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COLE > SEC Filings for COLE > Form 10-Q on 5-Nov-2013All Recent SEC Filings

Show all filings for COLE REAL ESTATE INVESTMENTS, INC.

Form 10-Q for COLE REAL ESTATE INVESTMENTS, INC.


5-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated unaudited financial statements, the notes thereto and the other unaudited financial data included in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements and the notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2012. The terms "we," "us," "our" and the "Company" refer to Cole Real Estate Investments, Inc. and unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our condensed consolidated unaudited financial statements and the notes thereto.
Forward-Looking Statements
Except for historical information, this section contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including discussion and analysis of our financial condition and our subsidiaries, our anticipated capital expenditures, amounts of anticipated cash dividends to our stockholders in the future and other matters. These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on their knowledge and understanding of our business and industry. Words such as "may," "will," "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "would," "could," "should" or comparable words, variations and similar expressions are intended to identify forward-looking statements. All statements not based on historical fact are forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or implied in the forward-looking statements. A full discussion of our risk factors may be found under "Item 1A - Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 and in this Quarterly Report on Form 10-Q.
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Investors are cautioned not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date of this Quarterly Report on Form 10-Q. We make no representation or warranty (expressed or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q. Additionally, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. Factors that could cause actual results to differ materially from any forward-looking statements made in this Quarterly Report on Form 10-Q include, among others, (1) changes in national, international, regional and local economic conditions, (2) changes in financial markets, interest rates, credit spreads, and foreign currency exchange rates, (3) changes in real estate conditions, (4) continued ability to source new investments, (5) risks associated with acquisitions, (6) construction costs that may exceed estimates, and construction delays, (7) lease-up risks, rent relief, and inability to obtain new tenants upon the expiration or termination of existing leases, (8) maintenance of real estate investment trust status, (9) legal matters, (10) availability of financing and capital generally, (11) inability to obtain financing or refinance existing debt and the potential need to fund tenant improvements or other capital expenditures out of operating cash flows,
(12) changes in demand for properties, (13) risks associated with the ability to consummate the ARCP Merger and the timing of the closing of the ARCP Merger, and
(14) additional risks and factors discussed in reports filed by the Company with the SEC from time to time. The forward-looking statements should be read in light of the risk factors identified under "Item 1A - Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 and in this Quarterly Report on Form 10-Q. Management's discussion and analysis of financial condition and results of operations are based upon our condensed consolidated unaudited financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management's historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates. Overview
We were formed on January 22, 2008 to acquire and operate a diverse portfolio of core commercial real estate investments primarily consisting of necessity retail properties located throughout the United States, including U.S. protectorates. We elected to be taxed, and currently qualify, as a REIT for federal income tax purposes. We are headquartered in Phoenix, Arizona and had approximately 350 employees as of September 30, 2013.


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On March 5, 2013, we entered into the Cole Holdings Merger Agreement with Holdings, Merger Sub and the Holdings Stockholder. The Cole Holdings Merger Agreement provided for the merger of Holdings with and into Merger Sub, with Merger Sub surviving and continuing its existence under the laws of the state of Maryland as our wholly owned subsidiary. Effective April 5, 2013, we consummated the Cole Holdings Merger and acquired the business conducted by Holdings. As a result of the Cole Holdings Merger, in addition to operating a diverse portfolio of core commercial real estate investments, we are responsible for managing the Managed REITs' affairs on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs' behalf, and recommending to each of the Managed REIT's respective board of directors an approach for providing investors with liquidity. We receive compensation and reimbursement for services relating to the Managed REITs' offerings and the investment, management, financing and disposition of their respective assets, as applicable. Furthermore, we, through a wholly owned subsidiary, wholly own CCA, which we and CCA jointly elected to treat as a TRS for federal income tax purposes. In order to avoid a potential adverse impact on our status as a REIT, we conduct substantially all of our investment management business through the TRS. Our business operates in two business segments, Real Estate Investment and Private Capital Management.
On October 22, 2013, we entered into the ARCP Merger Agreement with ARCP and ARCP Merger Sub. The ARCP Merger Agreement provides for the merger of us with and into ARCP Merger Sub, with ARCP Merger Sub surviving as a direct wholly owned subsidiary of ARCP. Our board of directors has, by unanimous vote of the members of the board of directors, approved the ARCP Merger Agreement, the ARCP Merger and the other transactions contemplated by the ARCP Merger Agreement. See Note 19 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further discussion regarding the ARCP Merger. Through our REI segment, we expect that we will continue to acquire properties throughout 2013 and 2014 prior to the ARCP Merger utilizing borrowings on the Credit Facility, the proceeds from the strategic sale of properties and/or marketable securities, proceeds from financings on owned properties and future property acquisitions and other investments and cash flows from operations. We expect property acquisitions through 2013 to be less than acquisitions in 2012. Our operating results and cash flows in the REI segment are primarily influenced by rental income from our commercial properties, interest expense on our property acquisition indebtedness and acquisition, compensation and operating expenses. Rental and other property income from our commercial real estate portfolio accounted for 87% and 86% of total revenue for the REI segment during the three months ended September 30, 2013 and 2012, respectively, and 87% of total revenue during each of the nine months ended September 30, 2013 and 2012. As 99% of our rentable square feet was under lease as of September 30, 2013, with a weighted average remaining lease term of 11.9 years, we believe our exposure to changes in commercial rental rates on our portfolio is substantially mitigated, except for vacancies caused by tenant bankruptcies or other factors. We regularly monitor the creditworthiness of our tenants by reviewing the tenant's financial results, credit rating agency reports (if any) on the tenant or guarantor, the operating history of the property with such tenant, the tenant's market share and track record within its industry segment, the general health and outlook of the tenant's industry segment, and other information for changes and possible trends. If we identify significant changes or trends that may adversely affect the creditworthiness of a tenant, we will gather a more in-depth knowledge of the tenant's financial condition and, if necessary, attempt to mitigate the tenant credit risk by evaluating the possible sale of the property, or identifying a possible replacement tenant should the current tenant fail to perform on the lease. As of September 30, 2013, the debt leverage ratio of our consolidated real estate assets, which is the ratio of debt to total gross real estate and related assets net of gross intangible lease liabilities, was 51%. As we acquire additional commercial real estate, we will be subject to changes in real estate prices and changes in interest rates on any new indebtedness used to acquire the properties. We may manage our risk of changes in real estate prices on future property acquisitions by entering into purchase agreements and loan commitments simultaneously, or through loan assumption, so that our operating yield is determinable at the time we enter into a purchase agreement, by contracting with developers for future delivery of properties, or by entering into sale-leaseback transactions. We manage our interest rate risk by monitoring the interest rate environment in connection with future property acquisitions or upcoming debt maturities to determine the appropriate financing or refinancing terms, which may include fixed rate loans, variable rate loans or interest rate hedges. If we are unable to acquire suitable properties or obtain suitable financing terms for future acquisitions or refinancing, our results of operations may be adversely affected. Our operating results in the PCM segment are primarily influenced by the capital we raise and commercial properties we acquire and manage on behalf of the Managed REITs. We are currently raising capital and/or acquiring assets on behalf of certain Managed REITs. We seek to manage the variability associated with these revenues by creating product offerings that last two years or more and offering multiple REITs with different investment objectives simultaneously. Additionally, we may seek to structure new REITs with similar investment objectives to commence their respective offerings upon the completion of the primary offering of an existing REIT with a similar investment objective.


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Recent Market Conditions
Beginning in late 2007, domestic and international financial markets experienced significant disruptions that severely impacted the availability of credit and contributed to rising costs associated with obtaining credit. Financial conditions affecting commercial real estate have improved and continue to improve, as low treasury rates and increased lending from banks, insurance companies and CMBS conduits have increased lending activity. Nevertheless, the debt market remains sensitive to the macro environment, such as Federal Reserve policy, market sentiment, or regulatory factors affecting the banking and CMBS industries. While we expect that financial conditions will remain favorable, if they were to deteriorate we may experience more stringent lending criteria, which may affect our ability to finance certain property acquisitions or refinance any debt at maturity. Additionally, for properties for which we are able to obtain financing, the interest rates and other terms on such loans may be unacceptable. We expect to manage the current mortgage lending environment by considering alternative lending sources, including securitized debt, fixed rate loans, Credit Facility borrowings, short-term variable rate loans, assumed mortgage loans in connection with property acquisitions, interest rate lock or swap agreements, or any combination of the foregoing.
Commercial real estate fundamentals continue to strengthen, as a moderate pace of job creation has supported gains in office absorption, retail sales, and warehouse distribution. Although construction activity has increased, it remains near historic lows; as a result, incremental demand growth has helped to reduce vacancy rates and support modest rental growth. Improving fundamentals have resulted in gains in property values; however, in many markets property values, occupancy and rental rates continue to be below those previously experienced before the economic downturn. As of September 30, 2013, 99% of our rentable square feet was under lease, and we expect that occupancy will remain high as the real estate recovery continues. However, if recent improvements in the economy reverse course, we may experience vacancies or be required to reduce rental rates on occupied space. If we do experience vacancies, we will actively seek to lease our vacant space; nevertheless, such space may be leased at lower rental rates and for shorter lease terms than our current leases provide.

In addition, as we are responsible for managing the Managed REITs and identifying and making acquisitions and investments on the Managed REITs' behalf, we continue to see investment opportunities that we believe will allow us to structure transactions on profitable terms for the Managed REITs and future REITs or other programs we may manage. We developed an investment approach that focuses on single-tenant commercial properties and multi-tenant power centers, which are leased to name-brand creditworthy tenants, subject to long-term net leases. We believe that the real estate and related investment environment remains attractive and that we will be able to deliver favorable yields for the Managed REITs. However, our primary investment focus on necessity-based real estate has gained popularity in the marketplace; as such, we have experienced increased competition for real estate and related investments. With increased competition, there is a potential for additional pressure on the returns that we can generate from our investments and our ability to execute transactions, which may impact our ability to raise capital on behalf of the Managed REITs.
Results of Operations
As a result of the Cole Holdings Merger, we evaluate our operating results by our two business segments, Real Estate Investment and Private Capital Management.
Real Estate Investment Segment
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate investments. The following table shows the property statistics of our real estate assets, including the Consolidated Joint Ventures, as of September 30, 2013 and 2012:

                                                   September 30,
                                               2013             2012
Number of commercial properties (1)              1,026              968
Approximate rentable square feet (2)      44.8 million     41.4 million
Percentage of rentable square feet leased           99 %             99 %


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(1) Excludes properties owned through the Unconsolidated Joint Ventures.

(2) Includes square feet of the buildings on land that are subject to ground leases.


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The following table summarizes our real estate investment activity, including the Consolidated Joint Ventures, during the three and nine months ended September 30, 2013 and 2012:

                              Three Months Ended September 30,     Nine Months Ended September 30,
                                  2013              2012               2013              2012
Commercial properties
acquired (1)                           17                  42               32                287
Approximate purchase price of  $    120.0     $ 371.0 million       $    410.7     $  1.5 billion
acquired properties               million                              million
Commercial properties                   5                   -               20                 12
disposed of
Approximate sales price of     $     13.4     $             -       $    100.1     $ 69.4 million
disposed properties               million                              million


________________


(1) Excludes properties owned through the Unconsolidated Joint Ventures.

Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012
Revenue. REI revenue increased $26.5 million, or 19%, to $166.7 million for the three months ended September 30, 2013, compared to $140.2 million for the three months ended September 30, 2012. Our REI revenue consisted primarily of rental and other property income from net leased commercial properties, which accounted for 87% and 86% of total REI revenue during the three months ended September 30, 2013 and 2012, respectively.
Rental and other property income increased $23.5 million, or 19%, to $144.6 million for the three months ended September 30, 2013, compared to $121.1 million for the three months ended September 30, 2012. The increase was primarily due to an increase in the average gross real estate assets net of gross intangible lease liabilities we owned to $7.0 billion for three months ended September 30, 2013, compared to $6.3 billion for the three months ended September 30, 2012. We also pay certain operating expenses subject to reimbursement by our tenants, which resulted in $15.2 million of tenant reimbursement income during the three months ended September 30, 2013, compared to $10.8 million during the three months ended September 30, 2012. We also review our stabilized operating results from properties that we owned for the entirety of both the current and prior year reporting periods, referred to as "same store." The following table shows our same store portfolio statistics for the three months ended September 30, 2013 and 2012, which include 887 properties, excluding properties acquired through the Unconsolidated Joint Ventures, acquired prior to July 1, 2012 and owned through September 30, 2013 (dollar amounts in thousands):

                                      Three Months Ended September
                                                  30,                    Increase/(Decrease)
                                          2013            2012         $ Change       % Change
Same store base rental revenue (1)    $   113,823     $  111,821     $     2,002          1.8  %
Same store other rental revenue (1)         5,721          7,190          (1,469 )      (20.4 )%
Total same store rental revenue           119,544        119,011             533          0.4  %

Rental and other property income
from income-producing properties
acquired subsequent to June 30,            25,016          2,094          22,922      1,094.7  %
2012 and properties sold prior to
September 30, 2013

Total rental and other property       $   144,560     $  121,105     $    23,455         19.4  %
income


________________


(1) Base rental revenue represents contractual base rental revenue earned and does not include the impact of certain GAAP adjustments to rental revenue, such as straight-line rent adjustments, amortization of above market intangible lease assets or the amortization of below market lease intangible liabilities. Such GAAP adjustments and other rental revenue such as tenant reimbursement income are included in the line item, referred to as "same store other rental revenue."


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In addition, we earn revenue on our real estate-related investments, including interest income on notes receivable and marketable securities. Interest income on notes receivable increased $190,000, or 11%, to $2.0 million for the three months ended September 30, 2013, compared to $1.8 million for the three months ended September 30, 2012. The increase was due to a full quarter of interest income earned on the $25.0 million Mezzanine Note during the three months ended September 30, 2013 as the Mezzanine Note was acquired during the three months ended September 30, 2012. We also recorded interest income on marketable securities of $5.0 million for the three months ended September 30, 2013, compared to $6.5 million for the three months ended September 30, 2012. We owned marketable securities with an average face value of $290.0 million during the three months ended September 30, 2013, compared to marketable securities with an average face value of $418.9 million during the three months ended September 30, 2012.
General and Administrative Expenses and Property and Asset Management Expenses. In aggregate, general and administrative expenses and property and asset management expenses decreased $2.3 million, or 15%, to $12.7 million for the three months ended September 30, 2013, compared to $15.0 million for the three months ended September 30, 2012. Prior to the Cole Holdings Merger, pursuant to the advisory agreement with Holdings, we paid property and asset management fees and reimbursements to Holdings related to these services. These fees and reimbursements were recorded in property and asset management expenses in the accompanying condensed consolidated unaudited financial statements included in this Quarterly Report on Form 10-Q. Subsequent to the Cole Holdings Merger Date, we were no longer required to pay these fees and reimbursements and all general and administrative expenses incurred are allocated between the PCM segment and REI segment and are recorded in general and administrative expenses in the accompanying condensed consolidated unaudited financial statements included in this Quarterly Report on Form 10-Q.
For the three months ended September 30, 2013, we incurred $12.5 million of general and administrative expenses. The primary general and administrative expense items were the REI segment's share of employee compensation and benefits, including stock-based compensation, of $6.5 million, professional and accounting fees and escrow and trustee fees. In addition, general and administrative expenses included $1.9 million of costs related to the Listing and Tender Offer expenses incurred during the three months ended September 30, 2013. During the three months ended September 30, 2013, we incurred $263,000 of third-party property management fees.
Merger Related Stock-Based Compensation. For the three months ended September 30, 2013, we recorded merger related stock-based compensation expense of $13.3 million, which was due to the amortization of the compensation expense related to the Escrow Shares in connection with the Upfront Stock Consideration and the Listing Consideration. See Note 3 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further details. No merger related stock-based compensation expense was recorded during the three months ended September 30, 2012.
Property Operating Expenses. Property operating expenses increased $5.0 million, or 39%, to $17.7 million for the three months ended September 30, 2013, compared to $12.7 million for the three months ended September 30, 2012. The increase was primarily due to increased property taxes, utilities, repairs and maintenance and insurance expenses relating to owning an average of $7.0 billion of gross real estate assets net of gross intangible lease liabilities during the three months ended September 30, 2013, compared to owning an average of $6.3 billion of gross real estate assets net of gross intangible lease liabilities during the three months ended September 30, 2012. In addition, the increase was due to the ownership of more properties during the three months ended September 30, 2013 than in the three months ended September 30, 2012, for which we initially pay certain operating expenses and are reimbursed by the tenant in accordance with the respective lease agreements. Of these property operating expenses, 93% are reimbursable by the respective tenants.
Merger and Acquisition Related Expenses. Merger and acquisition related expenses of $25.2 million for the three months ended September 30, 2013 primarily consisted of a $22.9 million increase in the fair value of the Merger Contingent Consideration recorded during such period, as discussed in Note 5 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. In addition, we recorded $2.0 million for legal, consulting and other expenses related to the Cole Holdings Merger during the three months ended September 30, 2013, and $2.5 million during the three months ended September 30, 2012. Property related acquisition expenses decreased $10.8 million to $308,000 for the three months ended September 30, 2013, compared to $11.1 million for the three months ended September 30, 2012. The decrease was due to acquisition related expenses incurred in connection with the purchase of 17 commercial properties, for an aggregate purchase price of $120.0 million, during the three months ended September 30, 2013, compared to 42 commercial properties, for an aggregate purchase price of $371.0 million, during the three months ended September 30, 2012. In addition, prior to the Cole Holdings Merger, pursuant to the advisory agreement with Holdings, we paid an acquisition fee to Holdings of 2% of the contract purchase price of each property or asset acquired. We also reimbursed Holdings for acquisition expenses incurred in the process of acquiring property or in the origination or acquisition of a loan other than for personnel costs for which Holdings received acquisition fees. Subsequent to the Cole Holdings Merger, these fees and reimbursements were eliminated.


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Depreciation and Amortization Expenses. Depreciation and amortization expenses increased $9.0 million, or 22%, to $49.8 million for the three months ended September 30, 2013, compared to $40.8 million for the three months ended September 30, 2012. The increase was primarily due to an increase in the average invested assets to $7.5 billion for the three months ended September 30, 2013 from $6.7 billion for the three months ended September 30, 2012.
Other Income. Other income decreased $205,000, or 42%, to $278,000 for the three months ended September 30, 2013, compared to $483,000 for the three months ended September 30, 2012. The decrease was primarily due to a decrease in equity in income of unconsolidated entities for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. This decrease was partially offset by an increase of other miscellaneous non-rental related income . . .

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