actual events on our investments and results of operations could differ materially from those expressed or implied in any forward-looking statements. Forward-looking statements are typically identified by the use of terms such as “may,” “should,” “expect,” “could,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “continue,” “predict,” “potential” or the negative of such terms and other comparable terminology.
Forward-looking statements included herein are based upon our current expectations, plans, estimates, assumptions and beliefs which involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to:
• | the fact that we have had a net loss for each annual period since our inception; | ||||
• | the risk that the pending Mergers will not be consummated within the expected time period or at all; | ||||
• | the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreements; | ||||
• | the failure to satisfy the conditions to completion of the pending Mergers; | ||||
• | risks related to disruption of management’s attention from the ongoing business operations due to the pending Mergers; | ||||
• | the effect of the announcement of the pending Mergers on our operating results and business generally; | ||||
• | the outcome of any legal proceedings relating to the pending Mergers; | ||||
• | the imposition of federal taxes if we fail to qualify as a REIT in any taxable year or forego an opportunity to ensure REIT status; | ||||
• | uncertainties related to the national economy, the real estate industry in general and in our specific markets; | ||||
• | legislative or regulatory changes, including changes to laws governing REITS; | ||||
• | construction costs that may exceed estimates or construction delays; | ||||
• | increases in interest rates; | ||||
• | availability of credit or significant disruption in the credit markets; | ||||
• | litigation risks; | ||||
• | risks inherent to the real estate business, including tenant defaults, potential liability related to environmental matters and the lack of liquidity of real estate investments; | ||||
• | inability to obtain new tenants upon the expiration of existing leases at our properties; | ||||
• | inability to generate sufficient cash flows due to market conditions, competition, uninsured losses, changes in tax or other applicable laws; | ||||
• | the impact of the global pandemic of the novel coronavirus that causes the disease known as coronavirus disease 2019 (“COVID-19”), and the measures taken in response to the pandemic, on the global economy and our real estate tenants; | ||||
• | the potential need to fund tenant improvements or other capital expenditures out of operating cash flow; | ||||
• | the fact that we pay fees and expenses to our advisor and its affiliates that were not negotiated on an arm’s length basis and the fact that the payment of these fees and expenses increases the risk that our stockholders will not earn a profit on their investment in us; | ||||
• | our ability to generate sufficient cash flows to pay distributions to our stockholders; | ||||
• | our ability to retain our executive officers and other key personnel of our advisor and other affiliates of our advisor; and |
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• | changes to generally accepted accounting principles, or GAAP. |
The forward-looking statements should be read in light of these factors and the factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the SEC on May 13, 2020.
The following discussion and analysis should be read in conjunction with the accompanying interim consolidated financial information.
Overview
We were formed as a Maryland corporation on February 5, 2009 to invest in and operate real estate and real estate-related assets on an opportunistic basis. We may acquire a wide variety of commercial properties, including office, industrial, retail, and other real properties. These properties may be existing, income-producing properties, newly constructed properties or properties under development or construction. In particular, we focus on acquiring properties with significant possibilities for short-term capital appreciation, such as those requiring development, redevelopment or repositioning or those located in markets with high growth potential. We also may invest in real estate-related securities and, to the extent that our advisor determines that it is advantageous, we may invest in mortgage loans.
On February 9, 2010, we commenced our initial public offering of up to $250,000,000 in shares of our common stock to the public at a price of $10.00 per share and up to $23,750,000 in shares of common stock to our stockholders pursuant to our distribution reinvestment plan at a price of $9.50 per share. On April 25, 2013, we terminated our initial public offering. As of the termination of our initial public offering on April 25, 2013, we had accepted subscriptions for and issued shares of our common stock, including shares of our common stock issued pursuant to our distribution reinvestment plan, resulting in aggregate gross offering proceeds of $43,943,731.
On July 16, 2013, we commenced our follow-on public offering, or our “follow-on offering,” of up to $200,000,000 in shares of our common stock to the public at a price of $10.00 per share and up to $19,000,000 in shares of our common stock to our stockholders pursuant to our distribution reinvestment plan at a price of $9.50 per share. Effective March 31, 2016, we terminated the offer and sale of our common shares to the public in our follow-on offering. Effective July 16, 2016, we terminated the sale of additional shares of our common stock to our stockholders pursuant to our distribution reinvestment plan. As of March 31, 2020, we had accepted subscriptions for, and issued shares of our common stock in our follow-on offering, including shares of our common stock issued pursuant to our distribution reinvestment plan, resulting in aggregate gross proceeds of $181,800,895.
As of March 31, 2020 we owned 43 commercial real properties comprising approximately 6.7 million square feet plus three pad sites, all located in Texas.
The SASB Loan outstanding as of March 31, 2020 has an initial maturity date of October 9, 2020, which is within one year of the date that this Quarterly Report was available to be issued. Management has considered whether there is substantial doubt about the Company's ability to continue as a going concern within one year of the issuance date of these consolidated financial statement due to the uncertainty regarding the SASB Loan maturity, as set forth in Accounting Standards Update (ASU) 2014-15, “Presentation of Financial Statements – Going Concern.”
Without limiting the foregoing, we believe that we will have sufficient capital to meet our existing debt service and other operating obligations for the next year and that we have adequate resources to fund our cash needs. However, our operations are subject to a variety of risks, including, but not limited to, changes in national economic conditions, the restricted availability of financing, changes in demographic trends and interest rates and declining real estate valuations. As a result of these uncertainties, there can be no assurance that we will meet our investment objectives or that the risks described above will not have an adverse effect on our properties or results of operations.
We operate under the direction of our board of directors, the members of which are accountable to us and our stockholders. We are externally managed by Hartman Advisors, LLC, which we refer to as our “advisor,” pursuant to an advisory agreement by and among us and our advisor, which we refer to as the “Advisory Agreement.” Subject to certain restrictions and limitations, our advisor manages our day-to-day operations and our portfolio of properties and real estate related assets. Our advisor sources and presents investment opportunities to our board of directors. Our advisor also provides investment management, marketing, investor relations and other administrative services on our behalf. The key personnel of our advisor are involved in the selection, acquisition, financing and disposition of our properties, and raising the capital to purchase properties. The key personnel of our advisor have extensive experience in selecting and operating commercial real estate and in
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operating investment entities that acquire commercial real estate. Our affiliated property manager is Hartman Income REIT Management, Inc. which we refer to as our “property manager,” which is responsible for operating, leasing and maintaining our properties. Our property manager is the wholly owned subsidiary of Hartman Income REIT, Inc. which we refer to as “HIREIT,” a real estate investment trust that has investment objectives that are similar to those that we employ.
Pending Mergers
On July 21, 2017, we entered into (i) an agreement and plan of merger (the “XIX Merger Agreement”) between us and Short Term Income Properties XIX, Inc. (“Hartman XIX”), and (ii) an agreement and plan of merger (the “HIREIT Merger Agreement,” and together with the XIX Merger Agreement, the “Merger Agreements”) by and among us, our operating partnership, Hartman Income REIT, Inc. (“HIREIT”), and Hartman Income REIT Operating Partnership LP, the operating partnership of HIREIT (“HIREIT Operating Partnership”).
Subject to the terms and conditions of the XIX Merger Agreement, Hartman XIX will merge with and into us, with our company surviving the merger (the “Hartman XIX Merger”). Subject to the terms and conditions of the HIREIT Merger Agreement, (i) HIREIT will merge with and into us, with our company surviving the merger (the “HIREIT Merger,” and together with the Hartman XIX Merger, the “REIT Mergers”), and (ii) HIREIT Operating Partnership will merge with and into our operating partnership, with our operating partnership surviving the merger (the “Partnership Merger,” and together with the REIT Mergers, the “Mergers”).
Subject to the terms and conditions of the XIX Merger Agreement, (i) each share of common stock of Hartman XIX (the “XIX Common Stock”) issued and outstanding immediately prior to the Effective Time (as defined in the XIX Merger Agreement) will be automatically canceled and retired and converted into the right to receive 9,171.98 shares of our common stock, (ii) each share of 8% cumulative preferred stock of Hartman XIX issued and outstanding immediately prior to the Effective Time will be automatically canceled and retired and converted into the right to receive 1.238477 shares of our common stock, and (iii) each share of 9% cumulative preferred stock of Hartman XIX issued and outstanding immediately prior to the Effective Time will be automatically canceled and retired and converted into the right to receive 1.238477 shares of our common stock.
Subject to the terms and conditions of the HIREIT Merger Agreement, (a) in connection with the HIREIT Merger, (i) each share of common stock of HIREIT (the “HIREIT Common Stock”) issued and outstanding immediately prior to the REIT Merger Effective Time (as defined in the HIREIT Merger Agreement) will be automatically cancelled and retired and converted into the right to receive 0.752222 shares of our common stock, and (ii) as provided in the HIREIT Merger Agreement, as amended May 8, 2018, each share of subordinate common stock of HIREIT will be automatically cancelled and retired and converted into the right to receive 0.863235 shares of our common stock, and (b) in connection with the Partnership Merger, each unit of limited partnership interest in HIREIT Operating Partnership (“HIREIT OP Units”) issued and outstanding immediately prior to the Partnership Merger Effective Time (as defined in the HIREIT Merger Agreement) (other than any HIREIT OP Units held by HIREIT) will be automatically cancelled and retired and converted into the right to receive 0.752222 validly issued, fully paid and non-assessable units of limited partnership interests in our operating partnership.
Impact of the COVID-19 Pandemic
Our business could be materially and adversely affected by the outbreak of a health epidemic or pandemic, including the coronavirus, particularly to the extent and degree to which the outbreak affects the U.S., state and local economies. Our revenues consist primarily of rental income and other tenant reimbursements derived from tenants of our commercial real estate properties. The effects of the COVID-19 coronavirus and other adverse public health developments could materially affect the financial viability of our tenants and their ability to pay rent. While it is premature to accurately predict the ultimate impact of these developments, our results for the quarter ended March 31, 2020 have not been significantly impacted; however, we do expect to be impacted with potentially continuing and possibly adverse impacts beyond March 31, 2020.
Our operations could be disrupted if any of our employees, employees of our vendors and business partners or employees of our tenants were to contract or be suspected of having any strain of flu or a coronavirus, since this could require us or vendors and business partners and tenants to quarantine some or all of any affected employees and or disinfect affected workspaces. We could also be adversely affected if government authorities impose mandatory closures, seek voluntary closures or impose restrictions on the operations of our business and the operations of our tenants’ businesses. Even if such measures are not implemented and a virus or other disease does not spread significantly, the perceived risk of infection or public health risk may adversely affect the business and operating results of our tenants and by extension affect our business and operating and results.
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Our collections as of June 2, 2020 of tenant rents, reimbursements and other income billed for the months of April and May 2020 were as follows:
Property type | April 2020 | May 2020 | ||||||
Retail | 66.6 | % | 65.0 | % | ||||
Flex | 96.5 | % | 100.0 | % | ||||
Office | 93.6 | % | 91.1 | % | ||||
Industrial | 97.9 | % | 85.3 | % | ||||
Total | 87.6 | % | 85.3 | % |
Investment Objectives and Strategy: Hartman Advantage
Our primary investment objectives are to:
• | realize growth in the value of our investments; | ||||
• | preserve, protect and return stockholders’ capital contributions; and | ||||
• | grow net cash from operations and pay regular cash distributions to our stockholders. |
We cannot assure our stockholders that we will achieve these objectives.
The cornerstone of our investment strategy is our advisor’s discipline in acquiring a portfolio of real estate properties, specifically properties that are located in Texas, that offer a blend of current and potential income based on in place occupancy plus relatively significant potential for growth in income and value from re-tenanting; repositioning or redevelopment. We refer to this strategy as “value add” or the “Hartman Advantage.”
We rely upon the value add or Hartman Advantage strategy to evaluate numerous potential commercial real estate acquisition and investment opportunities per completed acquisition or investment.
Effective March 31, 2016 we terminated our follow-on offering. Our board of directors continues to evaluate potential liquidity events to maximize the total potential return to our stockholders, including, but not limited to, a listing of our shares of common stock on a national securities exchange. However, our board of directors has not made a decision to pursue any specific liquidity event, and there can be no assurance that we will complete a liquidity event on the terms described above, or at all.
We do not anticipate that there will be any market for our shares of common stock unless they are listed on a national securities exchange. In the event that our shares of common stock are not listed or traded on an established securities exchange prior to the tenth anniversary of the termination of our initial public offering, which terminated on April 25, 2013, our charter requires that the board of directors must seek the approval of our stockholders of a plan to liquidate our assets, unless the board of directors has obtained the approval of our stockholders (1) to defer the liquidation of our assets or (2) of an alternate strategy.
We believe that we have sufficient capital to meet our existing debt service and other operating obligations for the next year and that we have adequate resources to fund our cash needs. However, our operations are subject to a variety of risks, including, but not limited to, changes in national economic conditions, the restricted availability of financing, changes in demographic trends and interest rates and declining real estate valuations. As a result of these uncertainties, there can be no assurance that we will meet our investment objectives or that the risks described above will not have an adverse effect on our properties or results of operations.
We elected under Section 856(c) of the Internal Revenue Code to be taxed as a REIT beginning with the taxable year ending December 31, 2011. As a REIT we generally are not subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year after the year in which we initially elected to be treated as a REIT, we will be subject to federal income tax on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied. Such an event could materially and adversely affect our net income. However, we believe that we are organized and will operate in a manner that will enable us to qualify for treatment as a REIT for federal income tax purposes and we intend to operate so as to remain qualified as a REIT for federal income tax purposes.
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Our Real Estate Portfolio
As of March 31, 2020, we owned 43 commercial properties listed below.
Property Name | Location | Gross Leasable Area SF | Percent Occupied | Annualized Base Rental Revenue (in thousands) | Average Base Rental Revenue per Occupied SF | Average Net Effective Annual Base Rent per Occupied SF | ||||||||||||||
Retail: | ||||||||||||||||||||
Promenade | Dallas | 176,585 | 77 | % | $ | 1,578 | $ | 11.63 | $ | 11.54 | ||||||||||
Prestonwood Park | Dallas | 105,783 | 85 | % | $ | 1,959 | $ | 21.91 | $ | 21.87 | ||||||||||
Richardson Heights | Dallas | 201,433 | 78 | % | $ | 3,066 | $ | 19.56 | $ | 19.56 | ||||||||||
Cooper Street | Dallas | 127,696 | 100 | % | $ | 1,649 | $ | 12.92 | $ | 12.95 | ||||||||||
One Mason SC | Houston | 75,183 | 86 | % | $ | 930 | $ | 14.44 | $ | 14.41 | ||||||||||
Chelsea Square SC | Houston | 70,275 | 79 | % | $ | 611 | $ | 11.07 | $ | 10.82 | ||||||||||
Mission Center SC | Houston | 112,971 | 99 | % | $ | 916 | $ | 8.19 | $ | 7.24 | ||||||||||
Garden Oaks SC | Houston | 106,858 | 71 | % | $ | 1,160 | $ | 15.33 | $ | 15.14 | ||||||||||
Harwin | Houston | 38,813 | 93 | % | $ | 372 | $ | 10.35 | $ | 10.39 | ||||||||||
Fondren | Houston | 93,196 | 92 | % | $ | 810 | $ | 9.48 | $ | 9.31 | ||||||||||
Northeast Square SC | Houston | 40,525 | 73 | % | $ | 395 | $ | 13.29 | $ | 13.33 | ||||||||||
Walzem Plaza SC | San Antonio | 182,713 | 73 | % | $ | 1,505 | $ | 11.24 | $ | 11.41 | ||||||||||
Total - Retail | 1,332,031 | 83 | % | $ | 14,951 | $ | 13.57 | $ | 13.45 | |||||||||||
Office: | ||||||||||||||||||||
North Central Plaza | Dallas | 198,374 | 76 | % | $ | 2,350 | $ | 15.50 | $ | 15.07 | ||||||||||
Gateway Tower | Dallas | 266,412 | 66 | % | $ | 2,780 | $ | 15.85 | $ | 15.16 | ||||||||||
Bent Tree Green | Dallas | 139,609 | 81 | % | $ | 2,088 | $ | 18.50 | $ | 18.25 | ||||||||||
Parkway Plaza I&II | Dallas | 136,506 | 82 | % | $ | 1,771 | $ | 15.77 | $ | 15.74 | ||||||||||
Hillcrest | Dallas | 203,688 | 84 | % | $ | 2,617 | $ | 15.28 | $ | 15.26 | ||||||||||
Skymark | Dallas | 115,700 | 79 | % | $ | 1,670 | $ | 18.30 | $ | 17.84 | ||||||||||
Corporate Park Place | Dallas | 113,429 | 77 | % | $ | 1,461 | $ | 16.66 | $ | 16.76 | ||||||||||
Westway One | Dallas | 165,982 | 92 | % | $ | 3,103 | $ | 20.33 | $ | 20.17 | ||||||||||
Three Forest Plaza | Dallas | 366,549 | 77 | % | $ | 5,478 | $ | 19.32 | $ | 19.27 | ||||||||||
Spring Valley | Dallas | 94,304 | 76 | % | $ | 892 | $ | 12.48 | $ | 12.56 | ||||||||||
Tower Pavilion | Houston | 87,589 | 88 | % | $ | 1,007 | $ | 13.08 | $ | 13.55 | ||||||||||
The Preserve | Houston | 218,689 | 93 | % | $ | 3,310 | $ | 16.28 | $ | 16.25 | ||||||||||
Westheimer Central | Houston | 182,506 | 80 | % | $ | 1,676 | $ | 11.42 | $ | 11.20 | ||||||||||
11811 N Freeway | Houston | 156,362 | 79 | % | $ | 1,971 | $ | 15.90 | $ | 15.85 | ||||||||||
Atrium I | Houston | 118,461 | 76 | % | $ | 1,314 | $ | 14.52 | $ | 14.35 | ||||||||||
3100 Timmons | Houston | 111,265 | 82 | % | $ | 1,379 | $ | 15.15 | $ | 15.47 | ||||||||||
Cornerstone | Houston | 71,008 | 90 | % | $ | 903 | $ | 14.18 | $ | 14.12 | ||||||||||
Northchase | Houston | 128,981 | 85 | % | $ | 1,552 | $ | 14.21 | $ | 13.92 | ||||||||||
616 FM 1960 | Houston | 142,194 | 47 | % | $ | 1,237 | $ | 18.37 | $ | 18.19 | ||||||||||
601 Sawyer | Houston | 88,258 | 76 | % | $ | 1,100 | $ | 16.35 | $ | 15.80 | ||||||||||
Gulf Plaza | Houston | 120,651 | 89 | % | $ | 2,241 | $ | 20.89 | $ | 21.09 | ||||||||||
Timbercreek Atrium | Houston | 51,035 | 78 | % | $ | 685 | $ | 17.15 | $ | 17.51 | ||||||||||
Copperfield | Houston | 42,621 | 95 | % | $ | 744 | $ | 18.45 | $ | 18.45 | ||||||||||
400 N. Belt | Houston | 230,872 | 58 | % | $ | 1,519 | $ | 11.41 | $ | 11.44 | ||||||||||
Ashford Crossing | Houston | 158,451 | 71 | % | $ | 1,825 | $ | 16.31 | $ | 16.35 | ||||||||||
Regency Square | Houston | 64,063 | 86 | % | $ | 681 | $ | 12.32 | $ | 12.03 | ||||||||||
Energy Plaza | San Antonio | 180,119 | 77 | % | $ | 2,881 | $ | 20.69 | $ | 20.71 | ||||||||||
One Technology Ctr | San Antonio | 196,348 | 96 | % | $ | 4,680 | $ | 24.79 | $ | 24.73 | ||||||||||
Total -office | 4,150,026 | 77 | % | $ | 54,916 | $ | 16.81 | $ | 16.71 | |||||||||||
Industrial/Flex | ||||||||||||||||||||
Central Park | Dallas | 73,099 | 88 | % | $ | 574 | $ | 8.94 | $ | 8.84 | ||||||||||
Quitman | Houston | 736,957 | 88 | % | $ | 1,290 | $ | 1.98 | $ | 1.98 | ||||||||||
Mitchelldale | Houston | 377,752 | 94 | % | $ | 2,351 | $ | 6.60 | $ | 6.56 | ||||||||||
Total -Industrial/Flex | 1,187,808 | 89 | % | $ | 4,214 | $ | 3.94 | $ | 3.92 | |||||||||||
Grand Total | 6,669,865 | 82 | % | $ | 74,081 | $ | 13.62 | $ | 13.53 |
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our results of operations and financial condition, as reflected in the accompanying consolidated financial statements and related notes, require us to make estimates and assumptions that are subject to management’s evaluation and interpretation of business conditions, changing capital market conditions and other factors related to the ongoing viability of our customers. With different estimates or assumptions, materially different amounts could be reported in our consolidated financial statements. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on May 13, 2020, in the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations." There have been no significant changes to these policies during the three months ended March 31, 2020. See also Note 2 to our consolidated financial statements in this Quarterly Report on Form 10-Q for a discussion of our significant accounting policies.
RESULTS OF OPERATIONS
Comparison of the three months ended March 31, 2020 versus March 31, 2019.
As of March 31, 2020 and 2019, respectively, we owned 43 commercial properties comprising approximately 6.7 million square feet plus three pad sites, all located in Texas. As of March 31, 2020 and 2019, respectively, we owned 15 properties located in Richardson, Arlington, and Dallas, Texas, 25 properties located in Houston, Texas and three properties located in San Antonio, Texas.
Revenues - The primary source of our revenue is rental revenues and tenant reimbursements. For the three months ended March 31, 2020 and 2019 we had total rental revenues and tenant reimbursements of $23,139,000 and $23,309,000, respectively. Rental income increased $491,000. Tenant reimbursements decreased $528,000 net, including a reduction in prior year billing for operating expense reconciliation billings of $920,000.
Property operating expenses - Property operating expenses consist of contract services, repairs and maintenance, utilities, management fees and property level administrative expense including bad debt expense. For the three months ended March 31, 2020 and 2019, we had property operating expenses of $6,945,000 and $7,751,000, respectively. The decrease of $806,000 is primarily due to the decrease in bad debt expense of $732,000.
Asset management fees - We pay asset management fees to our advisor in connection with the management of our properties. Asset management fees incurred to our advisor were $440,000 for the three months ended March 31, 2020 and 2019, respectively.
Real estate taxes and insurance - Real estate taxes and insurance were $3,170,000 and $3,157,000 for the three months ended March 31, 2020 and 2019, respectively.
Depreciation and amortization - Depreciation and amortization were $6,982,000 and $7,030,000 for the three months ended March 31, 2020 and 2019, respectively. Depreciation and amortization decreased due to decrease for in-place lease value intangible amortization.
General and administrative expenses - General and administrative expenses consist primarily of audit fees, transfer agent fees, other professional fees, and independent director's compensation. General and administrative expenses were $1,177,000 for the three months ended March 31, 2020 and 2019, respectively.
Net income - We generated a net income of $1,884,000 and $360,000 for the three months ended March 31, 2020 and 2019, respectively. The increase in net income is primarily attributable to decrease in property operating expenses and interest expense, as well as an increase in interest and dividend income.
Funds From Operations and Modified Funds From Operations
Funds From Operations, or FFO, is a non-GAAP financial measure defined by the National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, which we believe is an appropriate supplemental measure to reflect the operating performance of a real estate investment trust, or REIT in conjunction with net income. FFO is used by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income or loss as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004, or the White Paper. The White Paper defines FFO as net
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income or loss computed in accordance with GAAP, excluding gains or losses from sales of property and asset impairment write-downs, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO. Our FFO calculation complies with NAREIT’s policy described above.
We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations, or the Practice Guideline, issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, nonrecurring unrealized gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.
Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as an indication of our performance, as an alternative to cash flows from operations as an indication of its liquidity, or indicative of funds available to fund its cash needs including its ability to make distributions to its stockholders. FFO and MFFO should be reviewed in conjunction with other GAAP measurements as an indication of our performance. MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and net asset value is disclosed. FFO and MFFO are not useful measures in evaluating net asset value because impairments are taken into account in determining net asset value but not in determining FFO or MFFO.
Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, the SEC, NAREIT, or another regulatory body may decide to standardize the allowable adjustments across the non-listed REIT industry and as a result we may have to adjust our calculation and characterization of FFO or MFFO.
The table below summarizes our calculation of FFO and MFFO for the three months ended March 31, 2020 and 2019 including a reconciliation of such non-GAAP financial performance measures to our net loss, in thousands.
Three Months Ended March 31, | |||||||||||
2020 | 2019 | ||||||||||
Net Income | $ | 1,884 | $ | 360 | |||||||
Depreciation and amortization of real estate assets | 6,982 | 7,030 | |||||||||
Funds from operations (FFO) | 8,866 | 7,390 | |||||||||
Modified funds from operations (MFFO) | $ | 8,866 | $ | 7,390 |
Distributions
The following table summarizes the distributions we paid in cash and pursuant to our distribution reinvestment plan for the period from January 2011 (the month we first paid distributions) through March 31, 2020, in thousands:
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Period | Cash (1) | DRIP (2)(3) | Total | ||||||||
Year ending December 31, 2011 | $ | 255 | $ | 242 | $ | 497 | |||||
Year ending December 31, 2012 | 891 | 869 | 1,760 | ||||||||
Year ending December 31, 2013 | 1,681 | 1,594 | 3,275 | ||||||||
Year ending December 31, 2014 | 2,479 | 2,358 | 4,837 | ||||||||
Year ending December 31, 2015 | 3,475 | 3,718 | 7,193 | ||||||||
Year ending December 31, 2016 | 8,918 | 2,988 | 11,906 | ||||||||
Year ending December 31, 2017 | 12,650 | — | 12,650 | ||||||||
Year ending December 31, 2018 | 12,555 | — | 12,555 | ||||||||
Year ending December 31, 2019 | 12,811 | — | 12,811 | ||||||||
Quarter ending March 31, 2020 | 3,223 | — | 3,223 | ||||||||
Total | $ | 58,938 | $ | 11,769 | $ | 70,707 |
(1)Distributions are paid on a monthly basis. Distributions for all record dates of a given month are paid approximately 20 days following the end of such month.
(2)Distributions accrued for the period from December 27, 2010 through December 31, 2010 were paid on January 20, 2011, the date we first paid a distribution.
(3)Amount of distributions paid in shares of common stock pursuant to our distribution reinvestment plan. Effective July 16, 2016, we terminated the sale of additional shares of our common stock to our stockholders pursuant to our distribution reinvestment plan.
Distributions to non-controlling interests were $2,138,000 and $2,147,000 for the three months ended March 31, 2020 and 2019, respectively.
For the three months ended March 31, 2020, we paid aggregate distributions of $3,223,000 in cash to common stockholders. During the same period, cash used in operating activities was $4,522,000 and our FFO was $8,866,000. For the three months ended March 31, 2020, 0% of distributions were paid from cash provided by operating activities and 100% from other proceeds. For the three months ended March 31, 2019, we paid aggregate distributions of $3,141,000. During the same period, cash used in operating activities was $6,078,000, and our FFO was $7,390,000. For the three months ended March 31, 2020, 0% of distributions were paid from cash provided by operating activities and 100% from other proceeds.
Liquidity and Capital Resources
Our principal demands for funds are and will continue to be for real estate and real estate-related acquisitions, for the payment of operating expenses, for the payment of interest on our outstanding indebtedness, and for the payment of distributions. Generally, we expect to meet cash needs for items other than acquisitions from our cash flow from operations; provided, that some or all of our distributions have been and may continue to be paid from sources other than cash from operations (as discussed below). We expect to meet cash needs for acquisitions from the remaining net proceeds of our follow-on offering and from financings.
There may be a delay between the sale of our shares of common stock and the purchase of properties or other investments, which could result in a delay in our ability to make distributions to our stockholders. Some or all of our distributions have been and may continue to be paid from sources other than cash flow from operations, including proceeds of our public offerings, cash advances to us by our advisor, cash resulting from a waiver of asset management fees and borrowings secured by our assets in anticipation of future operating cash flow. We may have little, if any, cash flow from operations available for distribution until we make substantial investments and those investments stabilize. In addition, to the extent our investments are in development or redevelopment projects or in properties that have significant capital requirements, our ability to make distributions may be negatively impacted, especially during our early periods of operation.
We use, and intend to use in the future, secured and unsecured debt to acquire properties and make other investments. As of March 31, 2020, our outstanding secured debt is $301,982,000. There is no limitation on the amount we may invest in any single property or other asset or on the amount we can borrow for the purchase of any individual property or other investment. Under our charter, we are prohibited from borrowing in excess of 300% of our “net assets” (as defined by our charter) as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent directors and if such excess is disclosed to the stockholders in the next quarterly report along with the explanation for such excess borrowings. Our board of directors has adopted a policy to limit our aggregate borrowings to approximately 50% of the aggregate value of our
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assets unless substantial justification exists that borrowing a greater amount is in our best interests. Such limitation, however, does not apply to individual real estate assets and only will apply once we have ceased raising capital in our public offering and
invested substantially all of our capital. As a result, we expect to borrow more than 50% of the contract purchase price of each real estate asset we acquire to the extent our board of directors determines that borrowing these amounts is prudent.
Pursuant to ASU 2014-15, “Presentation of Financial Statements – Going Concern,” management is required to evaluate the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are issued. The SPE Loan has an initial maturity date of October 9, 2020. The SPE Loan provides for three successive one-year maturity date extensions. In order to exercise each successive one-year extension options, the Hartman SPE must meet five conditions in order to extend the maturity date without any further qualification. One of the five conditions is that Hartman SPE must have a debt yield, as defined, of 12.5% or greater as of June 30, 2020.
As of March 31, 2020 and December 31, 2019, Hartman SPE has a debt yield of 12.91% and 13.29%, respectively. In response to the coronavirus outbreak and related economic disruption, the Company has undertaken cost reduction and avoidance measures which began in March 2020. Management expects the test period debt calculation to be 12.5% or greater which will allow the Company to exercise the extension option based solely on the terms of the loan agreement.
If the debt yield calculation as of the end of the June 30, 2020 test period is less than 12.5%, management believes that the lender will agree to a one-year extension, however, extension terms may be less favorable to the Company than as provided under the loan agreement. Any required modification of the loan agreement to conclude an extension of the maturity date may involve additional loan costs which would not otherwise be incurred.
Management has concluded that there is substantial doubt about the Company's ability to continue as a going concern within one year of the issuance date of these consolidated financial statements due to the fact of the uncertainty regarding the loan maturity of the SPE Loan. Management believes that Hartman SPE will be able to extend the maturity date for one year which will mitigate the maturity date issue within one year of the issuance date of these consolidated financial statements.
Our advisor may, but is not required to, establish capital reserves from gross offering proceeds, out of cash flow generated by operating properties and other investments or out of non-liquidating net sale proceeds from the sale of our properties and other investments. Capital reserves are typically utilized for non-operating expenses such as tenant improvements, leasing commissions and major capital expenditures. Alternatively, a lender may require its own formula for escrow of capital reserves.
Potential future sources of capital include proceeds from additional private or public offerings of our securities, secured or unsecured financings from banks or other lenders, proceeds from the sale of properties and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures.
The consolidated financial statements as of March 31, 2020 include the accounts of the Company, our operating partnership and its subsidiaries and Hartman SPE, LLC. Prior to October 1, 2018, our consolidated financial statements did not include Hartman SPE, LLC.
Cash Flows from Operating Activities
For the three months ended March 31, 2020 and 2019, net cash used in operating activities was $4,522,000 and $6,078,000, respectively.
Cash Flows from Investing Activities
For the three months ended March 31, 2020 and 2019, net cash used in investing activities was $2,182,000 and $2,497,000, respectively.
Cash Flows from Financing Activities
Net cash used in financing activities for the three months ended March 31, 2020 and 2019, respectively, was $1,972,000 and $11,430,000. The decrease in cash used in financing activities is primarily due to the retirement of the pre Hartman SPE Promenade loan and due to $3,800,000 funds received from an affiliate.
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Contractual Commitments and Contingencies
We use, and intend to use in the future, secured and unsecured debt, as a means of providing additional funds for the acquisition of our properties and our real estate-related assets. We believe that the careful use of borrowings will help us achieve our diversification goals and potentially enhance the returns on our investments. Under our charter, we are prohibited from borrowing in excess of 300% of our net assets, which generally approximates to 75% of the aggregate cost of our assets. We may borrow in excess of this amount if such excess is approved by a majority of the independent directors and disclosed to stockholders in our next quarterly report, along with a justification for such excess. In such event, we will monitor our debt levels and take action to reduce any such excess as practicable. Our aggregate borrowings are reviewed by our board of directors at least quarterly. As of March 31, 2020, our borrowings were not in excess of 300% of the value of our net assets.
In addition to using our capital resources for investing purposes and meeting our debt obligations, we expect to use our capital resources to make certain payments to our advisor. We expect to make payments to our advisor or its affiliates in connection with the selection and origination or purchase of real estate and real estate-related investments, the management of our assets, the management of the development or improvement of our assets and costs incurred by our advisor in providing services to us.
As of March 31, 2020, we had notes payable totaling an aggregate principal amount of $306,682,000. For more information on our outstanding indebtedness, see Note 6 (Notes payable) to the consolidated financial statements included in this report.
Off-Balance Sheet Arrangements
As of March 31, 2020 and December 31, 2019, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Recent Accounting Pronouncements
Management does not believe that any recently issued, but not yet effective accounting standards, if currently adopted, would have a material effect on the accompanying consolidated financial statements. See Note 2 to the notes to the accompanying consolidated financial statements included in this quarterly report.
Related-Party Transactions and Agreements
We have entered into agreements with our advisor and its affiliates whereby we have paid, and may continue to pay, certain fees to, or reimburse certain expenses of, our advisor and its affiliates. See Item 13, “Certain Relationships and Related Transactions and Director Independence” in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on May 13, 2020, and Note 9 (Related Party Transactions) to the consolidated financial statements included in this Quarterly Report for a discussion of the various related-party transactions, agreements and fees.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We will be exposed to interest rate changes primarily as a result of short and long-term debt used to acquire properties and make loans and other permitted investments. Our interest rate risk management objectives will be to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve these objectives, we expect to borrow primarily at fixed rates or variable rates with the lowest margins available and, in some cases, with the ability to convert variable rates to fixed rates. With regard to variable rate financing, we will assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of this Form 10-Q, as of March 31, 2020, an evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). In performing this evaluation, management reviewed the selection, application and monitoring of our historical accounting policies. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2020, these disclosure controls and procedures were effective and designed to ensure that the information required to be disclosed in our reports filed with the SEC under the Exchange Act is recorded, processed, summarized and reported as and when required.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal controls over financial reporting that occurred during the quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financing reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
Our stockholders will be diluted by the Mergers.
The Mergers will dilute the ownership position of our current stockholders and result in our stockholders (excluding stockholders affiliated with our advisor or sponsor) having an ownership stake in us that is smaller than their current stake in our company. In connection with the Mergers, we will issue up to approximately 19,192,000 shares of our common stock to the holders of shares of Hartman XIX and HIREIT capital stock, based on the exchange ratios set forth in the Merger Agreements and the shares of Hartman XIX and HIREIT capital stock issued and outstanding as of March 31, 2020. Our current stockholders (excluding stockholders affiliated with our advisor or sponsor) are expected to hold in the aggregate approximately 49% of the issued and outstanding shares of our common stock following the Mergers, based on the ownership of stock by shareholders of each of the Merger Parties and the conversion ratios established in the Merger Agreements and the approximately 18,117,000 shares of our common stock issued and outstanding as of March 31, 2020. In addition, approximately 979,000 units of limited partnership interest in our operating partnership are issuable in connection with the Partnership Merger. Consequently, our stockholders (excluding stockholders affiliated with our advisor or sponsor), as a general matter, will have less influence over the management and policies of us after the Mergers than they exercised over the management and policies of us immediately prior to the Mergers.
Following the consummation of the Mergers, we will assume certain potential liabilities relating to Hartman XIX and HIREIT.
When the Mergers are consummated, we will have assumed certain potential liabilities relating to Hartman XIX and HIREIT. These liabilities could have a material adverse effect on our business to the extent we have not identified such liabilities or have underestimated the amount of such liabilities.
The future results of the combined company will suffer if the combined company does not effectively integrate and manage its expanded operations following the Mergers.
Following the Mergers, we expect to continue to expand our operations through additional acquisitions and other strategic transactions, some of which may involve complex challenges. Our future success will depend, in part, upon our ability to manage expansion opportunities, which may pose substantial challenges to integrate new operations into our existing business in an efficient and timely manner, and upon our ability to successfully monitor our operations, costs, regulatory compliance and service quality, and to maintain other necessary internal controls. There is no assurance that our expansion or acquisition opportunities will be successful, or that we will realize the expected operating efficiencies, cost savings, revenue enhancements or other benefits.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits
Exhibit | Description | |||||||
3.1 | ||||||||
3.2 | ||||||||
3.3 | ||||||||
3.4 | ||||||||
31.1* | ||||||||
31.2* | ||||||||
32.1* | ||||||||
101.INS* | XBRL Instance Document | |||||||
101.SCH* | XBRL Taxonomy Extension Schema Document | |||||||
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |||||||
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |||||||
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* Filed herewith
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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.
HARTMAN SHORT TERM INCOME PROPERTIES XX, INC.
Date: June 15, 2020
By: /s/ Allen R. Hartman
Allen R. Hartman,
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: June 15, 2020
By: /s/ Louis T. Fox, III
Louis T. Fox, III,
Chief Financial Officer,
(Principal Financial and Principal Accounting Officer)
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