UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

 

 

(Mark One)

 

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

OR

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

 

Commission file number 000-55776

 

 

 

RW Holdings NNN REIT, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Maryland   47-4156046
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
     
3090 Bristol Street Suite 550
Costa Mesa, CA
  92626
(Address of Principal Executive Offices)   (Zip Code)

 

(855) 742-4862

(Registrant’s Telephone Number, Including Area Code)

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class   Name of Each Exchange on Which Registered
None   None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value per share

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes   ¨   No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  ¨   No   x

 

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  x   No   ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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  x   No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment of this Form 10-K.   ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer ¨   Accelerated Filer ¨
Non-Accelerated Filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x
      Emerging growth company   x

 

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.    x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act). Yes  ¨   No   x

 

While there is no established market for the Registrant’s shares of common stock, the Registrant is in the process of making an initial public offering of its shares of Class C common stock pursuant to a Registration Statement on Form S-11 (Commission File No. 333-205684) and an offering of its shares of Class S common stock exclusively to non-U.S. Persons as defined under Rule 903 promulgated under the Securities Act pursuant to an exemption from the registration requirements of the Securities Act under and in accordance with Regulation S of the Securities Act. The Registrant is currently offering shares of both Class C and Class S common stock at $10.05 per share.

 

There were approximately 6,149,237 shares of Class C common stock and no shares of Class S common stock held by non-affiliates as of June 30, 2017, the last business day of the Registrant’s most recently completed second fiscal quarter.

 

As of March 27, 2018, there were 10,041,231 outstanding shares of the Registrant’s Class C common stock and 3,065 outstanding shares of the Registrant’s Class S common stock.

 

Documents Incorporated by Reference:

Portions of the Registrant’s definitive proxy statement with respect to the 2018 annual meeting of stockholders are incorporated by reference in Part III of this report. The definitive proxy statement or an amendment to this Form 10-K will be filed no later than 120 days after the end of the Registrant’s fiscal year ended December 31, 2017.

 

 

 

 

 

TABLE OF CONTENTS

 

PART I     4
  ITEM 1. BUSINESS 4
  ITEM 1A. RISK FACTORS 12
  ITEM 1B. UNRESOLVED STAFF COMMENTS 35
  ITEM 2. PROPERTIES 36
  ITEM 3. LEGAL PROCEEDINGS 41
  ITEM 4. MINE SAFETY DISCLOSURES 41
PART II     41
  ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 41
  ITEM 6. SELECTED FINANCIAL DATA 50
  ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 50
  ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 61
  ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 61
  ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 61
  ITEM 9A. CONTROLS AND PROCEDURES 61
  ITEM 9B. OTHER INFORMATION 63
PART III     63
  ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 63
  ITEM 11. EXECUTIVE COMPENSATION 63
  ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 63
  ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE 63
  ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 63
PART IV     63
  ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 63
  ITEM 16 FORM 10-K SUMMARY 65
       
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F-1

 

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FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Annual Report on Form 10-K of RW Holdings NNN REIT, Inc. (the “Company”), other than historical facts, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act, Section 21E of the Exchange Act and other applicable law. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. We caution readers not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date this Annual Report on Form 10-K is filed with the Securities and Exchange Commission (the “SEC”). 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.

 

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. Stockholders should carefully review the Item 1A. Risk Factors section below for a discussion of the risks and uncertainties that we believe are material to our business, operating results, prospects and financial condition.

 

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 Annual Report on Form 10-K. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained hereunder. Except as otherwise required by federal securities laws, we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I

 

ITEM 1.BUSINESS

 

Overview

 

RW Holdings NNN REIT, Inc. (the “Company”), formerly Rich Uncles NNN REIT, Inc, was formed on May 14, 2015 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2016 and it intends to continue to operate in such a manner. As used herein, the terms “we,” “our” and “us” refer to the Company and as required by context, Rich Uncles NNN Operating Partnership, LP, a Delaware limited partnership, which we refer to as our “Operating Partnership,” and to their subsidiaries. We expect to conduct our business substantially through our Operating Partnership, of which we are the sole general partner.

 

We intend to invest primarily in single tenant income-producing properties which are leased to creditworthy tenants under long-term net leases. Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in entities that own and operate real estate. We will make acquisitions of our real estate investments directly through our Operating Partnership or indirectly through limited liability companies or limited partnerships, including through other REITs, or through investments in joint ventures, partnerships, tenants-in-common, co-tenancies or other co-ownership arrangements with other owners of properties, affiliates of our advisor, Rich Uncles NNN REIT Operator (our “Advisor”) or other persons.

 

Subject to certain restrictions and limitations, our business is externally managed by our Advisor pursuant to a Second Amended and Restated Advisory Agreement (the “Advisory Agreement”) we entered into effective August 11, 2017 with our Advisor and BrixInvest, LLC (f/k/a Rich Uncles, LLC) (referred to herein as “Brix” or our “Sponsor”). Our Advisor, which is wholly-owned by our Sponsor, manages our operations and our portfolio of core real estate properties and real estate related assets. Our Advisor also provides asset management, and other administrative services on our behalf. Our Advisor is paid certain fees as set forth in Note 9 of the Notes to our Consolidated Financial Statements included herein.

 

We have investor relations personnel, but all expenses are reimbursed by our Sponsor as part of the organizational and offering services they provide to us to manage our organization and offering and provide administrative investor relations services. However, our Sponsor is then entitled to include the reimbursement of such expenses as part of our reimbursement to them of organizational and offering costs, but reimbursement shall not exceed an amount equal to 3% of our initial public offering gross offering proceeds.

 

 On June 24, 2015, our Sponsor purchased 10,000 shares of common stock for $100,000 and became the initial stockholder. Our Sponsor purchased another 10,000 shares of common stock on December 31, 2015 for $100,000.

 

On July 15, 2015, we filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to register an initial public offering of a maximum of $900,000,000 in shares of common stock for sale to the public (the “Primary Offering”). We also registered a maximum of $100,000,000 of common stock pursuant to the Company’s distribution reinvestment plan (the “Registered DRP Offering”) and, together with the Primary Offering, the “Registered Offering”). The SEC declared the Company’s registration statement effective on June 1, 2016 and on July 20, 2016, we began offering shares of common stock to the public. Commencing in August 2017, we began selling shares of Class C common stock only to U.S. persons as defined under Rule 903 promulgated under the Securities Act.

 

On August 11, 2017, we began offering up to 100,000,000 shares of Class S common stock exclusively to non-U.S. Persons as defined under Rule 903 promulgated under the Securities Act pursuant to an exemption from the registration requirements of the Securities Act and in accordance with Regulation S of the Securities Act (the “Class S Offering”) and, together with the Registered Offering (the “Offerings”). The Class S common stock has similar features and rights as the Class C common stock, including with respect to voting and liquidation except that the Class S common stock offered in the Class S offering may be sold through brokers or other persons who may be paid upfront and deferred selling commissions and fees.

 

On January 18, 2018, the Company’s board of directors approved and established an estimated NAV per share of the Company’s common stock in the Offerings of $10.05. Effective January 19, 2018, the purchase price per share of the Company’s common stock in the Offerings is $10.05, and the minimum initial investment in shares of our common stock in the Offerings is $500.

 

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Through December 31, 2017, we had sold 9,055,175 shares of Class C common stock in the Registered Offering, including 319,150 shares of Class C common stock sold under the Registered DRP Offering, for aggregate gross offering proceeds of $90,551,753, and 3,032 shares of Class S common stock in the Class S Offering, including 32 shares of Class S common stock sold under the Company’s dividend reinvestment plan applicable to Class S common stock, for aggregate gross offering proceeds of $30,324.

 

Our Advisor will make recommendations on all proposed real estate investments to our board of directors. All proposed real estate investments must be approved by at least a majority of our board of directors.

 

We elected to be taxed as a REIT under the Internal Revenue Code, beginning with the taxable year ended December 31, 2016. If we meet the REIT qualification requirements, we generally will not be subject to federal income tax on the income that we distribute to our stockholders each year. If we fail to qualify for taxation as a REIT in any year after electing REIT status, our income will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify. Such an event could materially and adversely affect our net income and cash available for distribution to our stockholders. 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 continue to operate so as to remain qualified as a REIT for federal income tax purposes thereafter.

 

Investment Objectives and Strategies

 

Overview

 

We expect to use substantially all of the net proceeds from the Offerings to acquire and manage a portfolio of real estate investments. We intend to invest primarily in single tenant income-producing corporate commercial properties which are leased to creditworthy tenants under long-term net leases. While our focus is on single tenant net leased properties, we plan to diversify our portfolio by geography, investment size and investment risk with the goal of acquiring a portfolio of income-producing real estate investments that provides attractive and stable returns to our stockholders. Our investment objectives and policies may be amended or changed at any time by our board of directors. Although we have no plans at this time to change any of our investment objectives, our board of directors may change any and all such investment objectives, including our focus on single tenant properties, if it believes such changes are in the best interests of our stockholders. We intend to notify our stockholders of any change to our investment policies by disclosing such changes in a public filing such as a prospectus supplement, or through a filing under the Exchange Act, as appropriate. There can be no assurance that our policies or investment objectives will be attained or that the value of our common stock will not decrease.

 

Primary Investment Objectives

 

Our primary investment objectives are:

 

·to provide our stockholders with attractive and stable cash distributions; and

·to preserve and return stockholder capital contribution.

 

We will also seek to realize growth in the value of our investment by timing the sale of our properties to maximize asset value. We may return all or a portion of stockholder capital contributions in connection with the sale of the Company or our properties.

 

While initial purchases of our properties will be funded with funds received from the sale of shares in the Offerings, we anticipate incurring mortgage debt (not to exceed 50% of total value of all of our properties) against individual properties and/or pools of individual properties and pledging such properties as security for that debt to obtain funds to acquire additional properties.

   

Investment Strategy

 

We will seek to acquire a portfolio consisting primarily of single tenant net leased properties throughout the United States diversified by corporate credit, physical geography, product type, and lease duration. Although we have no current intention to do so, we may also invest a portion of the net proceeds in single tenant net leased properties outside the United States. We intend to acquire assets consistent with our single tenant acquisition philosophy by focusing primarily on properties:

 

·where construction is substantially complete to reduce risks associated with construction of new buildings;

 

·leased on a “net” basis, where the tenant is responsible for the payment, and fluctuations in costs, of real estate and other taxes, insurance, utilities, and property maintenance;

 

·located in primary, secondary and certain select tertiary markets;

 

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·leased to tenants with strong financial statements, including investment grade credit quality, at the time we acquire them; and

 

·subject to long-term leases with defined rental rate increases.

 

We will seek to provide our stockholders the following benefits:

 

·a cohesive management team experienced in all aspects of real estate investment with a track record of acquiring single tenant net leased properties;

 

·stable cash flow backed by a portfolio of single tenant net leased real estate assets;

 

·minimal exposure to operating and maintenance expense increases via the net lease structure where the tenant assumes responsibility for these costs;

 

·contractual rental rate increases enabling higher potential distributions and a hedge against inflation;

 

·insulation from short-term economic cycles resulting from the long-term nature of the tenant leases;

 

·enhanced stability resulting from strong credit characteristics of most of the tenants; and

 

·portfolio stability promoted through geographic and product type investment diversification.

 

There can be no assurance that any of the properties we acquire will result in the benefits discussed above. See Item 1A, Risk Factors — Risks Related to Investments in Single Tenant Real Estate.

 

General Acquisition and Investment Policies

 

We will seek to make investments that satisfy the primary investment objective of providing regular cash distributions to our stockholders. However, because a significant factor in the valuation of income-producing real property is its potential for future appreciation, we anticipate that some properties we acquire may have the potential both for growth in value and for providing regular cash distributions to our stockholders.

 

Although this is our current focus, we may make adjustments to our target portfolio based on real estate market conditions and investment opportunities. We will not forego a good investment because it does not precisely fit our expected portfolio composition. We believe that we are most likely to meet our investment objectives through the careful selection of assets. When making an acquisition, we will emphasize the performance and risk characteristics of that investment, how that investment will fit with our portfolio-level performance objectives, the other assets in our portfolio and how the returns and risks of that investment compare to the returns and risks of available investment alternatives. Thus, to the extent that our Advisor presents us with what we believe to be good investment opportunities that allow us to meet the REIT requirements under the Internal Revenue Code, our portfolio composition may vary from what we initially expect. However, we will attempt to construct a portfolio that produces stable and attractive returns by spreading risk across different real estate investments.

 

Our Advisor has substantial discretion with respect to the selection of specific properties. However, acquisition parameters will be established by our board of directors. We and our Advisor consider a number of factors in the selection, including, but not limited to, the following:

 

·tenant creditworthiness;

·lease terms, including length of lease term, scope of landlord responsibilities if any under the net lease context, and frequency of contractual rental increases;

·projected demand in the area;

·a property’s geographic location and type;

·proposed purchase price, terms and conditions;

·historical financial performance;

·a property’s physical location, visibility, curb appeal and access;
·construction quality and condition;
·potential for capital appreciation;
·demographics of the area, neighborhood growth patterns, economic conditions, and local market conditions;
·potential capital reserves required to maintain the property;
·the potential for the construction of new properties in the area;

 

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·evaluation of title and obtaining of satisfactory title insurance;

·evaluation of any reasonable ascertainable risks such as environmental contamination; and

·replacement use of the property in the event of loss of existing tenant (no special use properties).

 

There is no limitation on the number, size or type of properties that we may acquire or on the percentage of net offering proceeds that may be invested in any particular property type or single property. The number and mix of properties will depend upon real estate market conditions and other circumstances existing at the time of acquisition and the amount of proceeds from the Offerings.

 

Creditworthiness of Tenants

 

In the course of making a real estate investment decision, we assess the creditworthiness of the tenant which leases the property we intend to purchase. Tenant creditworthiness is an important investment criterion, as it provides a barometer of relative risk of tenant default. Tenant creditworthiness analysis is just one element of due diligence which we perform when considering a property purchase; and the weight we intend to ascribe to tenant creditworthiness is a function of the results of other elements of due diligence.

 

Some of the properties we intend to acquire will be leased to public companies. Many public companies have their creditworthiness analyzed by bond rating firms such as Standard & Poor’s and Moody’s. These firms issue credit rating reports which segregate public companies into what are commonly called “investment grade” companies and “non-investment grade” companies. We expect that our portfolio of properties will contain a mix of properties that are leased to investment grade public companies, non-investment grade public companies, and non-public companies (or individuals).

  

The creditworthiness of investment grade public companies is generally regarded as very high. As to prospective property acquisitions leased to other than investment grade tenants, we intend to analyze publicly available information and/or information regarding tenant creditworthiness provided by the sellers of such properties and then make a determination in each instance as to whether we believe the subject tenant has the financial fortitude to honor its lease obligations.

 

We do not intend to systematically analyze tenant creditworthiness on an ongoing basis, post-acquisition. Many leases will limit our ability as landlord to demand on recurring bases non-public tenant financial information. It will be our policy and practice, however, to monitor public announcements regarding our tenants, as applicable, and tenant payment histories.

 

Description of Leases

 

We expect, in most instances, to acquire single tenant properties with existing net leases. “Net” leases means leases that typically require tenants to pay all or a majority of the operating expenses, including real estate taxes, special assessments and sales and use taxes, utilities, insurance, common area maintenance charges, and building repairs related to the property, in addition to the lease payments. There are various forms of net leases, typically classified as triple-net or double-net. Under most commercial leases, tenants are obligated to pay a predetermined annual base rent. Most of the leases also will contain provisions that increase the amount of base rent payable at points during the lease term. Triple-net leases typically require the tenant to pay common area maintenance, insurance, and taxes associated with a property in addition to the base rent and percentage rent, if any. Double-net leases typically require the landlord to be responsible for structural and capital elements of the leased property. We anticipate that most of our acquisitions will have remaining lease terms of five to 15 years at the time of the property acquisition. We may acquire properties under which the lease term has partially expired. We also may acquire properties with shorter lease terms if the property is located in a desirable location, is difficult to replace, or has other significant favorable real estate attributes. Generally, the leases require each tenant to procure, at its own expense, commercial general liability insurance, as well as property insurance covering the building for the full replacement value and naming the ownership entity and the lender, if applicable, as the additional insured on the policy. We may elect to obtain, to the extent commercially available, contingent liability and property insurance, flood insurance, environmental contamination insurance, as well as loss of rent insurance that covers one or more years of annual rent in the event of a rental loss. However, the coverage and amounts of our insurance policies may not be sufficient to cover our entire risk.

 

Our Borrowing Strategy and Policies

 

We may incur our indebtedness in the form of bank borrowings, purchase money obligations to the sellers of properties, and publicly or privately placed debt instruments or financing from institutional investors or other lenders. We may obtain a credit facility or separate loans for each acquisition. Our indebtedness may be unsecured or may be secured by mortgages or other interests in our properties. We may use borrowing proceeds to finance acquisitions of new properties, to pay for capital improvements, repairs or buildouts, to refinance existing indebtedness, to fund repurchases of our shares or to provide working capital. To the extent we borrow on a short-term basis, we may refinance such short-term debt into long-term, amortizing mortgages once a critical mass of properties has been acquired and to the extent such debt is available at terms that are favorable to the then in-place debt.

 

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Tenants will be required to provide proof of insurance by furnishing a certificate of insurance to our Advisor on an annual basis. The insurance certificates will be tracked and reviewed for compliance.

 

There is no limitation on the amount we can borrow for the purchase of any individual property. Our aggregate borrowings, secured and unsecured, must be reasonable in relation to our net assets, and we intend to utilize up to 50% leverage in connection with our acquisition strategy. Our charter limits our borrowing to 50% of our net assets (equivalent to 50% of the cost of our assets) unless any excess borrowing is approved by a majority of our conflicts committee and is disclosed to our stockholders in our next quarterly report, along with the justification for such excess. When calculating our use of leverage, we will not include temporary, unsecured borrowing for property acquisitions under a revolving credit facility (or similar agreement).

 

We may borrow amounts from our Advisor or its affiliates only if such loan is approved by a majority of our directors, including a majority of our conflicts committee, not otherwise interested in the transaction, as fair, competitive, commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties under the circumstances.

 

Except as set forth in our charter regarding debt limits, we may re-evaluate and change our debt strategy and policies in the future without a stockholder vote. Factors that we could consider when re-evaluating or changing our debt strategy and policies include then-current economic and market conditions, the relative cost of debt and equity capital, any acquisition opportunities, the ability of our properties to generate sufficient cash flow to cover debt service requirements and other similar factors. Further, we may increase or decrease our ratio of debt to equity in connection with any change of our borrowing policies.

  

Acquisition Structure

 

Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in entities that own and operate real estate.

 

We will make acquisitions of our real estate investments directly through our Operating Partnership or indirectly through limited liability companies or limited partnerships, or through investments in joint ventures, partnerships, tenants-in-common, co-tenancies or other co-ownership arrangements with other owners of properties, affiliates of our Advisor or other persons. See Item 1A. Risk Factors — General Risks Related to Investments in Real Estate.

 

Real Property Investments

 

Our Advisor will be continually evaluating various potential property investments and engaging in discussions and negotiations with sellers regarding the purchase of properties for us and other programs sponsored by our Sponsor. We expect to possess what we believe will be adequate insurance coverage for all properties in which we invest. Most of our leases will require that our tenants procure insurance for both commercial general liability and property damage. In such instances, the policy will list us an additional insured. However, lease terms may provide that tenants are not required to, and we may decide not to, obtain any or adequate earthquake or similar catastrophic insurance coverage because the premiums are too high, even in instances where it may otherwise be available. See Risk Factors – General Risks Related to Investments in Real Estate.

 

Conditions to Closing Acquisitions

 

Our Advisor performs a diligence review on each property that we purchase. As part of this review, our Advisor in most, if not all cases, obtains an environmental site assessment for each proposed acquisition (which at a minimum includes a Phase I environmental assessment). We will not close the purchase of any property unless we are generally satisfied with the environmental status of the property. We will also generally seek to condition our obligation to close the purchase of any investment on the delivery of certain documents from the seller. Such documents include, where available and appropriate:

 

·property surveys and site audits;
·building plans and specifications, if available;
·soil reports, seismic studies, flood zone studies, if available;
·licenses, permits, maps and governmental approvals;
·tenant leases and estoppel certificates;
·tenant financial statements and information, as permitted;
·historical financial statements and tax statement summaries of the properties;
·proof of marketable title, subject to such liens and encumbrances as are acceptable to us; and

  · liability and title insurance policies.

 

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Co-Ownership Investments

 

We may acquire some of our properties in the form of a co-ownership, including but not limited to tenants-in-common and joint ventures, some of which may be entered into with affiliates of our Advisor. Among other reasons, we may want to acquire properties through a co-ownership structure with third parties or affiliates in order to diversify our portfolio of properties in terms of geographic region or property type. Co-ownership structures may also allow us to acquire an interest in a property without requiring that we fund the entire purchase price. In addition, certain properties may be available to us only through co-ownership structures. In determining whether to recommend a particular co-ownership structure, our Advisor will evaluate the subject real property under the same criteria described elsewhere in this Annual Report on Form 10-K.

 

We may enter into joint ventures with affiliates of our Advisor for the acquisition of properties, but only provided that:

 

·a majority of our directors, including a majority of our conflicts committee, not otherwise interested in the transaction, approve the transaction as being fair and reasonable to us; and

 

·the investments by us and such affiliate are on substantially the same terms and conditions.

 

To the extent possible and if approved by our board of directors, including a majority of our conflicts committee, we will attempt to obtain a right of first refusal or option to buy the property held by the co-ownership structure and allow such co-owners to exchange their interest for our Operating Partnership’s units or to sell their interest to us in its entirety. Entering into joint ventures with affiliates of our Advisor will result in certain conflicts of interest.

 

Real Estate Properties and Investments

 

As of December 31, 2017, we owned eighteen (18) properties. For more information about our real estate investments, see Item 2. Properties of this Annual Report on Form 10-K.

 

Other Real Estate-related Investments

 

As of December 31, 2017, we owned one (1) tenant-in-common real estate investment in which we have an approximate 72.7% interest and one (1) real estate investment in Rich Uncles Real Estate Investment Trust I, an affiliated REIT, in which we have an approximate 4.4% interest.

 

2017 Investment Highlights

 

On March 7, 2017, we, through a wholly-owned subsidiary, acquired an office property (“Northrop”) leased to Northrop Grumman Systems Corporation, totaling approximately 106,613 square feet located in Melbourne, Florida. The aggregate purchase price for Northrop was $13,724,190, including closing costs. This property is financed by a mortgage note of $5,945,655 with an annual interest rate of 4.40% and matures on March 2, 2021.

 

On March 27, 2017, we, through a wholly-owned subsidiary, acquired an office property (“exp US Services”) leased to exp US Services, Inc., totaling approximately 33,118 square feet located in Maitland, Florida. The aggregate purchase price for exp US Services was $6,924,854, including closing costs. This property is financed by a mortgage note of $3,505,061 with an initial annual interest rate of 4.25% and 3.25% plus T-Bill Index starting November 11, 2022 and matures on November 17, 2024.

 

On April 13, 2017, we, through a wholly-owned subsidiary, acquired a retail property (“Harley”) leased to Calculated Risk Bedford, LP dba Texas Harley-Davidson, totaling approximately 70,960 square feet located in Bedford, Texas. The aggregate purchase price for Harley was $13,178,288, including closing costs. This property is financed by a mortgage note of $6,983,418 with an annual interest rate of 4.25% and matures on September 1, 2024.

  

On June 22, 2017, we, through a wholly-owned subsidiary, acquired an office property (“Wyndham”) leased to Wyndham Vacation Ownership, Inc., totaling approximately 41,300 square feet located in Summerlin, Nevada. The aggregate purchase price for Wyndham was $10,116,502, including closing costs. This property is financed by a mortgage note of $5,920,800 with an annual interest rate of one-month LIBOR plus 2.05% matures on June 5, 2027.

 

On June 22, 2017, we, through a wholly-owned subsidiary, acquired an office property (“Williams Sonoma”) leased to Williams-Sonoma, Inc., totaling approximately 35,867 square feet located in Summerlin, Nevada. The aggregate purchase price for Williams Sonoma was $7,231,767, including closing costs. This property is financed by a mortgage note of $4,699,200 with an annual interest rate of one-month LIBOR plus 2.05% and matures on June 5, 2022.

 

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On July 20, 2017, we, through a wholly-owned subsidiary, acquired an industrial property (“Omnicare”) leased to Williamson Drug Company, Incorporated, totaling approximately 51,800 square feet located in Richmond, Virginia. The aggregate purchase price for Omnicare was $7,324,370, including closing costs. This property is financed by a mortgage note of $4,423,574 with an annual interest rate of 4.36% and matures on May 1, 2026.

 

On August 29, 2017, we, through a wholly-owned subsidiary, acquired an office property (“EMCOR”) leased to EMCOR Facilities Services, Inc. (f/k/a Viox Services, Inc.), totaling approximately 39,385 square feet located in Cincinnati, Ohio. The aggregate purchase price for EMCOR was $6,138,537, including closing costs. This property is financed by a mortgage note of $2,955,000 with an annual interest rate of 4.35% and matures on December 1, 2024.

 

On September 28, 2017, we, through a wholly-owned subsidiary, acquired an approximate 72.7% tenant-in-common interest in a property consisting of three industrial and office buildings (“Santa Clara”) leased to Fujifilm Dimatix, Inc., totaling approximately 91,740 square feet located in Santa Clara, California. The aggregate purchase price for Santa Clara was $28,701,845, including closing costs. This property is financed by a mortgage note of $14,500,000 with an annual interest rate of 3.86% and matures on October 1, 2027.

 

On November 30, 2017, we, through a wholly-owned subsidiary, acquired an industrial property (“Husqvarna”) leased to Husqvarna Professional Products, Inc., totaling approximately 64,600 square feet located in Charlotte, North Carolina. The aggregate purchase price for Husqvarna was $12,003,048, including closing costs. This property is financed by a mortgage note of $6,380,000 with an annual interest rate of 4.60% and matures on March 31, 2028.

 

On December 28, 2017, we, through a wholly-owned subsidiary, acquired an industrial property (“AvAir”) leased to AvAir, Inc., totaling approximately 162,714 square feet located in Chandler, Arizona. The aggregate purchase price for AvAir was $27,353,125, including closing costs. This property is financed by a mortgage note of $12,000,000 with an annual interest rate of 8.25% and matures on January 1, 2019. This note was prepaid in March 2018. On March 28, 2018, we obtained a $14,575,000 mortgage loan through a nonaffiliated lender. The loan is secured by the AvAir property. The mortgage loan has a fixed interest rate of 4.84% for the first five years and matures on March 27, 2028.

 

Subsequent Acquisitions since December 31, 2017

 

On March 29, 2018, we, through a wholly-owned subsidiary, acquired an industrial building (“3M”) leased to 3M, totaling approximately 410,400 square feet, located in DeKalb, Illinois. The seller is not affiliated with us or the Advisor. The purchase price for 3M was $15,200,000, excluding acquisition fees and closing costs of approximately $531,000. On March 29, 2018, we obtained a $8,360,000 mortgage loan through a nonaffiliated lender. The loan is secured by the 3M property. The mortgage loan has a variable interest rate of one-month LIBOR plus 2.25% and matures on March 28, 2023. We have entered into an interest rate swap agreement to fix the interest on this mortgage.

 

Economic Dependency

 

We are dependent on our Advisor for certain services that are essential to us, including the identification, evaluation, negotiation, acquisition or origination and disposition of investments; management of the daily operations and leasing of our portfolio; and other general and administrative responsibilities. In the event that our Advisor is unable to provide these services, we will be required to obtain such services from other sources.

 

Competitive Market Factors

 

The U.S. commercial real estate investment and leasing markets remain competitive. We face competition from various entities for investment opportunities for prospective tenants and to retain our current tenants, including other REITs, pension funds, insurance companies, investment funds and companies, partnerships and developers. Many of these entities have substantially greater financial resources than we do and may be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of a tenant or the geographic location of their investments. Competition from these entities may reduce the number of suitable investment opportunities offered to us or increase the bargaining power of property owners seeking to sell. Further, as a result of their greater resources, those entities may have more flexibility than we do in their ability to offer rental concessions to attract and retain tenants. This could put pressure on our ability to maintain or raise rents and could adversely affect our ability to attract or retain tenants. As a result, our financial condition, results of operations, cash flow, ability to satisfy our debt service obligations and ability to pay distributions to our stockholders may be adversely affected.

 

Although we believe that we are well-positioned to compete effectively, there is enormous competition in our market sector and there can be no assurance that we will compete effectively or that we will not encounter increased competition in the future that could limit our ability to conduct our business effectively.

 

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Compliance with Federal, State and Local Environmental Law

 

Our business will be subject to many laws and governmental regulations. Changes in these laws and regulations, or their interpretation by agencies and courts, occur frequently.

 

Americans with Disabilities Act

 

Under the Americans with Disabilities Act of 1990, or ADA, all public accommodations and commercial facilities are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Complying with the ADA requirements could require us to remove access barriers. Failing to comply could result in the imposition of fines by the federal government or an award of damages to private litigants. Although we intend to acquire properties that substantially comply with these requirements, we may incur additional costs to comply with the ADA. In addition, a number of additional federal, state and local laws may require us to modify any properties we purchase, or may restrict further renovations thereof, with respect to access by disabled persons. Additional legislation could impose financial obligations or restrictions with respect to access by disabled persons. Although we believe that these costs will not have a material adverse effect on us, if required changes involve a greater amount of expenditures than we currently anticipate, our ability to make expected distributions could be adversely affected. See Item 1A. Risk Factors — General Risks Related to Investments in Real Estate.

 

Environmental Matters

 

Under various federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real property may be held liable for the costs of removing or remediating hazardous or toxic substances. These laws often impose clean-up responsibility and liability without regard to whether the owner or operator was responsible for, or even knew of, the presence of the hazardous or toxic substances. The costs of investigating, removing or remediating these substances may be substantial, and the presence of these substances may adversely affect our ability to rent properties or sell the property or to borrow using the property as collateral and may expose us to liability resulting from any release of or exposure to these substances. If we arrange for the disposal or treatment of hazardous or toxic substances at another location, we may be liable for the costs of removing or remediating these substances at the disposal or treatment facility, whether or not the facility is owned or operated by us. We may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site that we own or operate. Certain environmental laws also impose liability in connection with the handling of or exposure to asbestos-containing materials, pursuant to which third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials and other hazardous or toxic substances. We maintain a pollution insurance policy for all of our properties to insure against the potential liability of remediation and exposure risk. See Item 1A. Risk Factors — General Risks Related to Investments in Real Estate.

 

Other Regulations

 

The properties we acquire likely will be subject to various federal, state and local regulatory requirements, such as zoning and state and local fire and life safety requirements. Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants. We intend to acquire properties that are in material compliance with all such regulatory requirements. However, we cannot assure you that these requirements will not be changed or that new requirements will not be imposed which would require significant unanticipated expenditures by us and could have an adverse effect on our financial condition and results of operations.

 

Industry Segments

 

Our current business consists of owning, managing, operating, leasing, acquiring, investing in and disposing of commercial real estate assets. All of our consolidated revenues are derived from our consolidated real estate properties. We internally evaluate operating performance on an individual property level and view all of our real estate assets as one industry segment, and, accordingly, all of our properties are aggregated into one reportable segment.

 

 

Financial Information About Geographic Areas

 

See Note 4 of the Notes to our Consolidated Financial Statements included herein.

 

Employees

 

As of December 31, 2017, we had 14 full time paid employees which perform administrative investor services, but all expenses related to such personnel are reimbursed to us by our Sponsor as part of the organizational and offering services they provide in managing our organization and the Offerings. However, our Sponsor is then entitled to include the reimbursement of such expenses as part of our reimbursement to them of organizational and offering costs, but reimbursement shall not exceed an amount equal to 3% of gross offering proceeds.

 

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With respect to our other functions, the employees of our Advisor or its affiliates provide all of our management, acquisition, disposition, Advisory and other administrative services for us.

 

Principal Executive Office

 

Our principal executive offices are located at 3090 Bristol Street, Suite 550, Costa Mesa, California 92626.  Our telephone number and website address are (855) 742-4862 and http://www.richuncles.com, respectively.

 

Available Information

 

Access to copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and other filings with the SEC, including amendments to such filings, may be obtained free of charge from the following website, http://www.richuncles.com, and/or through a link to the SEC’s website, http://www.sec.gov. These filings are available promptly after we file them with, or furnish them to, the SEC.

 

ITEM 1A.RISK FACTORS

 

The following are some of the risks and uncertainties that could cause our actual results to differ materially from those presented in our forward-looking statements. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

 

Risks Related to the Limited Operating History of our Business

 

As a recently established business, investing in our common stock involves risks that are not present in other companies, including other real estate investment trusts, that have a more established investment portfolio and longer operating history. These risk factors include the following.

  

We have only a limited prior operating history or established financing sources, and the prior performance of real estate investment programs sponsored by affiliates of our Sponsor may not be an indication of our future results.

 

We have only a limited operating history, and our stockholders should not rely upon the past performance of other real estate investment programs sponsored by affiliates of our Sponsor to predict our future results. We were incorporated in the State of Maryland on May 14, 2015 and commenced our Registered Offering in July 2016. As of December 31, 2017, we had only acquired eighteen (18) properties, one (1) tenant-in-common real estate investment (an approximate 72.7% interest in a 91,740 square foot office property located in Santa Clara, California), and one (1) real estate investment in an affiliated REIT (an approximate 4.4% interest in Rich Uncles Real Estate Investment Trust I, which owns the properties described below in Item 2. Properties). As of December 31, 2017, we held approximately $149.8 million in real estate investments, based on a cost basis. The prior performance of real estate investment programs sponsored by affiliates of our Sponsor may not be indicative of our future results.

 

Investors should consider our prospects in light of the risks, uncertainties and difficulties frequently encountered by companies that are, like us, in their early stage of operations. To be successful in this market, we must, among other things:

 

·identify and acquire investments that further our investment objectives;

·increase awareness of the “RW Holdings NNN REIT” and “Rich Uncles NNN REIT” brand names within the investment products market;

·attract, integrate, motivate and retain qualified personnel to manage our day-to-day operations;

·respond to competition for our targeted real estate properties and other investments as well as for potential investors; and

·continue to build and expand our operational structure to support our business.

 

We cannot guarantee that we will succeed in achieving these goals, and our failure to do so could cause our stockholders to lose money.

 

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The Offerings are made on a “best efforts” basis. If we are unable to raise substantial funds in our Offerings, we will be limited in the number and type of investments we may make, and the value of our stockholder’s investment will fluctuate with the performance of the specific properties we acquire. As of December 31, 2017, we had raised approximately $90.8 million in the Registered Offering and approximately $30,000 in the Class S Offering.

 

The Offerings are being made on a “best efforts” basis, meaning that we are only required to use our best efforts to sell our Class C and Class S shares and have no firm commitment or obligation to purchase any of the Class C or Class S shares. As a result, the amount of proceeds we raise in the Offerings may be substantially less than the amount we would need to achieve a broadly diversified property portfolio. If we are unable to raise substantial funds, we will make fewer investments resulting in less diversification in terms of the number of investments owned, the types of investments that we make, and the geographic regions in which our investments are located. In such event, the likelihood of our profitability being affected by the performance of any one of our investments will increase. Additionally, we are not limited in the number or size of investments or the percentage of net proceeds we may dedicate to a single investment. An investment in our Class C or Class S shares will be subject to greater risk to the extent that we lack a diversified portfolio of investments. Further, we will have certain relatively fixed third party expenses such as legal, tax and audit, regardless of whether we are able to raise substantial funds in the Offerings. Our inability to raise substantial funds could increase our fixed third party expenses as a percentage of gross income, potentially reducing our net income and cash flow and potentially limiting our ability to make distributions.

 

Because our stockholders will not have the opportunity to evaluate the investments we may make before we make them, we are considered to be a blind pool. We may make investments with which our stockholders do not agree.

 

As of December 31, 2017, we had acquired eighteen (18) properties, an approximate 72.7% tenant-in-common interest in a 91,740 square foot office property located in Santa Clara, California (the “TIC”), and an approximate 4.4% interest in Rich Uncles Real Estate Investment Trust I, an affiliated REIT that owns the properties described below in Item 2. Properties. We have only identified a limited amount of other real estate investments that are reasonably probable of being acquired or originated with the proceeds from the Offerings. As a result, other than our current properties and real estate investment, we are not able to provide our stockholders with any information to assist them in evaluating the merits of any specific assets that we may acquire. We will seek to invest substantially all of the net proceeds from the Offerings, after the payment of fees and expenses, in real estate investments. Our board of directors and the management of our Advisor have broad discretion when identifying, evaluating and making such investments. Our stockholders will have no opportunity to evaluate the transaction terms or other financial or operational data concerning specific investments before we invest in them. Furthermore, our board of directors will have broad discretion in implementing policies regarding tenant creditworthiness and our stockholders will likewise have no opportunity to evaluate potential tenants. As a result, our stockholders must rely on our board of directors and our Advisor to identify and evaluate our investment opportunities, and they may not be able to achieve our business objectives, may make unwise decisions or may make investments with which our stockholders do not agree.

 

Because we are selling our shares directly to the public, our stockholders will not have the benefit of an independent due diligence review of us, which is customarily performed in underwritten offerings; the absence of an independent due diligence review increases the risks and uncertainty our stockholders face.

 

Because there is no independent third party underwriter selling our shares or managing the sales effort, there will be no outside independent review of our finances and operations in connection with the preparation of the Offerings, other than the audit of our Consolidated Financial Statements included herein. Other REITs who use a licensed broker-dealer to sell shares are subjected to a due diligence review by the underwriter or dealer manager to satisfy statutory duties under the Securities Act of 1933 and the rules of FINRA or the national securities exchange where the REIT securities are listed. Therefore, our stockholders must rely on the information in the prospectus or other offering documents for the Offerings and will not have the benefit of an independent review and investigation of the Offerings of the type normally performed by an unaffiliated, independent underwriter in a public securities offering. 

 

 Due diligence reviews typically include an independent investigation of the background of the Sponsor, Advisor and their affiliates, review of the Offering documents and independent analysis of the plan of business and any underlying financial assumptions. A licensed broker-dealer also has “know your customer” obligations to determine whether the REIT investment is suitable for each individual investor. We intend to perform these tasks ourselves, but our investors do not benefit from a third party review of these facts and considerations.

 

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Failure to continue to qualify as a REIT would reduce our net earnings available for investment or distribution.

 

Our continued qualification as a REIT will depend upon our ability to meet requirements regarding our organization and ownership, distributions of our income, the nature and diversification of our income and assets and other tests imposed by the Internal Revenue Code. If we fail to qualify as a REIT for any taxable year after electing REIT status, we will be subject to federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year in which we lost our REIT status. Losing our REIT status would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions would no longer qualify for the dividends-paid deduction and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.

 

The SEC’s ongoing investigation may require significant Advisor management time and attention, result in significant legal expenses or damages and could adversely affect our business, financial condition and results of operations.

 

The SEC is conducting an investigation related to the advertising and sale of securities by us in connection with the Registered Offering. The investigation is a non-public fact-finding inquiry. It is neither an allegation of wrongdoing nor a finding that violations of law have occurred. In connection with the investigation, we and certain associates have received and responded to subpoenas from the SEC requesting various documents and other documents related to us and the Registered Offering. We have cooperated and intend to continue to cooperate with the SEC in this matter.

 

The SEC’s investigation is ongoing, and we are presently unable to predict its duration, scope or results, or whether the SEC will commence any legal actions or launch additional investigations, inquiries or other actions related thereto. The SEC’s investigation could require significant attention from members of our Advisor’s senior management. Legal and other expenses we expect to incur in connection with the SEC’s investigation could become significant. If the SEC or another governmental entity were to commence legal action against us, we could be required to pay significant fines and could become subject to injunctions, a cease and desist order or other equitable remedies, which could have a material adverse effect on our business, financial condition and results of operations.

 

We face risks associated with security breaches through cyber-attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (“IT”) networks and related systems.

 

We face risks associated with security breaches, whether through cyber-attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our Sponsor’s proprietary online investment platform, www.RichUncles.com, our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations. Although we make efforts to maintain the security and integrity of these types of IT networks and related systems, and we have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is impossible for us to entirely mitigate this risk.

 

A security breach or other significant disruption involving our IT networks and related systems could:

 

·disrupt the proper functioning of our networks and systems and therefore our operations;
·result in misstated financial reports, violations of loan covenants and/or missed reporting deadlines;
·result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT;
·result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of, proprietary, confidential, sensitive or otherwise valuable information of ours or others, which others could use to compete against us or which could expose us to damage claims by third-parties for disruptive, destructive or otherwise harmful purposes and outcomes;
·require significant management attention and resources to remedy any damages that result;
·subject us to claims for breach of contract, damages, credits, penalties or termination of leases or other agreements; or
·damage our reputation among our stockholders.

 

Any or all of the foregoing could have a material adverse effect on our results of operations, financial condition and cash flows.

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Risks Related to an Investment in Our Common Stock

 

We may be unable to pay or maintain cash distributions or increase distributions over time.

 

There are many factors that can affect the availability and timing of cash distributions to stockholders. Distributions will be based principally on distribution expectations of our potential investors and cash available from our operations. The amount of cash available for distribution will be affected by many factors, such as our ability to buy properties as proceeds from the Offerings become available and our operating expense levels, as well as many other variables. Actual cash available for distribution may vary substantially from estimates. There can be no assurance that we will be able to pay or maintain distributions or that distributions will increase over time, nor can we give any assurance that rents from the properties will increase, or that future acquisitions of real properties will increase our cash available for distribution to stockholders. Because we have paid, and may continue to pay, distributions from sources other than our cash flow from operations, distributions at any point in time may not reflect the current performance of our properties or our current operating cash flows. In addition, if we pay distributions from sources other than our cash flow from operations, we may have less cash available for investments and our stockholders’ overall return may be reduced.

 

We face significant competition for real estate investment opportunities, which may limit our ability to acquire suitable investments and achieve our investment objectives or pay distributions.

 

We face competition from various entities for real estate investment opportunities, including other REITs, pension funds, banks and insurance companies, investment funds and companies, partnerships and developers. Many of these entities have substantially greater financial resources than we do and may be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of a tenant or the geographic location of their investments. Competition from these entities may reduce the number of suitable investment opportunities offered to us or increase the bargaining power of property owners seeking to sell. Additionally, disruptions and dislocations in the credit markets could impact the cost and availability of debt to finance real estate investments, which is a key component of our acquisition strategy. A downturn in the credit markets and a potential lack of available debt could result in a further reduction of suitable investment opportunities and create a competitive advantage for other entities that have greater financial resources than we do. In addition, the number of entities and the amount of funds competing for suitable investments may increase. If we acquire investments at higher prices and/or by using less-than-ideal capital structures, our returns will be lower, and the value of our respective assets may not appreciate or may decrease significantly below the amount we paid for such assets. If such events occur, our stockholders may experience a lower return on their investment.

 

If we are unable to find suitable investments, we may not be able to achieve our investment objectives or pay distributions.

 

Our ability to achieve our investment objectives and to pay distributions depends upon the performance of our Advisor in the acquisition of investments, including the determination of any financing arrangements. We are also subject to competition in seeking to acquire real estate-related investments. We expect to use a substantial amount of the net proceeds from the Offerings to primarily invest, directly or indirectly through investment in affiliated and non-affiliated entities, in single-tenant income-producing corporate properties, which are leased to creditworthy tenants under long-term net leases. The more shares we sell in our Offerings, the greater our challenge will be to invest the net offering proceeds on attractive terms. Our investors must rely entirely on the management abilities of our Advisor and the oversight of our board of directors. We can give no assurance that our Advisor will be successful in obtaining suitable investments on financially attractive terms or that, if it makes investments on our behalf, our objectives will be achieved. If we, through our Advisor, are unable to find suitable investments promptly, we will hold the proceeds from the Offerings in an interest-bearing account or invest the proceeds in short-term assets. In the event we are unable to timely locate suitable investments, we may be unable or limited in our ability to pay distributions and we may not be able to meet our investment objectives.

  

If we raise substantial proceeds from the Offerings in a short period of time, we may not be able to invest all of the net proceeds promptly, which may cause our distributions and the long-term returns to our stockholders to be lower than they otherwise would.

 

We could suffer from delays in locating suitable investments. The more shares we sell in our Offerings, the more difficult it will be to invest the net offering proceeds promptly and on attractive terms. Therefore, the large size of the Offerings increases the risk of delays in investing our net proceeds. Our reliance on our Advisor and the real estate and debt finance professionals that our Advisor retains to identify suitable investments for us at times when such persons are simultaneously seeking to identify suitable investments for other Rich Uncles-affiliated programs or Rich Uncles-advised investors could also delay the investment of the proceeds of the Offerings. See Risks Related to Conflicts of Interest. Delays we encounter in the selection, acquisition and development of income-producing properties or the acquisition of other real estate investments would likely limit our ability to pay distributions to our stockholders and reduce their overall returns.

 

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We are an “emerging growth company” under the federal securities laws and will be subject to reduced public company reporting requirements.

 

In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act. We are an “emerging growth company,” as defined in the JOBS Act, and are eligible to take advantage of certain exemptions from, or reduced disclosure obligations relating to, various reporting requirements that are normally applicable to public companies. We could remain an “emerging growth company” for up to five years, or until the earliest of (1) the last day of the first fiscal year in which we have total annual gross revenue of $1 billion or more, (2) December 31 of the fiscal year that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act (which would occur if the market value of our common stock held by non-affiliates exceeds $700 million, measured as of the last business day of our most recently completed second fiscal quarter, and we have been publicly reporting for at least 12 months) or (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period. Under the JOBS Act, emerging growth companies are not required to (1) provide an auditor’s attestation report on management’s assessment of the effectiveness of internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act, (2) comply with new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, which require mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor must provide additional information about the audit and the issuer’s financial statements, (3) comply with new audit rules adopted by the PCAOB after April 5, 2012 (unless the SEC determines otherwise), (4) provide certain disclosures relating to executive compensation generally required for larger public companies or (5) hold stockholder advisory votes on executive compensation. If we take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result.

 

Additionally, the JOBS Act provides that an “emerging growth company” may take advantage of an extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies. This means an “emerging growth company” can delay adopting certain accounting standards until such standards are otherwise applicable to private companies. However, we are electing to “opt out” of such extended transition period and will therefore comply with new or revised accounting standards on the applicable dates on which the adoption of such standards are required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of such extended transition period for compliance with new or revised accounting standards is irrevocable.

 

Disruptions in the financial markets and uncertain economic conditions could adversely affect market rental rates, commercial real estate values and our ability to secure debt financing, service future debt obligations, or pay distributions to our stockholders.

 

Currently, both the investing and leasing environments are highly competitive. While there has been an increase in the amount of capital flowing into the U.S. real estate markets, which resulted in an increase in real estate values in certain markets, the uncertainty regarding the economic environment has made businesses reluctant to make long-term commitments or changes in their business plans.

 

We plan to rely on debt financing to finance our real estate properties and we may have difficulty refinancing some of our debt obligations prior to or at maturity or we may not be able to refinance these obligations at terms as favorable as the terms of our initial indebtedness and we also may be unable to obtain additional debt financing on attractive terms or at all. If we are not able to refinance our initial indebtedness on attractive terms at the various maturity dates, we may be forced to dispose of some of our assets. Recent financial market conditions have improved from the bottom of the economic cycle, but material risks are still present. Market conditions can change quickly, which could negatively impact the value of our assets.

 

Disruptions in the financial markets and continued uncertain economic conditions could adversely affect the values of our investments. Lending activity only recently increased; however, it remains uncertain whether the capital markets can sustain the current transaction levels. Furthermore, declining economic conditions could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our real estate portfolio and in the collateral securing our loan investments, which could have the following negative effects on us:

  

  · the values of our investments in commercial properties could decrease below the amounts paid for such investments; and/or
  · revenues from our properties could decrease due to fewer tenants and/or lower rental rates, making it more difficult for us to pay distributions or meet our debt service obligations on debt financing.

 

All of these factors could reduce our stockholders’ return and decrease the value of an investment in us.

 

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If we fail to diversify our investment portfolio, downturns relating to certain geographic regions, industries or business sectors may have a more significant adverse impact on our assets and our ability to pay distributions than if we had a diversified investment portfolio.

 

While we intend to diversify our portfolio of investments in the manner described in this Annual Report, we are not required to observe specific diversification criteria. Therefore, our investments may at times be concentrated in a limited number of geographic locations or secured by assets concentrated in a limited number of geographic locations. To the extent that our portfolio is concentrated in limited geographic regions, industries or business sectors, downturns relating generally to such region, industry or business sector may result in defaults on a number of our investments within a short time period, which may reduce our net income and the value of our common stock and accordingly limit our ability to pay distributions to our stockholders.

 

Any adverse economic or real estate developments in our target markets could adversely affect our operating results and our ability to pay distributions to our stockholders.

 

Because we depend upon our Advisor and its affiliates to conduct our operations, adverse changes in the financial health of our Advisor or its affiliates could cause our operations to suffer.

 

We depend on our Advisor to manage our operations and our portfolio of assets. Our Advisor depends upon the fees and other compensation that it receives from us, and other Brix-affiliated programs that it advises in connection with the purchase, management and sale of assets to conduct its operations. Any adverse changes to our relationship with, or the financial condition of, our Advisor and its affiliates, could hinder their ability to successfully manage our operations and our portfolio of investments.

 

We may not be successful in conducting the Offerings, which would adversely impact our ability to implement our investment strategy.

 

The success of the Offerings and our ability to implement our business strategy depend upon our ability to sell our shares to investors. All investors have a choice of numerous competing real estate investment trust offerings, many with similar investment objectives, to invest in, which may make selling our shares to such investors more difficult. If we are not successful in growing, operating and managing this process, our ability to raise proceeds through the Offerings will be limited and we may not have adequate capital to implement our investment strategy.

 

The loss of or the inability to retain or obtain key real estate professionals at our Advisor could delay or hinder implementation of our investment strategies, which could limit our ability to make distributions and decrease the value of an investment in our shares.

 

Our success depends to a significant degree upon the contributions of Messrs. Harold Hofer and Ray Wirta, each of whom would be difficult to replace. Neither we nor our affiliates have employment agreements with these individuals and they may not remain associated with us, our Advisor or its affiliates. If any of these persons were to cease their association with us, our Advisor or its affiliates, we may be unable to find suitable replacements and our operating results could suffer as a result. We do not intend to maintain key person life insurance on any person. We believe that our future success depends, in large part, upon our Advisor’s and its affiliates’ ability to attract and retain highly skilled managerial, operational and marketing professionals. Competition for such professionals is intense, and our Advisor and its affiliates may be unsuccessful in attracting and retaining such skilled professionals. If we lose or are unable to obtain the services of highly skilled professionals, our ability to implement our investment strategies could be delayed or hindered.

 

Our rights and the rights of our stockholders to recover claims against our independent directors are limited, which could reduce our stockholders’ and our recovery against our independent directors if they negligently cause us to incur losses.

 

Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our bylaws provide that none of our independent directors shall be liable to us or our stockholders for monetary damages and that we will generally indemnify them for losses unless they are negligent or engage in willful misconduct. As a result, our stockholders and we may have more limited rights against our independent directors than might otherwise exist under common law, which could reduce our and our stockholders’ recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent directors (as well as by our other directors, officers, employees and agents) in some cases, which would decrease the cash otherwise available for distribution to our stockholders.

 

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We may change our targeted investments without stockholder consent.

 

We initially intend to invest in single-tenant income-producing corporate properties which are leased to credit worthy tenants under long-term net leases; however, we may make adjustments to our target portfolio based on real estate market conditions and investment opportunities, and we may change our targeted investments and investment guidelines at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this Annual Report on Form 10-K. A change in our targeted investments or investment guidelines may increase our exposure to interest rate risk, default risk and real estate market fluctuations, all of which could adversely affect the value of our common stock and our ability to make distributions to our stockholders. We will not forego a good investment because it does not precisely fit our expected portfolio composition. We believe that we are most likely to meet our investment objectives through the careful selection and underwriting of assets. When making an acquisition, we will emphasize the performance and risk characteristics of that investment, how that investment will fit with our portfolio-level performance objectives, the other assets in our portfolio and how the returns and risks of that investment compare to the returns and risks of available investment alternatives. Thus, to the extent that our Advisor presents us with what we believe to be good investment opportunities that allow us to meet the REIT requirements under the Internal Revenue Code, our portfolio composition may vary from what we initially expect. However, we will attempt to construct a portfolio that produces stable and attractive returns by spreading risk across different real estate investments.

 

The offering price per share of our common stock may not reflect the value that stockholders will receive for their investment.

 

As with any valuation methodology, the methodologies we use are based upon a number of estimates and assumptions that may not be accurate or complete. Different parties using different assumptions and estimates could derive a different estimated NAV per share of our common stock, and these differences could be significant. The estimated NAV per share is not audited and does not represent the fair value of our assets less the fair value of our liabilities according to accounting principles generally accepted in the United States (“GAAP”), nor does it represent a liquidation value of our assets and liabilities or the price at which our shares of common stock would trade on a national securities exchange. The estimated NAV per share does not reflect a discount for the fact that we are externally managed, nor does it reflect a real estate portfolio premium/discount versus the sum of the individual property values. The estimated NAV per share also does not take into account estimated disposition costs and fees for real estate properties that are not held for sale, debt prepayment penalties that could apply upon the prepayment of certain of our debt obligations, the impact of restrictions on the assumption of debt or swap breakage fees that may be incurred upon the termination of certain of our swaps prior to expiration.

 

Accordingly, with respect to our estimated NAV per share and our annually updated Registered Offering price and Class S Offering price, we can give no assurance that:

 

  · a stockholder would ultimately realize distributions per share equal to our estimated NAV per share upon a sale of the Company;
  · our shares of common stock would trade at our estimated NAV per share on a national securities exchange;
  · a third party would offer our estimated NAV per share in an arm’s-length transaction to purchase all or substantially all of our shares of common stock;
  · another independent third-party appraiser or third-party valuation firm would agree with our estimated NAV per share; or
  · the methodology used to determine our estimated NAV per share would be acceptable for compliance with ERISA reporting requirements.

 

The NAV of our shares will fluctuate over time in response to developments related to the capital raised during our offering stage, future investments, the performance of individual assets in our portfolio, the management of those assets, and the real estate and finance markets.

  

Risks Related to Conflicts of Interest

 

Our Advisor, Sponsor and their affiliates, including all of our executive officers and our affiliated directors and other key real estate professionals, face conflicts of interest caused by their compensation arrangements with us and with other Brix-affiliated programs, which could result in actions that are not in the long-term best interests of our stockholders.

  

Most of our executive officers and our affiliated directors and other key real estate professionals are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our Advisor, and/or other Brix-affiliated entities. Our Advisor, Sponsor and their affiliates receive substantial fees from us. These fees could influence our Advisor’s advice to us as well as the judgment of its affiliates. Among other matters, these compensation arrangements could affect their judgment with respect to:

 

·the continuation, renewal or enforcement of our agreements with our Advisor and its affiliates, including the Advisory Agreement;

·sales of real estate investments, which entitle our Advisor to disposition fees;

 

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·acquisitions of real estate investments, which entitle our Advisor to acquisition fees based on the cost of the investment and asset management fees based on the cost of the investment, and not based on the quality of the investment or the quality of the services rendered to us, which may influence our Advisor to recommend riskier transactions to us and/or transactions that are not in our best interest and, in the case of acquisitions of investments from other Brix-affiliated programs, which might entitle affiliates of our Advisor to disposition fees and possible subordinated incentive fees in connection with its services for the seller;
·borrowings to acquire real estate investments, which borrowings will increase the acquisition fees and asset management fees payable to our Advisor;
·whether and when we seek to list our shares of common stock on a national securities exchange, which listing may make it more likely for us to become self-managed or internalize our management and which could also adversely affect the sales efforts for other Brix-affiliated programs, depending on the price at which our shares trade; and
·whether we seek to sell the Company, which sale could terminate the asset management fees.

 

Our UPREIT structure may result in potential conflicts of interest with limited partners in the Operating Partnership whose interests may not be aligned with those of our stockholders.

 

Our Advisor, Sponsor and its affiliates face conflicts of interest relating to the acquisition of assets due to their relationship with other Brix-affiliated programs and Brix-advised investors, which could result in decisions that are not in our best interest or the best interests of our stockholders.

 

We rely on our Advisor, Sponsor and other key real estate professionals at our Advisor, including Messrs. Hofer and Wirta to identify suitable investment opportunities for us. Rich Uncles Real Estate Investment Trust I is advised by our Sponsor and relies on many of the same real estate professionals as will future Brix-affiliated programs advised by our Advisor. As such, we and the other Brix-affiliated programs, and Brix-advised investors rely on many of the same real estate professionals, as will future Brix-affiliated programs and Brix-advised investors. Many investment opportunities that are suitable for us may also be suitable for other Brix-affiliated programs and Brix-advised investors. When these real estate professionals direct an investment opportunity to any Brix-affiliated program or Brix-advised investor they, in their sole discretion, will offer the opportunity to the program or investor for which the investment opportunity is most suitable based on the investment objectives, portfolio and criteria of each program or investor. Our acquisition stage may overlap with future Brix-affiliated programs and Brix-advised investors.

 

We and other Brix-affiliated programs and Brix-advised investors also rely on these real estate professionals to supervise the management of investments. If the Brix team of real estate professionals directs creditworthy prospective tenants to properties owned by another Brix-affiliated program or Brix-advised investor when it could direct such tenants to our properties, our tenant base may have more inherent risk and our properties’ occupancy may be lower than might otherwise be the case.

 

Further, existing and future Brix-affiliated programs and Brix-advised investors and Messrs. Hofer and Wirta generally are not and will not be prohibited from engaging, directly or indirectly, in any business or from possessing interests in any other business venture or ventures, including businesses and ventures involved in the acquisition, development, ownership, leasing or sale of real estate-related investments.

 

There is a risk that stockholders could sue us and the directors involved if they determine that fiduciary duties to our stockholders were violated in connection with an internalization transaction, causing us to incur high litigation costs.

  

Our officers, our Advisor, our Sponsor, and the real estate, debt finance, management and accounting professionals assembled by our Advisor face competing demands on their time and this may cause our operations and our stockholders’ investment in us to suffer.

 

We rely on our officers, our Advisor, our Sponsor and the real estate, debt finance, management and accounting professionals that our Advisor retains, including Messrs. Hofer and Wirta to provide services to us for the day-to-day operation of our business. Rich Uncles Real Estate Investment Trust I is also advised by Brix and relies on our Sponsor and many of the same real estate, debt finance, management and accounting professionals, as will future Brix-affiliated programs and Brix-advised investors. Further, our officers and affiliated directors are also officers and/or affiliated directors of some or all of the other Brix-affiliated programs. Messrs. Hofer and Wirta are also executive officers of Rich Uncles Real Estate Investment Trust I and Brix. As a result of their interests in other Brixs-affiliated programs, their obligations to Brix-advised investors and the fact that they engage in and will continue to engage in other business activities on behalf of themselves and others, Messrs. Hofer and Wirta face conflicts of interest in allocating their time among us, Rich Uncles Real Estate Investment Trust I, other Brix-affiliated programs and other Brix-advised investors, as well as other business activities in which they are involved. During times of intense activity in other programs and ventures, these individuals may devote less time and fewer resources to our business than are necessary or appropriate to manage our business. Furthermore, some or all of these individuals may become employees of another Brix-affiliated program in an internalization transaction or, if we internalize our Advisor, may not become our employees as a result of their relationship with other Brix-affiliated programs. If these events occur, the returns on our investments, and the value of our stockholders’ investment in us, may decline.

 

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All of our executive officers, our affiliated directors and the key real estate professionals assembled by our Advisor face conflicts of interest related to their positions and/or interests in our Advisor, our Sponsor and their affiliates, which could hinder our ability to implement our business strategy and to generate returns to our stockholders.

 

Most of our executive officers, our affiliated directors and the key real estate professionals assembled by our Advisor are also executive officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our Advisor, our Sponsor, and/or other Brix-affiliated entities. As a result, they owe fiduciary duties to each of these entities, their members and these investors, which fiduciary duties may from time to time conflict with the fiduciary duties that they owe to us and our stockholders. Their loyalties to these other entities and investors could result in action or inaction that is detrimental to our business, which could harm the implementation of our business strategy and our investment and leasing opportunities. Further, Messrs. Hofer and Wirta and existing and future Brix-affiliated programs and Brix-advised investors generally are not and will not be prohibited from engaging, directly or indirectly, in any business or from possessing interests in any other business venture or ventures, including businesses and ventures involved in the acquisition, development, ownership, leasing or sale of real estate investments. If we do not successfully implement our business strategy, we may be unable to generate the cash needed to make distributions to our stockholders and to maintain or increase the value of our assets.

 

Because other Brix-affiliated programs may conduct offerings concurrently with the Offerings, our Advisor and our Sponsor may face potential conflicts of interest arising from competition among us and these other programs for investors and investment capital, and such conflicts may not be resolved in our favor.

 

Future Brix-affiliated programs may seek to raise capital through offerings conducted concurrently with the Offerings. As a result, our Advisor may face conflicts of interest arising from potential competition with these other programs for investors and investment capital. There may be periods during which one or more Rich Uncles-affiliated programs will be raising capital and may compete with us for investment capital. Such conflicts may not be resolved in our favor and our stockholders will not have the opportunity to evaluate the manner in which these conflicts of interest are resolved before or after making an investment in our shares.

 

Our board of directors’ loyalties to Rich Uncles Real Estate Investment Trust I and possibly to future Brix-affiliated programs could influence its judgment, resulting in actions that may not be in our stockholders’ best interest or that result in a disproportionate benefit to another Brix-affiliated program at our expense.

 

Most of our directors are also trust managers (the equivalent of trustees) of Rich Uncles Real Estate Investment Trust I. The loyalties of our directors serving on the board of trust managers of Rich Uncles Real Estate Investment Trust I, or possibly on the boards of directors of future Brix-affiliated programs, may influence the judgment of our board of directors when considering issues for us that also may affect other Brix-affiliated programs, such as the following:

 

  · Our conflicts committee must evaluate the performance of our Advisor with respect to whether our Advisor is presenting to us our fair share of investment opportunities. If our Advisor is not presenting a sufficient number of investment opportunities to us because it is presenting many opportunities to other Brix-affiliated programs or if our Advisor is giving preferential treatment to other Brix-affiliated programs in this regard, our conflicts committee may not be well-suited to enforce our rights under the terms of the Advisory Agreement or to seek a new Advisor.
  · We could enter into transactions with other Brix-affiliated programs, such as property sales, acquisitions or financing arrangements. Such transactions might entitle our Advisor or its affiliates to fees and other compensation from both parties to the transaction. For example, acquisitions from other Brix-affiliated programs might entitle our Advisor or its affiliates to disposition fees and possible subordinated incentive fees in connection with its services for the seller in addition to acquisition fees and other fees that we might pay to our Advisor in connection with such transaction. Similarly, property sales to other Brix-affiliated programs might entitle our Advisor or its affiliates to acquisition fees in connection with its services to the purchaser in addition to disposition and other fees that we might pay to our Advisor in connection with such transaction. Decisions of our board or our conflicts committee regarding the terms of those transactions may be influenced by our board’s or our conflicts committee’s loyalties to such other Brix-affiliated programs.
  · A decision of our board or our conflicts committee regarding the timing of a debt or equity offering could be influenced by concerns that the Offerings would compete with offerings of other Brix-affiliated programs.
  · A decision of our board or our conflicts committee regarding the timing of property sales could be influenced by concerns that the sales would compete with those of other Brix-affiliated programs.
  · A decision of our board or our conflicts committee regarding whether and when we seek to list our common stock on a national securities exchange could be influenced by concerns that such listing could adversely affect the sales efforts of other Brix-affiliated programs, depending on the price at which our shares trade.

 

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Because our conflicts committee members are also independent trust managers of Rich Uncles Real Estate Investment Trust I, they receive compensation for their services to Rich Uncles Real Estate Investment Trust I. Rich Uncles Real Estate Investment Trust I pays each independent trust manager $5,000 per meeting attended (including via email or telephone) and $1,000 per acquisition vote outside of votes in the course of a meeting. Compensation is paid in Rich Uncles Real Estate Investment Trust I shares. Like us, Rich Uncles Real Estate Investment Trust I also reimburses trust managers for reasonable out-of-pocket expenses incurred in connection with attendance at meetings of its board of directors. In addition to any of the foregoing independent trust manager compensation and trust manager reimbursement to which he may be entitled, Rich Uncles Real Estate Investment Trust I pays Jeffrey Randolph, for services to Rich Uncles Real Estate Investment Trust I as chair of the audit committee of Rich Uncles Real Estate Investment Trust I’s board of trust managers, 300 shares of Rich Uncles Real Estate Investment Trust I’s common stock per fiscal quarter. Such payments, which began in August 2017, shall continue for as long as Mr. Randolph is serving as chair of the audit committee of Rich Uncles Real Estate Investment Trust I’s board of trust managers.

 

 If we ever decided to become self-managed, the terms of the management arrangement would not be negotiated in an arms-length transaction.

 

If we ever decided to become self-managed by acquiring our Advisor and/or entities affiliated with our Advisor, there is a risk that internalization of management would not be fair to stockholders because it may not be negotiated in an arms-length transaction. Our amended and restated articles of incorporation require that a majority of our board of directors (including a majority of our conflicts committee) not otherwise interested in the transaction conclude that such internalization transaction is fair and reasonable to us and any fees or other compensation due by virtue of the internalization transaction to our Advisor and/or affiliated entities are also fair and reasonable to us.

 

Risks Related to Our Corporate Structure

 

Our articles of incorporation limit the number of shares a person may own and permits our board of directors to issue stock with terms that may subordinate the rights of our common stockholders or discourage a third party from acquiring us in a manner that could result in a premium price to our stockholders.

 

Our articles of incorporation, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. To help us comply with the REIT ownership requirements of the Internal Revenue Code, our charter as supplemented by actions of our board of directors prohibit a person from directly or constructively owning more than 9.8% of our outstanding shares, unless exempted by our board of directors. In addition, our board of directors may classify or reclassify any unissued common stock or preferred stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of repurchase of any such stock. Thus, our board of directors could authorize the issuance of preferred stock with priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. These provisions may have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price to holders of our common stock.

 

Stockholders’ investment return may be reduced if we are required to register as an investment company under the Investment Company Act; if we or our subsidiaries become an unregistered investment company, we could not continue our business.

 

Neither we nor any of our subsidiaries intend to register as investment companies under the Investment Company Act. If we or our subsidiaries were obligated to register as investment companies, we would have to comply with a variety of substantive requirements under the Investment Company Act that impose, among other things:

 

  · limitations on capital structure;
  · restrictions on specified investments;
  · prohibitions on transactions with affiliates; and
  · compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly increase our operating expenses.

 

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Under the relevant provisions of Section 3(a)(1) of the Investment Company Act, an investment company is any issuer that:

 

  · is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities (the “primarily engaged test”); or
  · is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of such issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis (the “40% test”). “Investment securities” excludes U.S. government securities and securities of majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company under Section 3(c)(1) or Section 3(c)(7) (relating to private investment companies).

 

We believe that neither we nor our Operating Partnership will be required to register as an investment company based on the following analysis. With respect to the 40% test, the entities through which we and our Operating Partnership intend to own our assets will be majority-owned subsidiaries that are not themselves investment companies and are not relying on the exceptions from the definition of investment company under Section 3(c)(1) or Section 3(c)(7).

 

With respect to the primarily engaged test, we and our Operating Partnership are holding companies and do not intend to invest or trade in securities ourselves. Rather, through the majority-owned subsidiaries of our Operating Partnership, we and our Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring real estate and real estate-related assets.

 

We believe that most of the subsidiaries of our Operating Partnership will be able to rely on Section 3(c)(5)(C) of the Investment Company Act for an exception from the definition of an investment company. (Any other subsidiaries of our Operating Partnership should be able to rely on the exceptions for private investment companies pursuant to Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act.) As reflected in no-action letters, the SEC staff’s position on Section 3(c)(5)(C) generally requires that an issuer maintain at least 55% of its assets in “mortgages and other liens on and interests in real estate,” or qualifying assets; at least 80% of its assets in qualifying assets plus real estate-related assets; and no more than 20% of the value of its assets in other than qualifying assets and real estate-related assets, which we refer to as miscellaneous assets. To constitute a qualifying asset under this 55% requirement, a real estate interest must meet various criteria based on no-action letters. We expect that each of the subsidiaries of our Operating Partnership relying on Section 3(c)(5)(C) will invest at least 55% of its assets in qualifying assets, and approximately an additional 25% of its assets in other types of real estate-related assets. We expect to rely on guidance published by the SEC staff or on our analyses of guidance published with respect to types of assets to determine which assets are qualifying real estate assets and real estate-related assets.

 

To maintain compliance with the Investment Company Act, our subsidiaries may be unable to sell assets we would otherwise want them to sell and may need to sell assets we would otherwise wish them to retain. In addition, our subsidiaries may have to acquire additional assets that they might not otherwise have acquired or may have to forego opportunities to make investments that we would otherwise want them to make and would be important to our investment strategy. Moreover, the SEC or its staff may issue interpretations with respect to various types of assets that are contrary to our views and current SEC staff interpretations are subject to change, which increases the risk of non-compliance and the risk that we may be forced to make adverse changes to our portfolio. In this regard, we note that in 2011 the SEC issued a concept release indicating that the SEC and its staff were reviewing interpretive issues relating to Section 3(c)(5)(C) and soliciting views on the application of Section 3(c)(5)(C) to companies engaged in the business of acquiring mortgages and mortgage-related instruments. If we were required to register as an investment company but failed to do so, we would be prohibited from engaging in our business and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement and a court could appoint a receiver to take control of us and liquidate our business.

   

Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exception from the definition of an investment company under the Investment Company Act.

 

If the market value or income potential of our qualifying real estate assets changes as compared to the market value or income potential of our non-qualifying assets, or if the market value or income potential of our assets that are considered “real estate-related assets” under the Investment Company Act or REIT qualification tests changes as compared to the market value or income potential of our assets that are not considered “real estate-related assets” under the Investment Company Act or REIT qualification tests, whether as a result of increased interest rates, prepayment rates or other factors, we may need to modify our investment portfolio in order to maintain our REIT qualification or exception from the definition of an investment company. If the decline in asset values or income occurs quickly, this may be especially difficult, if not impossible, to accomplish. This difficulty may be exacerbated by the illiquid nature of many of the assets that we may own. We may have to make investment decisions that we otherwise would not make absent REIT and Investment Company Act considerations.

 

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Our stockholders will have limited control over changes in our policies and operations, which increases the uncertainty and risks our stockholders face.

 

Our board of directors determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors may amend or revise these and other policies without a vote of the stockholders. Under Maryland General Corporation Law and our amended and restated articles of incorporation, our stockholders have a right to vote only on limited matters. Our board’s broad discretion in setting policies and our stockholders’ inability to exert control over those policies increases the uncertainty and risks our stockholders face.

 

Our stockholders may not be able to immediately sell their Class C or Class S shares under our share repurchase programs.

 

We do not expect that a secondary market for resale of our Class C or Class S shares will develop, but we do provide a monthly share repurchase program for stockholders who wish to sell their Class C or Class S shares. Our ability to repurchase Class C or Class S shares depends upon the levels of our cash reserves (including distribution reinvestment proceeds), availability under any line of credit that we might have, the respective pace of new Class C or Class S share sales, and our ability to sell properties. There can be no assurance that we will have sufficient cash reserves for Class C or Class S share repurchases at all times. In addition, we may not repurchase shares if the repurchase would violate the distributions under Maryland law which prohibit distributions that would cause a corporation to fail to meet statutory tests of solvency.

 

If we must sell properties in order to honor repurchase requests, the repurchase of shares tendered for repurchase could be delayed until we have sold sufficient properties to honor such requests. We expect that the property sale process, if required to honor repurchase requests, could take several months, and we cannot be sure how long it might take to raise sufficient capital from property sales and other sources to honor all such requests. We intend to honor such repurchase requests in the order they are received.

 

Following our initial calculation of NAV and NAV per share of $10.05, which our board approved on January 18, 2018 and calculated as of December 31, 2017, we will repurchase shares based on NAV (as described below) and share repurchases for any 12-month period will not exceed 2% of our aggregate NAV per month, or 5% of our aggregate NAV per quarter. These repurchase limits are described in greater detail in Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Share Repurchase Program—Limitations on Repurchase—Post-NAV Calculation. The Class C share repurchase program will also be subject to the revised procedures described in detail below in Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities —Share Repurchase Program—Repurchase Procedures-Post-NAV Calculation. However, we will only repurchase Class C or Class S shares if, among other conditions, in the opinion of our Advisor, we have sufficient reserves with which to repurchase such shares and at the same time maintain our then-current plan of operation.

 

The share repurchase price for Class C shares held by the stockholder for less than one year is 97% of the NAV per share. The share repurchase price for Class C shares held by the stockholder for at least one year but less than two years is 98% of the NAV per share. The share repurchase price for Class C shares held by the stockholder for at least two years but less than three years is 99% of the NAV per share. The repurchase price for Class C shares held by the stockholder for at least three years is the NAV per share. Our Class S stockholders are required to hold their Class S shares for a minimum of one year before they can participate in the Class S share repurchase program. Provided that the Class S shares being repurchased have been held by the stockholder for at least one year, such shares will be repurchased at a price equal to 100% of the most recently published NAV per share, which currently is $10.05.

 

Stockholders who wish to avail themselves of the share repurchase program for our Class C or Class S shares, as applicable, must notify us as provided on their on-line dashboard at www.RichUncles.com. All requests for repurchase must be received at least two business days before the end of a month. Share repurchase requests may be withdrawn, provided they are received by our Advisor at least two business days prior to the end of a month. Shares will be repurchased by the third business day of the following month. Pursuant to our current share repurchase programs, share repurchases may be funded by (a) distribution reinvestment proceeds, (b) the prior or future sale of shares, (c) operating cash flow not intended for distributions, (d) indebtedness, including a line of credit and traditional mortgage financing, and (e) capital transactions, such as asset sales or refinancings.

 

Our board may amend, suspend or terminate our Class C share repurchase program or Class S share repurchase program upon 30 days’ notice to Class C stockholders or Class S stockholders, respectively, if (a) the board believes such action is in our and such stockholders’ best interests, including because share repurchases place an undue burden on our liquidity, adversely affect our operations, adversely affect stockholders whose shares are not repurchased, or if the board determines that the funds otherwise available to fund our share repurchases are needed for other purposes, (b) due to changes in law or regulation, or (c) the board becomes aware of undisclosed material information that it believes should be publicly disclosed before shares are repurchased. See Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Share Repurchase Program, for more information about the program.

 

We may, at some future date, seek to list our Class C or Class S shares on a national securities exchange to create a secondary market for our stock, but we have no current plan to do so, and for the foreseeable future stockholders should assume that the only available avenue to sell their Class C or Class S shares will be our share repurchase programs, described above.

 

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Our investors’ interest in us could be diluted if we issue additional shares, which could reduce the overall value of their investment.

 

Our common stockholders do not have preemptive rights to any shares we issue in the future. Our charter currently authorizes us to issue 450,000,000 shares of capital stock, of which 400,000,000 shares are designated as common stock with 300,000,000 shares being designated as Class C common stock and 100,000,000 shares being designated as Class S common stock. In August 2017, our board of directors increased the number of authorized shares of common stock without stockholder approval to facilitate an offering by us of up to 100,000,000 shares of Class S common stock exclusively to non-U.S. persons as defined under Rule 903 promulgated under the Securities Act pursuant to an exemption from the registration requirements of the Securities Act under and in accordance with Regulation S thereunder. In the future, our board of directors may further increase the number of authorized shares of common stock without stockholder approval and after investors purchase shares in the Offerings. For example, after our investors purchase shares in the Registered Offering, our board may elect to (i) sell additional shares in this or in future public offerings, including through our distribution reinvestment plan; (ii) issue equity interests in private offerings; (iii) issue shares to our Advisor and/or Sponsor, or their successors or assigns, in payment of outstanding fee obligations; (iv) issue shares of our common stock to sellers of properties or assets we acquire in connection with an exchange of limited partnership interests of the Operating Partnership; or (v) otherwise issue additional shares of our capital stock. To the extent we issue additional equity interests after our investors purchase shares, whether in this or future primary offerings, including the Regulation S offering described above, pursuant to our distribution reinvestment plan or otherwise, our investors’ percentage ownership interest in us would be diluted. In addition, depending upon the terms and pricing of any additional issuance of shares, the use of the proceeds and the value of our real estate investments, our investors could also experience dilution in the book value and NAV of their shares and in the earnings and distributions per share.

 

Payment of fees to our Advisor, Sponsor and their affiliates reduces cash available for investment and distribution to our stockholders and increases the risk that our stockholders will not be able to recover the amount of their investment in our shares.

 

Our Advisor, Sponsor and their affiliates perform services for us in connection with the selection and acquisition of our real estate investments, the management and leasing of our real estate properties, the administration of our real estate-related investments and the disposition of our real estate investments. We pay them substantial fees for these services, which results in immediate dilution of the value of our stockholders’ investment and reduces the amount of cash available for investment or distribution to stockholders. Compensation to be paid to our Advisor may be increased subject to approval by our conflicts committee and the other limitations in our charter, which would further dilute our stockholders’ investment and reduce the amount of cash available for investment or distribution to stockholders.

 

If we are unable to obtain funding for future capital needs, cash distributions to our stockholders and the value of our investments could decline.

 

When tenants do not renew their leases or otherwise vacate their space, we will often need to expend substantial funds for improvements to the vacated space in order to attract replacement tenants. Even when tenants do renew their leases we may agree to make improvements to their space as part of our negotiations. If we need additional capital in the future to improve or maintain our properties or for any other reason, we may have to obtain funding from sources other than our cash flow from operations or proceeds from our distribution reinvestment plans, such as borrowings or future equity offerings. These sources of funding may not be available on attractive terms or at all. If we cannot procure additional funding for capital improvements, our investments may generate lower cash flows or decline in value, or both, which would limit our ability to make distributions to our stockholders and could reduce the value of our stockholders’ investment in us.

 

Although we will not currently be afforded the protection of the Maryland General Corporation Law relating to deterring or defending hostile takeovers, our board of directors could opt into these provisions of Maryland law in the future, which may discourage others from trying to acquire control of us and may prevent our stockholders from receiving a premium price for their stock in connection with a business combination.

 

Under Maryland law, “business combinations” between a Maryland corporation and certain interested stockholders or affiliates of interested stockholders are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. Also, under Maryland law, control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter. Shares owned by the acquirer, an officer of the corporation or an employee of the corporation who is also a director of the corporation are excluded from the vote on whether to accord voting rights to the control shares. Should our board of directors opt into these provisions of Maryland law, it may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. Similarly, provisions of Title 3, Subtitle 8 of the Maryland General Corporation Law could provide similar anti-takeover protection.

 

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We are subject to risks relating to litigation and regulatory liability.

 

We face legal risks in our businesses, including risks related to the securities laws and regulations across various state and federal jurisdictions. Non-traded REITs have been the subject of increased scrutiny by regulators and media outlets resulting from inquiries and investigations initiated by FINRA and the Securities and Exchange Commission. In March, April and May 2016, our affiliate, Rich Uncles Real Estate Investment Trust I, sold shares of its stock in excess of the amount which it had registered for sale in California, resulting in a violation of the registration requirements of the California Securities Law of 1968. To remedy this, Rich Uncles Real Estate Investment Trust I reported the sales in excess of the California permit to the Department of Business Oversight and made a repurchase offer pursuant to the California securities law to those investors who had purchased shares in excess of the permit. Violations of state and federal securities registration laws may result in contingent liabilities to purchasers for sales of unregistered securities and may also subject the seller to fines and penalties by securities regulatory agencies. It is possible that we and our affiliates could be subject to sanctions or to similar liabilities in the future, should another violation of securities registration requirements occur. A finding of such a violation could have a material adverse effect on our business, financial condition and operating results. See also “The SEC’s ongoing investigation may require significant Advisor management time and attention, result in significant legal expenses or damages and could adversely affect our business, financial condition and results of operationsabove.

 

General Risks Related to Investments in Real Estate

 

Economic, market and regulatory changes that impact the real estate market generally may decrease the value of our investments and weaken our operating results.

 

Our operating results and the performance of the properties we acquire are subject to the risks typically associated with real estate, any of which could decrease the value of our investments and could weaken our operating results, including:

 

  · downturns in national, regional and local economic conditions;
  · competition from other commercial buildings;
  · adverse local conditions, such as oversupply or reduction in demand for commercial buildings and changes in real estate zoning laws that may reduce the desirability of real estate in an area;
  · vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space;
  · changes in interest rates and the availability of permanent mortgage financing, which may render the sale of a property or loan difficult or unattractive;
  · changes in tax (including real and personal property tax), real estate, environmental and zoning laws;

  · we rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business;

  · natural disasters such as hurricanes, earthquakes and floods;
  · acts of war or terrorism, including the consequences of terrorist attacks, such as those that occurred on September 11, 2001;
  · the potential for uninsured or underinsured property losses; and
  · periods of high interest rates and tight money supply.

 

Any of the above factors, or a combination thereof, could result in a decrease in our cash flow from operations and a decrease in the value of our investments, which would have an adverse effect on our operations, on our ability to pay distributions to our stockholders and on the value of our stockholders’ investment.

 

We may obtain only limited warranties when we purchase a property.

 

The seller of a property will often sell such property in its “as is” condition on a “where is” basis and “with all faults,” without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. Also, most sellers of large commercial properties are special purpose entities without significant assets other than the property itself. The purchase of properties with limited warranties or from undercapitalized sellers increases the risk that we may lose some or all of our invested capital in the property as well as the loss of rental income from that property.

 

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We may finance properties with lock-out provisions, which may prohibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.

 

Lock-out provisions are provisions that generally prohibit repayment of a loan balance for a certain number of years following the origination date of a loan. Such provisions are typically provided by the code or the terms of the agreement underlying a loan. Lock-out provisions could materially restrict us from selling or otherwise disposing of or refinancing properties. These provisions would affect our ability to turn our investments into cash and thus affect cash available for share repurchases or distributions to stockholders. Lock-out provisions may prohibit us from reducing the outstanding indebtedness with respect to any properties, refinancing such indebtedness on a non-recourse basis at maturity, or increasing the amount of indebtedness with respect to such properties.

  

Lock-out provisions could impair our ability to take actions during the lock-out period that would otherwise be in stockholders’ best interests and, therefore, may have an adverse impact on the value of the shares, relative to the value that would result if the lock-out provisions did not exist. In particular, lock-out provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in stockholders’ best interests.

 

Properties that become vacant could be difficult to re-lease or sell, which could diminish the return on these properties and adversely affect our cash flow and ability to pay distributions to our stockholders.

 

Properties may incur vacancies either by the expiration and non-renewal of tenant leases or the default of tenants under their leases. If vacancies continue for a long period of time, we may suffer reduced revenues resulting in less cash available for distribution to our stockholders.

 

We intend to purchase properties with (or enter into, as necessary) long-term leases with tenants, which may not result in fair market rental rates over time.

 

We intend to purchase properties with (or enter into, as necessary) long-term leases with tenants and include renewal options that specify a maximum rate increase. These leases would provide for rent to increase over time; however, if we do not accurately judge the potential for increases in market rental rates, we may set the terms of these long-term leases at levels such that, even after contractual rent increases, the rent under our long-term leases is less than then-current market rates. Further, we may have no ability to terminate those leases or to adjust the rent to then-prevailing market rates. As a result, our cash available for distribution could be lower than if we did not purchase properties with, or enter into, long-term leases.

 

We depend on tenants for our revenue generated by our real estate investments and, accordingly, our revenue generated by our real estate investments and our ability to make distributions to our stockholders are dependent upon the success and economic viability of our tenants and our ability to retain and attract tenants. Non-renewals, terminations or lease defaults could reduce our net income and limit our ability to make distributions to our stockholders.

 

The success of our real estate investments materially depends upon the financial stability of the tenants leasing the properties we own. The inability of a single major tenant or a significant number of smaller tenants to meet their rental obligations would significantly lower our net income. A non-renewal after the expiration of a lease term, termination or default by a tenant on its lease payments to us would cause us to lose the revenue associated with such lease and require us to find an alternative source of revenue to meet mortgage payments and prevent a foreclosure if the property is subject to a mortgage. In the event of a tenant default or bankruptcy, we may experience delays in enforcing our rights as landlord of a property and may incur substantial costs in protecting our investment and re-leasing the property. Tenants may have the right to terminate their leases upon the occurrence of certain customary events of default and, in other circumstances, may not renew their leases or, because of market conditions, may only be able to renew their leases on terms that are less favorable to us than the terms of their initial leases. Further, some of our assets may be outfitted to suit the particular needs of the tenants. We may have difficulty replacing the tenants of these properties if the outfitted space limits the types of businesses that could lease that space without major renovation. If a tenant does not renew, terminates or defaults on a lease, we may be unable to lease the property for the rent previously received or sell the property without incurring a loss. These events could cause us to reduce distributions to stockholders.

 

The bankruptcy or insolvency of our tenants or delays by our tenants in making rental payments could seriously harm our operating results and financial condition.

 

Any bankruptcy filings by or relating to any of our tenants could bar us from collecting pre-bankruptcy debts from that tenant, unless we receive an order permitting us to do so from the bankruptcy court. A tenant bankruptcy could delay our efforts to collect past due balances under the relevant leases and could ultimately preclude full collection of these sums. If a lease is rejected by a tenant in bankruptcy, we would have only a general unsecured claim for damages. Any unsecured claim we hold against a bankrupt entity may be paid only to the extent that funds are available and only in the same percentage as is paid to all other holders of unsecured claims. We may recover substantially less than the full value of any unsecured claims, which would harm our financial condition.

 

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Actions of our potential future tenants-in-common could reduce the returns on tenants-in-common investments and decrease our stockholders’ overall return.

 

We may enter into tenants-in-common or other joint ownership structures with third parties to acquire properties and other assets. Such investments may involve risks not otherwise present with other methods of investment, including, for example, the following risks:

 

  · our co-owner in an investment could become insolvent or bankrupt;
  · our co-owner may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals;
  · our co-owner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives; or
  · disputes between us and our co-owner may result in litigation or arbitration that would increase our expenses and prevent our officers and directors from focusing their time and effort on our operations.

 

While we intend that any co-ownership investment that we enter into will be subject to a co-ownership contractual arrangement that will address some or all of the above issues, any of the above might still subject a property to liabilities in excess of those contemplated and thus reduce our returns on that investment and the value of stockholders’ investment in us.

 

Costs imposed pursuant to laws and governmental regulations may reduce our net income and our cash available for distribution to our stockholders.

 

Real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to protection of the environment and human health. We could be subject to liability in the form of fines, penalties or damages for noncompliance with these laws and regulations. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, the remediation of contamination associated with the release or disposal of solid and hazardous materials, the presence of toxic building materials and other health and safety-related concerns.

 

Some of these laws and regulations may impose joint and several liability on the tenants, owners or operators of real property for the costs to investigate or remediate contaminated properties, regardless of fault, whether the contamination occurred prior to purchase, or whether the acts causing the contamination were legal. Activities of our tenants, the condition of properties at the time we buy them, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties may affect our properties.

 

The presence of hazardous substances, or the failure to properly manage or remediate these substances, may hinder our ability to sell, rent or pledge such property as collateral for future borrowings. Any material expenditures, fines, penalties or damages we must pay will reduce our ability to pay distributions to our stockholders and may reduce the value of our stockholders’ investment in us.

 

The costs of defending against claims of environmental liability, of complying with environmental regulatory requirements, of remediating any contaminated property or of paying personal injury or other damage claims could reduce our cash available for distribution to our stockholders.

 

Under various federal, state and local environmental laws, ordinances and regulations, a current or previous real property owner or operator may be liable for the cost of removing or remediating hazardous or toxic substances on, under or in such property. These costs could be substantial. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Environmental laws also may impose liens on property or restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures or prevent us from entering into leases with prospective tenants that may be impacted by such laws. Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or, in certain circumstances, by private parties. Certain environmental laws and common law principles could be used to impose liability for the release of and exposure to hazardous substances, including asbestos-containing materials and lead-based paint. Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances and governments may seek recovery for natural resource damage. The costs of defending against claims of environmental liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury, property damage or natural resource damage claims could reduce our cash available for distribution to our stockholders.

 

We intend that most if not all of our real estate acquisitions be subject to Phase I environmental assessments prior to the time they are acquired; however, such assessments may not provide complete environmental histories due, for example, to limited available information about prior operations at the properties or other gaps in information at the time we acquire the property. A Phase I environmental assessment is an initial environmental investigation to identify potential environmental liabilities associated with the current and past uses of a given property. If any of our properties were found to contain hazardous or toxic substances after our acquisition, the value of our investment could decrease below the amount paid for such investment.

 

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Costs associated with complying with the Americans with Disabilities Act may decrease our cash available for distribution.

 

Our properties may be subject to the Americans with Disabilities Act of 1990, as amended, or the Disabilities Act. Under the Disabilities Act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The Disabilities Act has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services be made accessible and available to people with disabilities. The Disabilities Act’s requirements could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages. Any funds used for Disabilities Act compliance will reduce our net income and the amount of cash available for distribution to our stockholders.

 

Uninsured losses relating to real property could reduce our cash flow from operations and the return on our stockholders’ investment in us.

 

We expect that most of the properties we acquire will be subject to leases requiring the tenants thereunder to be financially responsible for property liability and casualty insurance. However, there are types of losses, generally catastrophic in nature, such as losses due to wars, acts of terrorism, earthquakes, floods, hurricanes, pollution or environmental matters that are uninsurable and/or that the tenants are not contractually obligated to provide insurance for. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We may not have adequate coverage for such losses. If any of our properties incurs a casualty loss that is not fully insured, the value of our assets will be reduced by any such uninsured loss, which will reduce the value of stockholders' investment in us. In addition, other than any working capital reserve and other reserves we may establish, we have limited sources of funding to repair or reconstruct any uninsured property.

 

Other general real estate risks include those set forth below.

 

·If we sell properties by providing financing to purchasers, defaults by the purchasers would adversely affect our cash flows.
·If we purchase an option to acquire a property but do not exercise the option, we likely would forfeit the amount we paid for such option, which would reduce the amount of cash we have available to make other investments.
·We may not have funding for future tenant improvements, which may adversely affect the value of our assets, our results of operations and returns to our stockholders.
·We depend on the availability of public utilities and services, especially for water and electric power. Any reduction, interruption or cancellation of these services may adversely affect us.
·We may be required to reimburse tenants for overpayments of estimated operating expenses.

 

Risks Related to Investments in Single Tenant Real Estate

 

Most of our properties will depend upon a single tenant for their rental income, and our financial condition and ability to make distributions may be adversely affected by the bankruptcy or insolvency, a downturn in the business, or a tenant’s lease termination.

 

We expect that most of our properties will be occupied by only one tenant or will derive a majority of their rental income from one tenant and, therefore, the success of those properties will be materially dependent on the financial stability of such tenants. Lease payment defaults by tenants could cause us to reduce the amount of distributions we pay. A default of a tenant on its lease payments to us and the potential resulting vacancy would cause us to lose the revenue from the property and force us to find an alternative source of revenue to meet any mortgage payment and prevent a foreclosure if the property is subject to a mortgage. In the event of a default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-letting the property. If a lease is terminated or an existing tenant elects not to renew a lease upon its expiration, there is no assurance that we will be able to lease the property for the rent previously received or sell the property without incurring a loss. A default by a tenant, the failure of a guarantor to fulfill its obligations or other premature termination of a lease, or a tenant’s election not to extend a lease upon its expiration, could have an adverse effect on our financial condition and our ability to pay distributions.

 

If a tenant declares bankruptcy, we may be unable to collect balances due under relevant leases.

 

Any of our tenants, or any guarantor of a tenant’s lease obligations, could be subject to a bankruptcy proceeding pursuant to Title 11 of the bankruptcy laws of the United States. Such a bankruptcy filing would bar all efforts by us to collect pre-bankruptcy debts from these entities or their properties, unless we receive an enabling order from the bankruptcy court. Post-bankruptcy debts would be paid currently. If a lease is assumed, all pre-bankruptcy balances owing under it must be paid in full. If a lease is rejected by a tenant in bankruptcy, we would have a general unsecured claim for damages. If a lease is rejected, it is unlikely we would receive any payments from the tenant because our claim is capped at the rent reserved under the lease, without acceleration, for the greater of one year or 15% of the remaining term of the lease, but not greater than three years, plus rent already due but unpaid. This claim could be paid only in the event funds were available, and then only in the same percentage as that realized on other unsecured claims.

 

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A tenant or lease guarantor bankruptcy could delay efforts to collect past due balances under the relevant leases and could ultimately preclude full collection of these sums. Such an event could cause a decrease or cessation of rental payments that would mean a reduction in our cash flow and the amount available for distributions to stockholders. In the event of a bankruptcy, we cannot assure stockholders that the tenant or its trustee will assume our lease. If a given lease, or guaranty of a lease, is not assumed, our cash flow and the amounts available for distributions to stockholders may be adversely affected. Further, our lenders may have a first priority claim to any recovery under the leases, any guarantees and any credit support, such as security deposits and letters of credit.

 

Net leases may not result in fair market lease rates over time.

 

We expect most of our rental income to come from net leases. Net leases typically contain (1) longer lease terms; (2) fixed rental rate increases during the primary term of the lease; and (3) fixed rental rates for initial renewal options, and, thus, there is an increased risk that these contractual lease terms will fail to result in fair market rental rates if fair market rental rates increase at a greater rate than the fixed rental rate increases.

  

Our real estate investments may include special use single tenant properties that may be difficult to sell or re-lease upon tenant defaults or early lease terminations.

 

We focus our investments on commercial properties, a number of which will be special use single tenant properties. With these properties, if the current lease is terminated or not renewed, we may be required to renovate the property or to make rent concessions in order to lease the property to another tenant or sell the property. In addition, in the event we are forced to sell the property, we may have difficulty selling it to a party other than the tenant or borrower due to the special purpose for which the property may have been designed. These and other limitations may affect our ability to sell or re-lease properties and adversely affect returns to stockholders.

 

A high concentration of our properties in a particular geographic area, or that have tenants in a similar industry, would magnify the effects of downturns in that geographic area or industry.

 

In the event that we have a concentration of properties in any particular geographic area, any adverse situation that disproportionately affects that geographic area would have a magnified adverse effect on our portfolio. Similarly, if our tenants are concentrated in a certain industry or industries, any adverse effect to that industry generally would have a disproportionately adverse effect on our portfolio.

 

If a sale-leaseback transaction is recharacterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.

 

We may enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be recharacterized as either a financing or a joint venture, either of which outcomes could adversely affect our business. If the sale-leaseback were recharacterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms, and prevented from foreclosing our lien on the property. If the sale-leaseback were recharacterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property. Either of these outcomes could adversely affect our cash flow and the amount available for distributions to stockholders.

 

Risks Associated with Debt Financing

 

We obtain lines of credit, mortgage indebtedness and other borrowings, which increases our risk of loss due to potential foreclosure.

 

We obtain lines of credit and long-term financing that may be secured by our properties and other assets. In some instances, we acquire real properties by financing a portion of the price of the properties and mortgaging or pledging some or all of the properties purchased as security for that debt. We may also incur mortgage debt on properties that we already own in order to obtain funds to acquire additional properties, to fund property improvements and other capital expenditures, to pay distributions and for other purposes. In addition, we may borrow as necessary or advisable to ensure that we maintain our qualification as a REIT for federal income tax purposes, including borrowings to satisfy the REIT requirement that we distribute at least 90% of our annual REIT taxable income to our stockholders (computed without regard to the dividends-paid deduction and excluding net capital gain). However, we can give our stockholders no assurance that we will be able to obtain such borrowings on satisfactory terms or at all.

 

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If we do mortgage a property and there is a shortfall between the cash flow generated by that property and the cash flow needed to service mortgage debt on that property, then the amount of cash available for distribution to our stockholders may be reduced. In addition, incurring mortgage debt increases the risk of loss of a property since defaults on indebtedness secured by a property may result in lenders initiating foreclosure actions. In that case, we could lose the property securing the loan that is in default, reducing the value of our stockholders’ investment in us. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure even though we would not necessarily receive any cash proceeds. We may give full or partial guarantees to lenders of mortgage or other debt on behalf of the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of all or a part of the debt or other amounts related to the debt if it is not paid by such entity. If any mortgages contain cross-collateralization or cross-default provisions, a default on a mortgage secured by a single property could affect mortgages secured by other properties.

 

We may utilize repurchase agreements as a component of our financing strategy. Repurchase agreements economically resemble short-term, variable-rate financing and usually require the maintenance of specific loan-to- collateral value ratios. If the market value of the assets subject to a repurchase agreement declines, we may be required to provide additional collateral or make cash payments to maintain the required loan-to-collateral value ratios. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying assets.

 

We may also obtain recourse debt to finance our acquisitions and meet our REIT distribution requirements. If we have insufficient income to service our recourse debt obligations, our lenders could institute proceedings against us to foreclose upon our assets. If a lender successfully forecloses upon any of our assets, our ability to pay cash distributions to our stockholders will be limited and our stockholders could lose money.

 

High mortgage rates or changes in underwriting standards may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our cash flow from operations and the amount of cash available for distribution to our stockholders.

 

If mortgage debt is unavailable at reasonable rates, we may not be able to finance the purchase of properties. If we place mortgage debt on a property, we run the risk of being unable to refinance part or all of the debt when it becomes due or of being unable to refinance on favorable terms. If interest rates are higher when we refinance properties subject to mortgage debt, our income could be reduced. We may be unable to refinance or may only be able to partly refinance properties if underwriting standards, including loan to value ratios and yield requirements, among other requirements, are more strict than when we originally financed the properties. If any of these events occurs, our cash flow could be reduced and/or we might have to pay down existing mortgages. This, in turn, would reduce cash available for distribution to our stockholders, could cause us to require additional capital and may hinder our ability to raise capital by issuing more stock or by borrowing more money.

 

We may use leverage in connection with any real estate investments we make, which increases the risk of loss associated with this type of investment.

 

We may finance the acquisition of certain real estate-related investments with warehouse lines of credit and repurchase agreements. Although the use of leverage may enhance returns and increase the number of investments that we can make, it may also substantially increase the risk of loss. There can be no assurance that leveraged financing will be available to us on favorable terms or that, among other factors, the terms of such financing will parallel the maturities of the leases in underlying assets acquired. If alternative financing is not available, we may have to liquidate assets at unfavorable prices to pay off such financing. The return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that we can derive from the assets we acquire.

 

Our debt service payments will reduce our cash available for distribution. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to foreclosure or sale to satisfy our debt obligations. If we utilize repurchase financing and if the market value of the assets subject to a repurchase agreement declines, we may be required to provide additional collateral or make cash payments to maintain the required loan-to-collateral value ratio. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying assets. Further, credit facility providers and warehouse facility providers may require us to maintain a certain amount of cash reserves or to set aside unleveraged assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

 

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We may not be able to access financing sources on attractive terms, which could adversely affect our ability to execute our business plan.

 

We may finance our assets over the long-term through a variety of means, including repurchase agreements, credit facilities, issuances of commercial mortgage-backed securities and other structured financings. Our ability to execute this strategy will depend on various conditions in the markets for financing in this manner that are beyond our control, including lack of liquidity and greater credit spreads. We cannot be certain that these markets will remain an efficient source of long-term financing for our assets. If our strategy is not viable, we will have to find alternative forms of long-term financing for our assets, as secured revolving credit facilities and repurchase agreements may not accommodate long-term financing. This could subject us to more recourse indebtedness and the risk that debt service on less efficient forms of financing would require a larger portion of our cash flow, thereby reducing cash available for distribution to our stockholders and funds available for operations as well as for future business opportunities.

 

Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to pay distributions to our stockholders.

 

When providing financing, a lender may impose restrictions on us that affect our distribution and operating policies and our ability to incur additional debt. Loan agreements into which we enter may contain covenants that limit our ability to further mortgage a property or that prohibit us from discontinuing insurance coverage or replacing our Advisor. These or other limitations would decrease our operating flexibility and our ability to achieve our operating objectives and limit our ability to pay distributions to our stockholders.

 

Increases in interest rates would increase the amount of our debt payments and limit our ability to pay distributions to our stockholders.

 

We may incur variable rate debt. Increases in interest rates will increase the cost of that debt, which could reduce our cash flow from operations and the cash we have available for distribution to our stockholders. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments at times that may not permit realization of the maximum return on such investments.

 

We have broad authority to incur debt and debt levels could hinder our ability to make distributions and decrease the value of our stockholders’ investment in us.

 

We may incur debt until our total liabilities would exceed 50% of the cost of our tangible assets (before deducting depreciation or other noncash reserves and without taking into account borrowings relating to the initial acquisition of properties that are outstanding under a revolving credit facility or similar agreement) and we may exceed this limit with the approval of the majority of our conflicts committee. Our borrowings on one or more individual properties may exceed 50% of their individual cost, so long as our overall leverage does not exceed 50%. Our charter limits our borrowing to 50% of our net assets (equivalent to 50% of the cost of our assets) unless any excess borrowing is approved by a majority of our conflicts committee and is disclosed to our stockholders in our next quarterly report, along with the justification for such excess. When calculating our use of leverage, we will not include borrowings relating to the initial acquisition of properties and that are outstanding under a revolving credit facility (or similar agreement). There is no limitation on the amount we may borrow for the purchase of any single asset.

 

To hedge against interest rate fluctuations, we may use derivative financial instruments that may be costly and ineffective.

 

From time to time, we may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions will be determined in light of the facts and circumstances existing at the time of the hedge and may differ from our currently anticipated hedging strategy. There is no assurance that our hedging strategy will achieve our objectives. We may be subject to costs, such as transaction fees or breakage costs, if we terminate these arrangements.

 

To the extent that we use derivative financial instruments to hedge against interest rate fluctuations, we will be exposed to credit risk, basis risk and legal enforceability risks. In this context, credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. Basis risk occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. Finally, legal enforceability risks encompass general contractual risks including the risk that the counterparty will breach the terms of, or fail to perform its obligations under, the derivative contract. As a result of the global credit crisis, there is a risk that counterparties could fail, shut down, file for bankruptcy or be unable to pay out contracts. The failure of a counterparty that holds collateral that we post in connection with an interest rate swap agreement could result in the loss of that collateral.

 

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Federal Income Tax Risks

 

Failure to qualify as a REIT would subject us to federal income tax, which would reduce the cash available for distribution to our stockholders.

 

We expect to operate in a manner that will allow us to continue to qualify as a REIT for federal income tax purposes. However, the federal income tax laws governing REITs are extremely complex, and interpretations of the federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we intend to continue to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, including the tax treatment of certain investments we may make, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year. If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay federal income tax on our taxable income. We might need to borrow money or sell assets to pay that tax. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT were excused under federal tax laws, we would be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.

  

Our stockholders may have current tax liability on distributions they elect to reinvest in our common stock.

 

If our stockholders participate in our distribution reinvestment plan, they will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. In addition, our stockholders will be treated for tax purposes as having received an additional distribution to the extent the shares are purchased at a discount to fair market value, if any. As a result, unless our stockholders are tax-exempt entities, they may have to use funds from other sources to pay their tax liability on the value of the shares of common stock received.

 

Even if we qualify as a REIT for federal income tax purposes, we may be subject to other tax liabilities that reduce our cash flow and our ability to make distributions to our stockholders.

 

Even if we qualify as a REIT for federal income tax purposes, we may be subject to some federal, state and local taxes on our income or property. For example:

 

  · In order to qualify as a REIT, we must distribute annually at least 90% of our REIT taxable income to our stockholders (which is determined without regard to the dividends-paid deduction or net capital gain). To the extent that we satisfy the distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on the undistributed income.
  · We will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years.
  · If we elect to treat property that we acquire in connection with certain leasehold terminations as “foreclosure property,” we may avoid the 100% tax on the gain from a resale of that property, but the income from the sale or operation of that property may be subject to corporate income tax at the highest applicable rate.
  · If we sell an asset that we hold primarily for sale to customers in the ordinary course of business, our gain would be subject to the 100% “prohibited transaction” tax unless such sale were made by one of our taxable REIT subsidiaries.

 

REIT distribution requirements could adversely affect our ability to execute our business plan.

 

We generally must distribute annually at least 90% of our REIT taxable income, subject to certain adjustments and excluding any net capital gain, in order for federal corporate income tax not to apply to earnings that we distribute. To the extent that we satisfy this distribution requirement but distribute less than 100% of our REIT taxable income, we will be subject to federal corporate income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws. We intend to make distributions to our stockholders to comply with the REIT requirements of the Internal Revenue Code.

 

From time to time, we may generate taxable income greater than our income for financial reporting purposes, or our taxable income may be greater than our cash flow available for distribution to stockholders. If we do not have other funds available in these situations we could be required to borrow funds, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirements and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.

 

 32 

 

 

To maintain our REIT status, we may be forced to forego otherwise attractive business or investment opportunities, which may delay or hinder our ability to meet our investment objectives and reduce our stockholders’ overall return.

 

To qualify as a REIT, we must satisfy certain tests on an ongoing basis concerning, among other things, the sources of our income, nature of our assets and the amounts we distribute to our stockholders. We may be required to make distributions to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits and reduce the value of our stockholders’ investment.

 

Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.

 

If a tax-exempt stockholder has incurred debt to purchase or hold our common stock, then a portion of the distributions to and gains realized on the sale of common stock by such tax-exempt stockholder may be subject to federal income tax as unrelated business taxable income under the Internal Revenue Code.

 

If we were considered to actually or constructively pay a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.

 

In order to qualify as a REIT, we must distribute to our stockholders at least 90% of our annual REIT taxable income (excluding net capital gain), determined without regard to the deduction for dividends paid. In order for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distribution must not be “preferential dividends.” A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. There is no de minimis exception with respect to preferential dividends; therefore, if the IRS were to take the position that we paid a preferential dividend, we may be deemed to have failed the 90% distribution test, and our status as a REIT could be terminated for the year in which such determination is made if we were unable to cure such failure.

 

Complying with REIT requirements may force us to liquidate otherwise attractive investments.

 

To qualify as a REIT, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and residential and commercial mortgage-backed securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

 

Liquidation of assets may jeopardize our REIT qualification.

 

To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.

 

Characterization of any repurchase agreements we enter into to finance our investments as sales for tax purposes rather than as secured lending transactions would adversely affect our ability to qualify as a REIT.

 

We may enter into repurchase agreements with a variety of counterparties to achieve our desired amount of leverage for the assets in which we invest. When we enter into a repurchase agreement, we generally sell assets to our counterparty to the agreement and receive cash from the counterparty. The counterparty is obligated to resell the assets back to us at the end of the term of the transaction. We believe that for federal income tax purposes we will be treated as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreement may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the Internal Revenue Service could successfully assert that we did not own these assets during the term of the repurchase agreements, in which case we could fail to qualify as a REIT if tax ownership of these assets was necessary for us to meet the income and/or asset tests.

 

 33 

 

 

Complying with REIT requirements may limit our ability to hedge effectively.

 

The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate, inflation and/or currency risks will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges (i) interest rate risk on liabilities incurred to carry or acquire real estate or (ii) risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75% or 95% gross income tests, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute nonqualifying income for purposes of both the REIT 75% and 95% gross income tests. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes than we would otherwise incur.

  

Ownership limitations may restrict change of control or business combination opportunities in which our stockholders might receive a premium for their Class C or Class S shares.

 

In order for us to qualify as a REIT for each taxable year, no more than 50% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” for this purpose include natural persons, and some entities such as private foundations. To preserve our REIT qualification, our charter as supplemented by actions of our board of directors generally prohibits any person from directly or indirectly owning more than 9.8% in value of our capital stock. This ownership limitation could have the effect of discouraging a takeover or other transaction in which our stockholders might receive a premium for their shares over the then prevailing market price or which our stockholders might believe to be otherwise in their best interests.

 

Our ownership of and relationship with our taxable REIT subsidiaries will be limited and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.

 

A REIT may own up to 100% of the stock of one or more taxable REIT subsidiaries. A taxable REIT subsidiary may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a taxable REIT subsidiary. A corporation of which a taxable REIT subsidiary directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a taxable REIT subsidiary. Overall, no more than 25% (reducing to 20% beginning in 2018) of the value of a REIT’s assets may consist of stock or securities of one or more taxable REIT subsidiaries. A domestic taxable REIT subsidiary will pay federal, state and local income tax at regular corporate rates on any income that it earns. In addition, the taxable REIT subsidiary rules limit the deductibility of interest paid or accrued by a taxable REIT subsidiary to its parent REIT to assure that the taxable REIT subsidiary is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a taxable REIT subsidiary and its parent REIT that are not conducted on an arm’s-length basis. We cannot assure our stockholders that we will be able to comply with the 25% (20% beginning in 2018) value limitation on ownership of taxable REIT subsidiary stock and securities on an ongoing basis so as to maintain REIT status or to avoid application of the 100% excise tax imposed on certain non-arm’s length transactions.

 

The IRS may challenge characterizations of certain income from offshore taxable REIT subsidiaries.

 

We may form offshore corporate entities treated as taxable REIT subsidiaries. If we do form such subsidiaries, we may receive certain “income inclusions” with respect to our equity investments in these entities, which would flow through to us. We intend to treat such income inclusions, to the extent matched by repatriations of cash in the same taxable year, as qualifying income for purposes of the 95% gross income test but not the 75% gross income test. Because there is no clear precedent with respect to the qualification of such income inclusions for purposes of the REIT gross income tests, no assurance can be given that the IRS will not assert a contrary position. If such income does not qualify for the 95% gross income test, we could be subject to a penalty tax or we could fail to qualify as a REIT, in both events only if such inclusions (along with certain other non-qualifying income) exceed 5% of our gross income.

 

We may be subject to adverse legislative or regulatory tax changes.

 

At any time, the federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new federal income tax law, regulation or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.

 

 34 

 

 

Distributions payable by REITs do not qualify for the reduced tax rates.

 

The maximum tax rate for distributions payable to domestic stockholders that are individuals, trusts and estates is 23.8%. Distributions payable by REITs, however, are generally not eligible for the reduced rates. While this tax treatment does not adversely affect the taxation of REITs or distributions paid by REITs, the more favorable rates applicable to regular corporate distributions could cause investors who are individuals, trusts or estates to perceive investments in REITs to be relatively less attractive than investments in stock of non-REIT corporations that pay distributions, which could adversely affect the value of the stock of REITs, including our common stock.

 

Retirement Plan Risks

 

If the fiduciary of an employee benefit plan subject to ERISA (such as a profit sharing, Section 401(k) or pension plan) or an owner of a retirement arrangement subject to Section 4975 of the Internal Revenue Code (such as an individual retirement account (“IRA”)) fails to meet the fiduciary and other standards under ERISA or the Internal Revenue Code as a result of an investment in our stock, the fiduciary could be subject to penalties and other sanctions.

 

There are special considerations that apply to employee benefit plans subject to ERISA (such as profit sharing, Section 401(k) or pension plans) and other retirement plans or accounts subject to Section 4975 of the Internal Revenue Code (such as an IRA) that are investing in our shares. Fiduciaries and IRA owners investing the assets of such a plan or account in our common stock should satisfy themselves that:

 

·the investment is consistent with their fiduciary and other obligations under ERISA and the Internal Revenue Code;
·the investment is made in accordance with the documents and instruments governing the plan or IRA, including the plan’s or account’s investment policy;
·the investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and other applicable provisions of ERISA and the Internal Revenue Code;
·the investment in our shares, for which no public market currently exists, is consistent with the liquidity needs of the plan or IRA;
·the investment will not produce an unacceptable amount of “unrelated business taxable income” for the plan or IRA;
·our stockholders will be able to comply with the requirements under ERISA and the Internal Revenue Code to value the assets of the plan or IRA annually; and
·the investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code.

 

With respect to the annual valuation requirements described above, we will provide an estimated value for our shares annually. We can make no claim whether such estimated value will or will not satisfy the applicable annual valuation requirements under ERISA and the Internal Revenue Code. The Department of Labor or the Internal Revenue Service may determine that a plan fiduciary or an IRA custodian is required to take further steps to determine the value of our common stock. In the absence of an appropriate determination of value, a plan fiduciary or an IRA custodian may be subject to damages, penalties or other sanctions.

 

Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Internal Revenue Code may result in the imposition of civil and criminal penalties and could subject the fiduciary to claims for damages or for equitable remedies, including liability for investment losses. In addition, if an investment in our shares constitutes a prohibited transaction under ERISA or the Internal Revenue Code, the fiduciary or IRA owner who authorized or directed the investment may be subject to the imposition of excise taxes with respect to the amount invested.

 

In addition, the investment transaction must be undone. In the case of a prohibited transaction involving an IRA owner, the IRA may be disqualified as a tax-exempt account and all of the assets of the IRA may be deemed distributed and subjected to tax. ERISA plan fiduciaries and IRA owners should consult with counsel before making an investment in our common stock.

 

ITEM 1B.UNRESOLVED STAFF COMMENTS

 

None.

 

 35 

 

 

ITEM 2.PROPERTIES

 

Properties:

 

As of December 31, 2017, we owned the following properties:

 

Property and
Location (1)
  Rentable
Square
Feet
    Property
Type
  Investment
in Real
Property,
net, plus
Above-/Below
Market
Leases, net
    Mortgage
Financing
(Principal)
    Annualized
Base Lease
Revenue (2)
    Acquisition
Fee (3)
    Lease
Expiration
(4)
    Renewal
Options
(number
/years)
(4)
Accredo Health Orlando, FL     63,000     Office   $ 10,145,910     $ 4,932,287 (5)   $ 899,010     $ 327,890       6/14/2021       1/5-yr
Walgreens Stockbridge, GA     15,120     Retail     4,463,020       2,201,679 (5)     360,000       152,026       2/28/2021      8/5-yr
Dollar General  Litchfield, ME     9,026     Retail     1,352,840       656,846 (6)     92,961       40,008       9/30/2030       3/5-yr
Dollar General  Wilton, ME     9,100     Retail     1,626,487       662,231 (6)     112,439       48,390       7/31/2030       3/5-yr
Dollar General Thompsontown, PA     9,100     Retail     1,263,090       662,231 (6)     85,998       37,014       10/31/2030       3/5-yr
Dollar General Mt. Gilead, OH     9,026     Retail     1,244,328       656,846 (6)     85,924       36,981       6/30/2030       3/5-yr
Dollar General Lakeside, OH     9,026     Retail     1,170,924       656,846 (6)     81,036       34,875       5/31/2030       3/5-yr
Dollar General Castalia, OH     9,026     Retail     1,146,905       656,846 (6)     79,320       34,140       5/31/2030       3/5-yr
Dana Cedar Park, TX     45,465     Industrial     8,962,210       4,709,889       665,917       274,200     6/30/2024       2/5-yr
Northrop Grumman Melbourne, FL     107,419     Office     13,104,293       5,945,655       1,162,274       398,100       5/31/2021       1/5-yr
exp US Services Maitland, FL     33,118     Office     6,702,507       3,505,061       701,510       200,837       11/30/2026       2/5-yr
Harley Bedford, TX     70,960     Retail     12,960,473       6,983,418       900,000       382,500     4/12/2032       2/5-yr
Wyndham Summerlin, NV     41,390     Office     9,959,125       5,920,800 (7)     806,027       292,968     2/28/2025 (8)     1/5-yr
Williams Sonoma Summerlin, NV     35,867     Office     7,614,762       4,699,200 (7)     624,086       223,924       10/31/2022      None
Omnicare Richmond, VA     51,800     Industrial     7,218,979       4,423,574       535,379       211,275       5/31/2026      1/5-yr
EMCOR Cincinnati, OH     39,385     Office     6,077,888       2,955,000       472,620       177,210       2/28/2027       2/5-yr
Husqvarna Charlotte, NC     64,637     Industrial     11,965,814       -       783,029       348,000       6/30/2027 (9)     2/5-yr
AvAir Chandler, AZ     162,714     Industrial     27,353,125       12,000,000       2,100,000       795,000     12/31/2032       2/5-yr
      785,179         $ 134,332,680     $ 62,228,409     $ 10,547,530     $ 4,015,338            

 

(1)Each of the properties was 100% occupied by a single tenant at the time of acquisition and has remained 100% occupied by that tenant through December 31, 2017.

(2)Annualized Base Lease Revenue is calculated based on the contractual monthly base rent, excluding rent abatements, at December 31, 2017 multiplied by 12.

(3) The Acquisition Fee is paid to the Advisor in connection with the acquisition of a property. The fee is equal to 3.0% of the contract purchase price of a property, as defined in the Advisory Agreement.

(4)Represents the lease term beginning with the later of the purchase date or the rent commencement date through the end of the non-cancelable lease term, assuming no renewals are exercised unless otherwise noted.

(5)These properties are both collateral for one mortgage note payable. The amounts shown on this schedule are based on the pro rata investment in the two properties.
(6)These properties are cross-collateralized with each other. The deeds of trust for the Company’s six Dollar General properties contain cross-collateralization and cross-default provisions. There is one loan for these six Dollar Generals and the amounts shown in this schedule are based on the pro rata investment in the six properties.
(7)The loans for each of the Wyndham and Williams Sonoma properties located in Summerlin, Nevada were originated by Nevada State Bank (“Bank”). The loans are collateralized by a deed of trust and a security agreement with assignment of rents and fixture filing; in addition, the individual loans are subject to a cross-collateralization and cross-default agreement whereby any default under, or failure to comply with the terms of any one loan is an event of default under the terms of both loans. The value of the property must be in an amount sufficient to maintain a loan to value ratio of no more than 60%. If the loan to value ratio is ever more than 60%, the borrower shall, upon the Bank’s written demand, reduce the principal balance of the loans so that the loan to value ratio is no more than 60%.

(8)The actual expiration date is February 29, 2028, after which the renewal option can be exercised.

(9)The tenant’s right to cancel the lease on June 30, 2025 was not determined to be probable for financial accounting purposes.

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Lease Expirations   

 

The following tables reflect lease expirations with respect to our properties as of December 31, 2017:   

 

Year  2018   2019   2020   2021   2022   2023 
Number of Leases   -    -    -    3    1    - 
Square Footage   -    -    -    185,539    35,867    - 
Annualized Base Lease Rent (1)  $-   $-   $-   $2,421,284   $624,086   $- 
% of Total Annualized
Base Lease Rent
   -%   -%   -%   23.0%   5.9%   -%

 

Year  2024   2025   2026   Thereafter   Total 
Number of Leases   1    1    2    10    18 
Square Footage   45,465    41,390    84,918    392,000    785,179 
Annualized Base Lease Rent (1)  $665,917   $806,027   $1,236,889   $4,793,327   $10,547,530 
% of Total Annualized
Base Lease Rent
   6.3%   7.6%   11.7%   45.5%   100.0%

 

(1) Annualized Lease Revenue is calculated based on the contractual monthly base rent at December 31, 2017 multiplied by twelve.

 

In evaluating these properties and investments for acquisition, including the determination of an appropriate purchase price to be paid for the properties, we considered a variety of factors, including the condition and financial performance of the properties, the terms of the existing leases and the creditworthiness of the tenants, property location, visibility and access, age of the properties, physical condition and curb appeal, neighboring property uses, local market conditions, including vacancy rates, area demographics, including trade area population and average household income and neighborhood growth patterns and economic conditions. We do not currently have plans to incur any significant costs to renovate, improve or develop the properties, and we believe that the properties are adequately insured.

 

2017 Acquisitions: 

 

On March 7, 2017, through a wholly owned subsidiary, the Company acquired a 106,613 square feet office property in Melbourne, Florida, which it leases to Northrop Grumman Systems Corporation (“Northrop”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Northrop Property was $13,724,190, including closing costs.

 

On March 27, 2017, through a wholly owned subsidiary, the Company acquired a 33,118 square feet office property in Maitland, Florida, which it leases to exp US Services, Inc. (“exp US Services”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the exp US Services Property was $6,924,854, including closing costs.

 

On April 13, 2017, through a wholly owned subsidiary, the Company acquired a 70,960 square feet retail property in Bedford, Texas, which it leases to Calculated Risk Bedford, LP dba Texas Harley-Davidson (“Harley”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Harley Property was $13,178,288, including closing costs.

 

On June 22, 2017, through a wholly owned subsidiary, the Company acquired a 41,300 square feet office property in Summerlin, Nevada, which it leases to Wyndham Vacation Ownership, Inc. (“Wyndham”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Wyndham Property was $10,116,502, including closing costs.

 

On June 22, 2017, through a wholly owned subsidiary, the Company acquired a 35,867 square feet office property in Summerlin, Nevada, which it leases to Williams-Sonoma, Inc. (“Williams Sonoma”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Williams Sonoma Property was $7,231,767, including closing costs.

 

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On July 20, 2017, through a wholly owned subsidiary, the Company acquired a 51,300 square feet industrial property in Richmond, Virginia, which it leases to Williamson Drug Company, Incorporated (“Omnicare”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Omnicare Property was $7,324,370, including closing costs.

 

On August 9, 2017, through a wholly owned subsidiary, the Company acquired a 39,385 square feet office property in Cincinnati, Ohio, which it leases to EMCOR Facilities Services, Inc. (“EMCOR”) (f/k/a Viox Services, Inc.). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the EMCOR Property was $6,138,537, including closing costs.

 

On September 28, 2017, through a wholly owned subsidiary, the Company acquired an approximate 72.7% tenant-in-common interest in a 91,740 square feet office in Santa Clara, California, which is leased to Fujifilm Dimatix, Inc. The seller in not affiliated with the Company nor the Advisor. The aggregate purchase price for the Santa Clara property was $29,625,075, including closing costs. The Company’s investment in the tenant-in-common entity was $10,542,594 plus $626,073, which represented the Company’s share of the acquisition fee.

 

On November 30, 2017, through a wholly owned subsidiary, the Company acquired a 64,600 square feet industrial property in Charlotte, North Carolina, which it leases to Husqvarna Professional Products, Inc. (“Husqvarna”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Husqvarna Property was $12,003,048, including closing costs.

 

On December 28, 2017, through a wholly owned subsidiary, the Company acquired a 162,714 square feet industrial property in Chandler, Arizona, which it leases to AvAir, Inc. (“AvAir”). The seller is not affiliated with the Company nor the Advisor. The aggregate purchase price for the Husqvarna Property was $27,353,125, including closing costs.

 

2017 Debt Financing 

 

On July 14, 2017, the Company obtained a $5,945,955 mortgage loan through a nonaffiliated lender. The loan is secured by the Northrop property. The mortgage loan has a fixed interest rate of 4.40% per annum and matures on March 2, 2021.

 

On November 17, 2017, the Company obtained a $3,505,061 mortgage loan through a nonaffiliated lender. The loan is secured by the exp US Services property. The mortgage loan has an initial fixed interest rate of 4.25% per annum and starting November 11, 2022, 3.25% plus T-Bill Index and matures on November 17, 2024.

 

On August 28, 2017, the Company obtained a $6,983,418 mortgage loan through a nonaffiliated lender. The loan is secured by the Harley property. The mortgage loan has a fixed interest rate of 4.25% per annum and matures on September 1, 2024. 

 

On June 22, 2017, the Company obtained a $5,920,800 mortgage loan through a nonaffiliated lender. The loan is secured by the Wyndham property. The mortgage loan has an interest rate of one-month LIBOR plus 2.05% per annum and matures on June 5, 2027. 

 

On June 22, 2017, the Company obtained a $4,699,200 mortgage loan through a nonaffiliated lender. The loan is secured by the Williams Sonoma property. The mortgage loan has an interest rate of one-month LIBOR plus 2.05% per annum and matures on June 5, 2022. 

 

On August 29, 2017, the Company obtained a $4,423,574 mortgage loan through a nonaffiliated lender. The loan is secured by the Omnicare property. The mortgage loan has a fixed interest rate of 4.36% per annum and matures on May 1, 2026.

 

On September 28, 2017, the tenant-in-common entity that the Company has an approximate 72.7% interest in, obtained a $14,500,000 mortgage loan through a nonaffiliated lender. The loan is secured by the Santa Clara property. The mortgage loan has a fixed interest rate of 3.86% per annum and matures on December 1, 2024.

 

On November 16, 2017, the Company obtained a $2,955,000 mortgage loan through a nonaffiliated lender. The loan is secured by the EMCOR property. The mortgage loan has a fixed interest rate of 4.35% per annum and matures on December 1, 2024. 

 

On December 22, 2017, the Company obtained a $6,380,000 mortgage loan through a nonaffiliated lender. The loan is secured by the Husqvarna property. The mortgage loan has a fixed interest rate of 4.60% per annum and matures on March 31, 2028. 

 

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Investments:

 

As of December 31, 2017, we had the following other real estate investments:

 

  Investment
Balance

Santa Clara Property –  an approximate 72.7% tenant-in-common interest (1)

  $11,103,547 
Rich Uncles Real Estate Investment Trust I –  an approximate 4.4% interest   3,420,475 
   $14,524,022 

 

(1)

This office property has approximately 91,740 rentable square feet. The purchase price was $29,625,075, including closing costs. The annualized base lease revenue is $1,981,584. The acquisition fee was $861,055, of which $626,073 was paid by the Company. The lease expiration date is March 16, 2026 and the lease provides for three five-year renewal options.

 

Investment in Rich Uncles Real Estate Investment Trust I

 

In June 2016 we purchased 200,000 shares of common stock of Rich Uncles Real Estate Investment Trust I, a California business trust for $2,000,000. $2,884 of Rich Uncles Real Estate Investment Trust I’s 2016 second quarter dividends were reinvested for an additional 288 shares. We purchased an additional 163,162 shares amounts in November 2016 for $1,631,618 and an additional 902 shares in December 2016 for $9,016. Rich Uncles Real Estate Investment Trust I is an affiliate of ours and we share the same Advisor, Sponsor, and officers and directors. As of December 31, 2017, we own approximately 4.4% of the outstanding common stock of Rich Uncles Real Estate Investment Trust I and share in the same rights and economic interests of all other stockholders. We have no present intention of increasing our ownership in Rich Uncles Real Estate Investment Trust I, and the current investment was based upon the unanimous conclusion of our directors that the properties portfolio of Rich Uncles Real Estate Investment Trust I uniquely meet our investment criteria for the properties that we have and will continue to acquire.

 

Our Advisor receives no fees or other compensation in connection with our investment in Rich Uncles Real Estate Investment Trust I. Our investment in Rich Uncles Real Estate Investment Trust I was also approved by our conflicts committee which is composed of all of our independent directors, and our conflicts committee is charged with reviewing all interactions between us and Rich Uncles Real Estate Investment Trust I. The conflicts committee oversees this investment and all potential conflicts of interest that may arise, including those that may arise in connection with prospective acquisitions and dispositions within Rich Uncles Real Estate Investment Trust I’s portfolio.

 

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As of December 31, 2017, Rich Uncles Real Estate Investment Trust I owned each of the following properties:

 

Property and Location  Rentable
Square
Feet
   Property
Type
  Investment in
Real
Property, net,
plus
Above-/Below
Market
Leases, net
   Mortgage
Financing
(Principal)
  

Acquisition
Fee

   Annualized
Base
Lease
Revenue
(1)
   Lease
Expiration
  Renewal
Options
(number
/years)
Chase Bank, Antioch, CA   5,660   Retail  $2,222,455   $1,525,103 (2)  $60,978 (2)  $-   12/31/2017  None
Great Clip, Antioch, CA   1,348   Retail   529,305    363,222 (2)   14,523 (2)   32,352   6/30/2023  1 5-yr
Chevron, San Jose, CA   1,060   Retail   2,673,248    -     27,750     199,800   5/27/2025  4 5-yr
Levins, Sacramento, CA   76,000   Industrial   3,244,412    2,169,908     75,000 (3)   277,860   8/20/2023  2 5-yr
Chevron, Roseville, CA (4)   3,300   Retail   2,580,996    -     56,000 (3)   201,600   9/30/2025  4 5-yr
Island Pacific Supermarket, Elk Grove   13,963   Retail   3,341,575    1,973,170     74,400 (3)   216,426   5/31/2025  2 5-yr
Dollar General, Bakersfield, CA   18,827   Retail   4,291,619    2,430,065     91,500 (3)   328,250   7/31/2028  3 5-yr
Rite Aid, Lake Elsinore, CA   17,272   Retail   7,372,243    3,827,722     158,100 (3)   487,070   2/25/2028  6 5-yr
PMI Preclinical, San Carlos, CA   20,800   Office   8,500,228    4,305,955     178,400 (3)   584,288   10/31/2025  2 5-yr
Eco Thrift Sacramento, CA   38,536   Retail   4,366,250    2,765,351     95,000     351,495   2/28/2026  2 5-yr
General Services Administration Vacaville, CA   11,014   Office   2,970,693    1,881,256     63,500     336,852   8/24/2026  None
PreK Education Center, San Antonio, TX   50,000   Retail   10,124,343    5,333,749     217,000     825,000   7/31/2021  2 8-yr
Dollar Tree Morrow, GA   10,906   Retail   1,344,685    -     30,036     103,607   7/31/2025  3 5-yr
Dinan Cars Morgan Hill, CA   27,296   Industrial   4,719,814    2,816,882     106,120     472,988   4/30/2023  None
Amec Foster Wheeler, San Diego, CA   37,449   Office   7,041,896    3,710,117 (5)   51,378     671,161   2/28/2021  2 3-yr
Solar Turbines, San Diego, CA   26,036   Office   5,595,053    2,947,828 (5)   117,418     489,144   7/31/2021  1 5-yr
Illinois Tool Works, El Dorado Hills, CA   38,500   Industrial   6,069,013    3,197,540 (5)   12,820     483,758   8/1/2022  1 3-yr
Dollar General, Big Spring, TX   9,026   Retail   1,240,434    632,218     24,688     86,041   4/30//2030  3 5-yr
Gap, Rocklin, CA   40,110   Office   7,554,087    3,782,712     154,000     539,078   2/8/2023  1 5-yr
L3 Communications, Carlsbad, CA   46,214   Office   10,383,527    5,471,050     202,523     720,938   4/30/2022  2 3-yr
Sutter, Rancho Cordova, CA   106,592(6)   Office   26,675,507    14,665,829     540,000     1,835,231   10/31/2025  3 5-yr
Walgreen, Santa Maria, CA   14,490   Retail   5,176,461    -     102,314     369,000   3/31/2062  8 5-yr
    614,399      $128,017,844   $63,799,677    $2,453,448    $9,611,939        

  

(1)Annualized Base Lease Revenue is calculated based on the contractual monthly base rent at December 31, 2017 multiplied by 12.

(2)One building, so mortgage financing and acquisition fee were allocated on a pro rata basis based on cash investments.

(3)

In lieu of Rich Uncles Real Estate Investment Trust I paying acquisition fees, the seller paid the acquisition fee through escrow.

(4)Rich Uncles Real Estate Investment Trust I owns an undivided 70.14% interest through a tenancy in common agreement that was entered into in March 2016.

(5)

One loan, cross collateralized by Amec Foster, Solar Turbines and ITW Rippey properties; allocated pro rata based on investment in real property for purposes of this table.

(6)Excludes 83,199 square feet of land relating to the water tower ground lease.

 

Lease Expirations

 

Year  2018   2019   2020   2021   2022   2023   2024 
Number of Leases   -    -    -    3    3    4    - 
Square Footage   -    -    -    113,485    99,204    144,754    - 
Annualized Base Lease Revenue (1)  $-   $-   $-   $1,985,305   $1,573,696   $1,322,278   $- 
% of Total Annualized Based Lease Revenue   -%   -%   -%   20.68%   16.39%   13.77%   -%

 

Year  2025   2026   2027   Thereafter   Total 
Number of Leases   6    2    -    3    21 
Square Footage   156,621    49,550    -    45,125    608,739 
Annualized Base Lease Revenue (1)  $3,140,952   $688,347   $-   $901,361   $9,611,939 
% of Total Annualized Based Lease Revenue   32.60%   7.17%   -%   9.39%   100%

 

(1)Annualized Lease Revenue is calculated based on the contractual monthly base rent at December 31, 2017 multiplied by twelve.

 

There are currently no other properties in contract for purchase or pending debt financing by Rich Uncles Real Estate Investment Trust I.

 

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ITEM 3.LEGAL PROCEEDINGS

 

The information disclosed under Legal Matters in Note 10 of the Notes to our Consolidated Financial Statements is incorporated herein by reference.

 

ITEM 4.MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Stockholder Information

 

As of March 27, 2018, we had 10,041,231 shares of Class C common stock outstanding held by a total of approximately 5,280 stockholders of record and 3,065 shares of Class S common stock outstanding held by 1 stockholder.

 

Market Information

 

No public market currently exists for our shares of common stock, and we currently have no plans to list our shares on a national securities exchange. Until our shares are listed, if ever, our stockholders may not sell their shares unless the buyer meets the applicable suitability and minimum purchase requirements. Any sale must comply with applicable state and federal securities laws. In addition, our charter as supplemented by actions of our board of directors prohibits the ownership of more than 9.8% of our stock by a single person, unless exempted by our board of directors. Consequently, there is the risk that our stockholders may not be able to sell their shares at a time or price acceptable to them.

 

 Determination of Estimated Per Share Value

 

Overview

 

On January 18, 2018, the conflicts committee of the Company’s board of directors recommended, and the board of directors unanimously approved and established, an estimated per share NAV of the Company’s common stock of $10.05 based on an estimated market value of the Company’s assets less the estimated market value of the Company’s liabilities, divided by the number of shares outstanding, as of December 31, 2017. This is the first time that the board of directors has determined an estimated per share NAV of the Company’s common stock. Going forward, the Company intends to publish an updated estimated per share NAV on at least an annual basis.

 

Process

 

The conflicts committee of our board of directors, composed solely of all of our independent directors, is responsible for the oversight of the valuation process used to determine the estimated NAV per share of our common stock, including oversight of the valuation processes and methodologies used to determine our estimated NAV per share, the consistency of the valuation methodologies with real estate industry standards and practices and the reasonableness of the assumptions used in the valuations and appraisals. In determining the estimated NAV of our shares, our conflicts committee and board of directors considered information and analysis, including valuation materials that were provided by Cushman & Wakefield Western, Inc., (“Cushman & Wakefield”) and information provided by our Advisor. Cushman & Wakefield is an independent third-party real estate advisory and consulting firm that was engaged by us to develop an estimate of the fair value of the Company. Cushman and Wakefield developed an opinion of fair value of the real estate assets and real estate related liabilities associated with the Company’s properties. The valuation was performed in accordance with the provisions of the Investment Program Association Practice Guideline 2013-01, Valuations of Publicly Registered Non Listed REITs.

 

The engagement of Cushman & Wakefield was approved by our board of directors, including all members of the conflicts committee. Cushman & Wakefield’s scope of work was conducted in conformity with the requirements of the Code of Professional Ethics and Standards of Professional Practice of the Appraisal Institute. Several members of the Cushman & Wakefield engagement team who certified the methodologies and assumptions applied by us hold a Member of Appraisal Institute designation. Other than its engagement as described herein, Cushman & Wakefield does not have any direct interests in any transaction with us and has not performed any services for us other than asset allocation services related to property acquisitions.

 

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The materials provided by Cushman & Wakefield included a range of NAV of our shares, and the conflicts committee of our board of directors believes that the use of the “Valuation Methodology,” as discussed below, as the primary or sole indicator of value has become widely accepted as a best practice in the valuation of non-listed REIT shares, and therefore the conflicts committee and our board of directors determined to use the Valuation Methodology in establishing the estimated per share NAV. This Valuation Methodology is consistent with the Net Asset Value Calculation and Valuation Procedures adopted by the board of directors, including a majority of our independent directors. Based on these considerations, the conflicts committee recommended that our board of directors establish an estimated value of our common stock, as of December 31, 2017, of $10.05 per share, which estimated value was within the $9.08 to $10.10 per share valuation range calculated by Cushman & Wakefield using the Valuation Methodology. The board of directors unanimously agreed to accept the recommendation of the conflicts committee and approved $10.05 as the estimated NAV per share of our common stock. Our board of directors is ultimately and solely responsible for the establishment of the per share estimated value.

 

Valuation Methodology

 

In preparing its valuation materials and in reaching its conclusions as to the reasonableness of the methodologies and assumptions used by the Company to value its assets, Cushman & Wakefield, among other things:

 

·investigated numerous sales in the properties' relevant markets, analyzed rental data and considered the input of buyers, sellers, brokers, property developers and public officials;
·reviewed and relied upon Company-provided data regarding the size, year built, construction quality and construction type of the properties in order to understand the characteristics of the existing improvements and underlying land;
·reviewed and relied upon Company-provided data regarding lease summaries, real estate taxes and operating expense data for the properties;
·reviewed and relied upon Company-provided balance sheet items such as cash and other assets, as well as debt and other liabilities;
·relied upon Company-provided derivative instrument valuation reports prepared by a third-party pricing service;
·researched the market by means of publications, public and private databases and other resources to measure current market conditions, supply and demand factors, and growth patterns and their effect on the properties; and
·performed such other analyses and studies, and considered such other factors, as Cushman & Wakefield considered appropriate.

 

Cushman & Wakefield utilized two approaches in valuing the Company’s real estate assets that are commonly used in the commercial real estate industry. The following is a summary of the NAV Methodology and the valuation approaches used by Cushman & Wakefield:

 

NAV Methodology-The NAV Methodology determines the value of the Company by determining the estimated market value of the Company's entity level assets, including real estate assets, and subtracting the market value of its entity level liabilities, including its debt. The materials provided by Cushman & Wakefield to estimate the value of the real estate assets were prepared using discrete estimations of "as is" market valuations for each of the properties in the Company’s portfolio using the income capitalization approach as the primary indicator of value and the sales comparison approach as a secondary approach to value, as discussed in greater detail below. Cushman & Wakefield also estimated the fair value of the Company’s real estate related debt and also reviewed the methodology used by a third-party pricing service to estimate the fair value of the Company’s derivatives and determined that the approach was reasonable. Cushman & Wakefield then added the non-real estate related assets and subtracted non-real estate related liabilities. The resulting amount, which is the estimated Preliminary NAV of the portfolio, is divided by the number of common shares outstanding to determine the estimated per share Preliminary NAV The Preliminary NAV was used to calculate the subordinated participation fee that is due to the Advisor. The amount of the subordinated participation fee was deducted from the estimated Preliminary NAV to calculate the estimated NAV.

 

Determination of Estimated Market Value of the Company’s Real Estate Assets Under the NAV Methodology

 

Income Capitalization Approach - The income capitalization approach first determines the income-producing capacity of a property by using contract rents on existing leases and by estimating market rent from rental activity at competing properties for the vacant space. Deductions are then made for vacancy and collection loss and operating expenses. The net operating income (“NOI”) developed in Cushman & Wakefield’s analysis is the balance of potential income remaining after vacancy and collection loss and operating expenses. This NOI was then capitalized at an appropriate rate to derive an estimate of value (the “Direct Capitalization Method”) or discounted by an appropriate yield rate over a typical projection period in a discounted cash flow analysis (the “DCF Method”). Thus, two key steps were involved: (1) estimating the NOI applicable to the subject property and (2) choosing appropriate capitalization rates and discount rates.

 

The material assumptions used in this income capitalization approach are NOI and the capitalization rate. All of our existing leases are triple net, and therefore NOI is equal to the contractual cash basis rents. The 2018 contractual cash basis rents were used.

 

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The following summarizes the range of capitalization rates Cushman & Wakefield used to arrive at the estimated market values of our properties valued using the DCF Method:

 

   Range   Weighted-Average 
Capitalization Rate   6.75% to 10.00%    7.44% 

 

The capitalization rate was weighted based on NOI. An increase (or decrease) in the selected capitalization rate of 0.25% would result in an increase (or decrease) in net asset value of approximately $5,500,000.

 

Sales Comparison Approach -The sales comparison approach estimates value based on what other purchasers and sellers in the market have agreed to as the price for comparable improved properties. This approach is based upon the principle of substitution, which states that the limits of prices, rents, and rates tend to be set by the prevailing prices, rents, and rates of equally desirable substitutes.

 

Utilizing the NAV Methodology, including use of the two approaches to value the Company’s real estate assets noted above, when divided by the 8.8 million shares of the Company’s common stock outstanding on December 31, 2017, Cushman & Wakefield determined a valuation range of $9.08 to $10.10 per share.

 

Cushman & Wakefield prepared and provided to the Company a report containing, among other information, the range of net asset values for the Company’s common stock as of December 31, 2017 (the “Valuation Report”). On January 18, 2018, the conflicts committee of our board of directors conferred with Cushman & Wakefield regarding the methodologies and assumptions used in the Valuation Report. On January 18, 2018, the conflicts committee of our board of directors recommended, and our board of directors unanimously approved an estimated per share NAV of the Company’s common stock, as of December 31, 2017, of $10.05 per share.

 

The table below sets forth the calculation of the Company’s estimated per share NAV as of December 31, 2017:

    Estimated Value     Estimated 
per share NAV
 
Real Estate Properties   $ 145,333,660     $ 16.45  
Investments in unconsolidated entities:                
Santa Clara Property Tenant-in-Common Interest     11,783,704       1.33  
Rich Uncles Real Estate Investment Trust 1 (1)     3,883,891       0.44  
Cash and Restricted Cash     4,158,570       0.47  
Other Assets     451,040       0.05  
Total Assets     165,610,865       18.74  
                 
Mortgage Notes Payable and Unsecured Credit Facility, Net     72,622,179       8.22  
Tenant Improvement Liability     1,524,720       0.17  
Accounts Payable, Accrued Expenses and Other Liabilities     1,807,235       0.20  
Unearned Rent     542,215       0.06  
Total Liabilities     76,496,349       8.65  
Preliminary NAV     89,114,516       10.09  
                 
Subordinated Participation Fee Payable (2)     (315,802 )     (0.04 )
                 
Total Estimated Value as of December 31, 2017   88,798,714     10.05  
                 
Shares of Common Stock Outstanding     8,838,002          

  

(1) On January 19, 2018, Rich Uncles Real Estate Investment Trust I (“REIT I”) announced its NAV of $10.66 per share. As of December 31, 2017, we owned approximately 4.4% of the outstanding shares of REIT I common stock. The estimated value of REIT I, based on its NAV announced on January 19, 2018, was $89,080,075 as of December 31, 2017. Our share is $3,883,891, which equals REIT I’s estimated value of $89,080,075 multiplied by our approximately 4.4% ownership interest as of December 31, 2017.

 

(2) The Company announced that the amount of the subordinated participation fee, $315,802, would be paid by issuing 6,075 Class C common shares to our Advisor with the balance being paid in cash. However, it was subsequently determined that such fee would be paid entirely in cash.

 

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Exclusions from Estimated NAV

 

The estimated share value approved by the board of directors does not reflect any "portfolio premium," nor does it reflect an enterprise value of the Company, which may include a premium or discount to NAV for:

 

·the size of the Company’s portfolio as some buyers may pay more for a portfolio compared to prices for individual investments;
·the overall geographic and tenant diversity of the portfolio as a whole;
·the characteristics of the Company’s working capital, leverage, credit facilities and other financial structures where some buyers may ascribe different values based on synergies, cost savings or other attributes;
·certain third-party transaction or other expenses that would be necessary to realize the value;
·services being provided by personnel of advisors under the advisory agreement and the Company’s potential ability to secure the services of a management team on a long-term basis; or
·the potential difference in per share value if the Company were to list its shares of common stock on a national securities exchange.

 

Limitations of the Estimated Share Value

 

As with any valuation methodology, the NAV Methodology used by the board of directors in reaching an estimate of the value of the Company’s shares is based upon a number of estimates, assumptions, judgments and opinions that may, or may not, prove to be correct. The use of different valuation methods, estimates, assumptions, judgments or opinions may have resulted in significantly different estimates of the value of the Company’s shares. In addition, the board of directors’ estimate of share value is not based on the book values of the Company's real estate, as determined by generally accepted accounting principles, as the Company’s book value for most real estate is based on the amortized cost of the property, subject to certain adjustments.

 

Furthermore, in reaching an estimate of the value of the Company’s shares, our board of directors did not include a discount for debt that may include a prepayment obligation or a provision precluding assumption of the debt by a third party. In addition, selling costs were not considered by Cushman & Wakefield in the valuation of the properties. Other costs that are likely to be incurred in connection with an appropriate exit strategy, whether that strategy involves a listing of the Company's shares of common stock on a national securities exchange, a merger of the Company, or a sale of the Company’s portfolio were also not included in the board of directors is estimate of the value of the Company’s shares.

 

As a result, there can be no assurance that:

 

·stockholders will be able to realize the estimated share value upon attempting to sell their shares;
·the Company will be able to achieve, for its stockholders, the estimated per share NAV upon a listing of the Company’s shares of common stock on a national securities exchange, a merger of the Company, or a sale of the Company’s portfolio; or
·the estimated share value, or the methodology relied upon by the board of directors to estimate the share value, will be found by any regulatory authority to comply with ERISA, the Internal Revenue Code or other regulatory requirements.

 

Furthermore, the estimated value of the Company's shares was calculated as of a particular point in time. The value of the Company's shares will fluctuate over time as a result of, among other things, developments related to individual assets and responses to the real estate and capital markets.

 

Class C Common Stock (Registered Offering)

 

Commencing on January 19, 2018, the offering price for shares of the Company's Class C common stock pursuant to the Registered Offering is $10.05 per share.

 

Class S Common Stock (Class S Offering)

 

Commencing on January 19, 2018, the offering price for shares of the Company’s Class S common stock offered exclusively to non-US Persons pursuant to an exemption from the registration requirements of the Securities Act under and in accordance with Regulation S of the Securities Act is $10.05 per share, plus the amount of any applicable upfront commissions and fees.

 

 44 

 

 

Distribution Reinvestment Plan

 

Pursuant to the terms of the Company's distribution reinvestment plan currently in effect (the "DRIP"), on or after the date that the board of directors determines a reasonable estimated value of the Company's shares, distributions will be reinvested in shares of our common stock at a price equal to the most recently disclosed estimated per share value, as determined by the board of directors excluding those the board of directors designates as ineligible for reinvestment through the DRIP. Accordingly, shares of the Company's common stock issued pursuant to the DRIP will be issued for $10.05 per share.

 

A participant may terminate participation in the DRIP at any time by delivering a written notice to the administrator. To be effective for any monthly distribution, such termination notice must be received by the Company at least ten (10) business days prior to the last day of the month to which the distribution relates. Any termination should be provided by written notice.

 

Stockholders who presently participate in the DRIP do not need to take any action to continue their participation in the DRIP.

 

Use of Proceeds from Sales of Registered Securities and Unregistered Sales of Equity Securities

 

Use of Proceeds from Sales of Registered Securities

 

On June 1, 2016, our Registration Statement on Form S-11 (File No. 333-205684) (the “Registration Statement”), covering an initial public offering to offer a maximum of 90,000,000 shares of common stock for sale to the public in the primary offering, was declared effective under the Securities Act. Pursuant to the Registration Statement, we also registered a maximum of 10,000,000 shares of common stock pursuant to our Registered DRP Offering. The shares of common stock covered by the Registration Statement were renamed and redesignated as Class C shares of common stock pursuant to amendments to the Company’s charter that became effective in August 2017.

 

The Registered Offering commenced on July 20, 2016. We intend to sell the shares of Class C common stock offered in our primary offering and pursuant to our distribution reinvestment plan until June 1, 2019, unless our board of directors terminates the offering at an earlier date or all shares being offered have been sold, in which case the offering will be terminated. If all of the shares we are offering have not been sold by June 1, 2019, our board of directors may further extend the offering in accordance with Rule 415 of the Securities Act. Rule 415 of the Securities Act permits us to file a new registration statement on Form S-11 with the SEC, so that we may continuously offer shares of our Class C common stock. If our board of directors determines to extend the offering beyond June 1, 2019, we will notify stockholders by filing a supplement to the prospectus for the Registered Offering with the SEC. We will also need to renew the registration statement or file a new registration statement in many states to continue the offering. We may terminate this offering at any time. Our board of directors will adjust the offering price of the primary offering shares and distribution reinvestment plan shares during the course of this offering as described elsewhere herein.

 

As of December 31, 2017, we had sold 9,055,175 shares of Class C common stock in the Registered Offering, including 319,150 shares of Class C common stock sold under our Registered DRP Offering, for aggregate gross offering proceeds of $90,551,753.

 

Also, as of December 31, 2017, we paid $2,707,517 to our Sponsor as reimbursement for organizational and offering costs, which reimbursement is subject to the 3% of gross offering proceeds limitation.

 

From the commencement of the Registered Offering through December 31, 2017, the net offering proceeds to us, after deducting the reimbursable organizational and offering expenses incurred as described above, were approximately $88,058,614, including net offering proceeds from our dividend reinvestment plan of $3,066,828. Substantially all of these proceeds, along with proceeds from the Class S Offering and debt financing, were used to make approximately $155,100,000 of investments in real estate properties, including the purchase price of our investments, deposits paid for future acquisitions, acquisition fees and expenses, and costs of leveraging each real estate investment. Of the use of the offering proceeds described in the prior statement, $4,167,292 and $326,600 were used to pay acquisition fees and financing coordination fees to our Advisor, respectively. Our Sponsor was reimbursed for $2,707,517 of organizational and offering costs. See Note 9 of the Notes to our Consolidated Financial Statements for details about fees paid to affiliates. In addition, as of December 31, 2017, $288,370 of proceeds from the Offerings were used to fund stockholder distributions. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations —Distributions for a description of the sources that have been used to fund our distributions.

 

Unregistered Sales of Equity Securities

 

During the three months ended December 31, 2017, we issued 3,800 shares of Class C common stock to the Company’s directors for their services as board members. Such issuance was made in reliance on the exemption from registration under Rule 4(a)(2) of the Securities Act.

 

 45 

 

 

During the three months ended December 31, 2017, we also issued 32 shares of Class S common stock in the Class S Offering for aggregate gross offering proceeds of $320. Such issuances were made in reliance of an exemption from the registration requirements of the Securities Act under and in accordance with Regulation S of the Securities Act.

 

Distributions Information

 

We intend to pay distributions on a monthly basis, and we paid our first distribution on July 11, 2016. The rate is determined by our board of directors based on our financial condition and such other factors as our board of directors deems relevant. Our board of directors has not pre-established a percentage range of return for distributions to stockholders. We have not established a minimum distribution level, and our charter does not require that we make distributions to our stockholders.

 

During our offering stage, when we may raise capital more quickly than we acquire income producing assets, and from time to time during our operational state, we may not pay distributions from operations. In these cases, distributions may be paid in whole or in part from the waiver or deferral of fees otherwise due to our Advisor or other sources, if so elected by our Advisor. Historically, the sources of cash used to pay our distributions have been from net rental income received and deferral of management fees. The leases for certain of our real estate acquisitions may provide for rent abatements. These abatements are an inducement for the tenant to enter into or extend the term of its lease. In connection with the acquisition of some properties, we may be able to negotiate a reduced purchase price for the acquired property in an amount that equals the previously agreed-upon rent abatement. During the period of any rent abatement on properties that we acquire, we may be unable to fully fund out distributions from net rental income received and waivers or deferrals of Advisor asset management fees, In that event, we may expand the sources of cash used to fund out stockholder distributions to include proceeds from the sale of our common stock, but only during the periods, and up to the amounts, of any rent abatements where we are able to negotiate a reduced purchase price. Distributions declared, distributions paid out, cash flows from operations and the source of distribution payments were as follows:

 

                       Sources of Distribution Payment 
                   Cash flows       Waived         
                   (used in)       Advisor   Deferred     
   Total   Distributions           provided by   Net Rental   Asset   Advisor Asset     
   distributions   declared per   Cash distributions paid   operating   Income   Management   Management   Offering 
Period  declared   share   Cash   Reinvested   activities   Received   Fees   Fees (3)   Proceeds 
                                     
2016:                                             
First Quarter 2016  $-   $-   $-   $-   $(91)  $-   $-   $-   $- 
Second Quarter 2016   -    -    -    -    56,531    -    -    -    - 
Third Quarter 2016   12,078    0.140    4,852    7,226    (589,184)(1)   280    11,798    35,395    - 
Fourth Quarter 2016   159,083(1)   0.175    41,313    117,770    (139,388)(1)(2)   113,803    15,703    47,108    - 
2016 Totals  $171,161   $0.315   $46,165   $124,996   $(672,132)  $114,083   $27,501   $82,503   $- 
                                              
2017:                                             
First Quarter 2017  $486,862   $0.175   $100,126   $386,736   $182,764   $377,405   $27,316   $82,141   $- 
Second Quarter 2017   824,641    0.175    152,193    672,448    1,248,798    629,515    48,709    146,417    - 
Third Quarter 2017   1,120,503    0.175    212,300    908,203    1,114,810    658,133    43,499    

130,501

    288,370 
Fourth Quarter 2017   1,368,619    0.175    268,911    1,099,708(4)   1,244,465    1,272,850    24,016    71,753    - 
2017 Totals  $3,800,625   $0.700   $733,530   $3,067,095   $3,790,837   $2,937,903   $143,540   $430,812   $288,370 

 

(1)Updated for immaterial corrections.

(2)Includes the reclassification of $37,554 of distributions received in the fourth quarter of 2016 from our investment in Rich Uncles REIT I as a result of retroactively adopting ASU 2016-15.

(3)During the year ended December 31, 2016, $35,395 and $17,531 of deferred Advisor asset management fees relating to the third quarter and fourth quarter 2016, respectively, were paid.

  (4)

The distribution paid per share of Class S common stock is net of deferred selling commissions.

 

In 2017 and 2016, we paid all of our dividends in cash. The following presents the federal income tax characterization of the distributions paid:

 

   Years ended December 31 
   2017   2016 
Ordinary income  $0.111   $0.000 
Non-taxable distribution   0.589    0.320 

Total

  $0.700   $0.320 

 

For the year ended December 31, 2017, distributions paid to our stockholders were 15.8% ordinary income, 0% capital gain, and 84.2% return of capital/non-dividend distribution. Distributions are paid on a monthly basis

 

 46 

 

 

Distributions to stockholders for the year ended December 31, 2017 were declared and paid monthly based on daily record dates at rates per share per day as follows:

 

Distribution Period   Rate per Share
per Day
    Declaration Date   Payment Date
2016              
June 15 (date of purchase of first property)-30   $ 0.00180556     July 5, 2016   July 11, 2016
July 1-31   $ 0.00174731     August 10, 2016   August 11, 2016
August 1-31   $ 0.00174731     September 7, 2016   September 12, 2016
September 1-30   $ 0.00194440     October 7, 2016   October 11, 2016
October 1-31   $ 0.00188170     November 9, 2016   November 10, 2016
November 1-30   $ 0.00194440     December 12, 2016   December 12, 2016
December 1-31   $ 0.00188170     January 10, 2017   January 10, 2017
                 
2017                
January 1-31   $ 0.00188170     February 10, 2017   February 10, 2017
February 1-28   $ 0.00208333     March 10, 2017   March 10, 2017
March 1-31   $ 0.00188170     April 10, 2017   April 10, 2017
April 1-30   $ 0.00194440     May 10, 2017   May 10, 2017
May 1-31   $ 0.00188170     June 10, 2017   June 10, 2017
June 1-30   $ 0.00194440     July 11, 2017   July 11, 2017
July 1-31   $ 0.00188170     August 10, 2017   August 10, 2017
August 1-31   $ 0.00188170     September 11, 2017   September 11, 2017
September 1-30   $ 0.00194440     October 11, 2017   October 11, 2017
October 1-31   $ 0.00188170   (1)  November 10, 2017   November 10, 2017
November 1-30   $ 0.00194440   (1)  December 10, 2017   December 10, 2017
December 1-31   $ 0.00188170   (1)  January 19, 2018   January 25, 2018

  

2018              
January 1-31   $ 0.00189113   (1)  February 1, 2018   February 26, 2018
February 1-28   $ 0.00209380   (1)  February 1, 2018   February 26, 2018
March 1-31   $ 0.00189113   (1)  March 20, 2018   April 25, 2018

 

(1)The distribution paid per share of Class S common stock is net of deferred selling commissions.

 

Going forward, we expect our board of directors to continue to declare cash distributions based on daily record dates and to pay these distributions on a monthly basis, and after the Offerings to continue to declare stock distributions based on a single record date as of the end of the month, and to pay these dividends on a monthly basis. Cash distributions will be determined by our board of directors based on our financial condition and such other factors as our board of directors deems relevant. Our board of directors has not pre-established a percentage rate of return for stock dividends or cash distributions to stockholders. We have not established a minimum dividend or distribution level, and our charter does not require that we make dividends or distributions to our stockholders other than as necessary to meet IRS REIT qualification standards.

 

Our operating performance cannot be accurately predicted and may deteriorate in the future due to numerous factors, including those discussed under “Risk Factors.” Those factors include: our ability to continue to raise capital to make additional investments; the future operating performance of our current and future real estate investments in the existing real estate and financial environment; our Advisor’s ability to identify additional real estate investments that are suitable to execute our investment objectives; the success and economic viability of our tenants; our ability to refinance existing indebtedness at comparable terms; changes in interest rates on any variable rate debt obligations we incur; and the level of participation in our dividend reinvestment plan. In the event our cash flow from operations decreases in the future, the level of our distributions may also decrease. In addition, future distributions declared and paid may exceed cash flow from operations, to the extent that the Advisor defers payment of fees and reimbursements to which it is entitled.

 

To maintain our qualification as a REIT, we must make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (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). If we meet the REIT qualification requirements, we generally will not be subject to federal income tax on the income that we distribute to our stockholders each year. Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant.

 

Share Repurchase Program

 

Our board of directors has authorized a share repurchase program for our Class C common stock and a share repurchase program for our Class S common stock.

 

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In accordance with our share repurchase program for our Class C common stock, the per share repurchase price depends on the length of time the redeeming stockholder has held such shares as follows: less than one year from the purchase date, 97% of the most recently published NAV per share; after at least one year but less than two years from the purchase date, 98% of the most recently published NAV per share; after at least two years but less than three years from the purchase date, 99% of the most recently published NAV per share; and after three years from the purchase date, 100% of the most recently published NAV per share. Our most recently published NAV per share effective as of January 19, 2018 is $10.05. Prior to January 19, 2018, repurchases under the share repurchase program of shares of our Class C common stock were made based on our initial offering price of $10.00 per share, subject to the same discounts for the length of time such shares were held as described above.

 

In accordance with our share repurchase program for our Class S common stock, shares of Class S common stock are not eligible for repurchase unless they have been held for at least one year. After this holding period has been met, Class S shares can be redeemed at the most recently published NAV, which is currently $10.05.

 

As of December 31, 2017, 303,004 shares had been tendered for redemption by the Company, which represented all redemption requests received in good order and eligible for redemption through December 31, 2017. All of these shares had been redeemed except for the 39,731 of shares in connection with the repurchase requests that were made in December 2017 and were repurchased on January 4, 2018. These shares were repurchased with the proceeds from reinvested dividends at 97% of the pre-NAV $10.00 price per share during the 12-month period and 98% of the pre-NAV $10.00 price per share during the 12- to 24-month period following a stockholder’s investment in the shares.

 

Limitations on Repurchase

 

We may, but are not required to, use available cash not otherwise dedicated to a particular use to pay the repurchase price, including cash proceeds generated from the dividend reinvestment plan, securities offerings, operating cash flow not intended for distributions, borrowings and capital transactions, such as asset sales or loan refinancings. We cannot guarantee that we will have sufficient available cash to accommodate all repurchase requests made in any given month.

 

In addition, we may not repurchase shares in an amount that would violate the restrictions on distributions under Maryland law, which prohibits distributions that would cause a corporation to fail to meet statutory tests of solvency.

 

Additional limitations on share repurchases under the share repurchase program are as follows:

 

Post-NAV Calculation

 

Following the initial calculation of our NAV and NAV per share which occurred in January 2018, we are subject to the following limitations on the number of shares we may repurchase under the program:

 

  · Repurchases per month will be limited to no more than 2% of our most recently determined aggregate NAV, which the we currently intend to calculate on an annual basis, in January of each year (and calculated as of December 31 of the immediately preceding year). Repurchases for any calendar quarter will be limited to no more than 5% of our most recently determined aggregate NAV, which means we will be permitted to repurchase shares with a value of up to an aggregate limit of approximately 20% of our aggregate NAV in any 12-month period.
     
  · We currently intend that the foregoing repurchase limitations will be based on “net repurchases” during a quarter or month, as applicable. The term “net repurchases” means the excess of our share repurchases (capital outflows) over the proceeds from the sale of our shares (capital inflows) for a given period. Thus, for any given calendar quarter or month, the maximum amount of repurchases during that quarter or month will be equal to (1) 5% or 2% (as applicable) of our most recently determined aggregate NAV, plus (2) proceeds from sales of new shares in the offering (including purchases pursuant to our dividend reinvestment plan) since the beginning of a current calendar quarter or month, less (3) repurchase proceeds paid since the beginning of the current calendar quarter or month.
     
  · While we currently intend to calculate the foregoing repurchase limitations on a net basis, our board of directors may choose whether the 5% quarterly limit will be applied to “gross repurchases,” meaning that amounts paid to repurchase shares would not be netted against capital inflows. If repurchases for a given quarter are measured on a gross basis rather than on a net basis, the 5% quarterly limit could limit the number of shares redeemed in a given quarter despite us receiving a net capital inflow for that quarter.
     
  · In order for our board of directors to change the basis of repurchases from net to gross, or vice versa, we will provide notice to our stockholders in a prospectus supplement to the prospectus for the Registered Offering or current or periodic report filed with the SEC, as well as in a press release or on our website, at least 10 days before the first business day of the quarter for which the new test will apply. The determination to measure repurchases on a gross basis, or vice versa, will only be made for an entire quarter, and not particular months within a quarter.

 

 48 

 

 

The following table summarizes our repurchase activity under our share repurchase program for our Class C common stock for the three months ended December 31, 2017. As of December 31, 2017, we have not repurchased any shares of our Class S common stock.

 

   Total number of
Shares
Requested to be
Repurchased (1)
   Total Number of
Shares
Repurchased
During the
Month
   Average Price
Paid per Share (2)
   Dollar Value of
Shares Available
That May
Be Repurchased
Under the
Program (2)
 
October 2017   21,651    19,980   $9.72   $439,348 
November 2017   52,143    21,651   $9.72   $545,600 
December 2017   39,731    52,143   $9.72   $648,006 
Total   113,525    93,774   $9.72   $1,632,954 

 

  (1) We generally repurchase shares approximately 5 days following the end of the applicable month in which requests were received and not withdrawn.
  (2) Because our initial calculation of NAV did not occur until January 2018, the maximum amount that could be repurchased was limited to 5% of the weighted average outstanding shares of Class C common stock in the prior 12 months less the actual shares repurchased during the same 12-month period. The dollar value is as of the last day of the month presented. The dollar value is calculated as (1) the maximum number of shares that could be repurchased (5% of the weighted average number of shares outstanding during the prior twelve months (or a shorter period if we had not been selling shares for twelve months) reduced by the number of shares already repurchased multiplied by (2) the repurchase price (which was 97% of the then-current $10.00 per share offering price for shares of Class C common stock held by the stockholder for less than a year (which would be most of the shares through December 31, 2017), 98% of the then-current $10.00 per share offering price for shares of Class C common stock held by the stockholder for more than a year and less than two years, 99% of the then-current $10.00 per share offering price for shares of Class C common stock held by the stockholder for more than a two years and less than three years, and 100% of the then-current $10.00 per share offering price for shares of Class C common stock held by the stockholder for more than three years).

 

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Procedures for Repurchase

 

Post-NAV Calculation

 

Qualifying stockholders who desire to have their shares repurchased by us would have to give notice as provided on their personal on-line dashboard at www.RichUncles.com. All requests for repurchase must be received by our Advisor at least two business days prior to the end of a month. Stockholders may also withdraw a previously made request to have stockholder shares repurchased but must do so at least two business days prior to the end of a month. We will repurchase shares on the third business day after the end of a month in which a request for repurchase was received and not withdrawn.

 

As noted above, we may use cash not otherwise dedicated to a particular use to fund repurchases under the share repurchase program. However, we have the discretion to repurchase fewer shares than have been requested to be repurchased in a particular month or quarter, or to repurchase no shares at all, in the event that we lack readily available funds to do so due to market conditions beyond our control, our need to main liquidity for our operations or because we determine that investing in real property or other illiquid investments is a better use of our capital than repurchasing our shares. Any determination to repurchase fewer shares than have been requested to be repurchased may be made immediately prior to the applicable date of repurchase. We will disclose any such determination to our current and prospective stockholders.

 

In the event that we repurchase some but not all of the shares submitted for repurchase in a given period, share submitted for repurchase during such period will be repurchased on a pro rata basis. If, in each of the first two months of a quarter, the 2% monthly repurchase limit is reached and repurchases are reduced pro rata for such months, then in the third and final month of that quarter, the applicable limit for such month will be less than 2% of our aggregate NAV because repurchases for that month, combined with repurchases for the two previous months, cannot exceed 5% of our aggregate NAV.

 

If we do not repurchase all shares presented for repurchase in a given period, then all unsatisfied repurchase requests must be resubmitted at the start of the next month or quarter, or upon the recommencement of the share repurchase program (in the event of its suspension), as applicable.

 

Any stockholder can withdraw a repurchase request by sending written notice to the program administrator, provided such notice is received at least three business days before the end of the month.

 

Amendment, Suspension or Termination of Program and Notice

 

Our board of directors may amend, suspend or terminate the share repurchase program without stockholder approval upon 30 days’ notice, if our directors believe such action is in our and our stockholders’ best interests, including because share repurchases place an undue burden on our liquidity, adversely affect our operations, adversely affect stockholders whose shares are not repurchased, or if board of directors determines that the funds otherwise available to fund our share repurchase program are needed for other purposes. In addition, our board of directors may amend, suspend or terminate the share repurchase program due to changes in law or regulation, or if the board of directors becomes aware of undisclosed material information that it believes should be publicly disclosed before shares are repurchased. Material modifications, including any reduction to the monthly or quarterly limitations on repurchases, and suspensions of the stock repurchase program, will be promptly disclosed in a prospectus supplement (or post-effective amendment) or current or periodic report filed with SEC, as well as on our website.

 

ITEM 6.SELECTED FINANCIAL DATA

 

The following is selected financial data as of December 31, 2017, 2016 and 2015, and for the years ended December 31, 2017 and 2016 and for the period ended from May 14, 2015 (date of inception) to December 31, 2015, should be read in conjunction with the accompanying consolidated financial statements and related notes therefor and Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations:

 

   December 31, 
Balance sheet data  2017   2016   2015 
Total real estate investment, net  $149,759,638   $36,275,665   $-- 
Total assets   157,073,447    41,302,560    200,815 
Mortgage notes payable, net   60,487,303    7,113,701    -- 
Unsecured credit facility, net   12,000,000    10,156,685    -- 
Total liabilities   77,777,232    18,874,794    7,000 
Redeemable common stock   46,349    196,660    -- 
Total stockholders’ equity   79,249,866    22,231,106    193,815 
                

 

   

 

Years ended
December 31,

   

Period from

May 14, 2015

(date of inception) to

 
Operating data   2017     2016     December 31, 2015  
Total revenues   $ 7,390,206     $ 861,744     $ --  
Net loss     (868,484 )     (1,237,441 )     (6,185 )
Other data:                        
Cash flows provided by (used in) operations     3,790,837       (672,132 )     815  
Cash flows used in investing activities     (115,593,935 )     (37,155,065 )     --  
Cash flows provided by financing activities     112,308,480       41,303,755       200,000  
Per share data:                        
Distributions declared per common share:                    
Class C     0.700       0.32       --  
Class S     0.175 (1)     --       --  
Net loss per common share – basic and diluted (see Note 2 to the Notes to our consolidated financial statements)     (0.15 )     (2.89 )     (4.95 )
Weighted-average number of common shares outstanding, basic and diluted     5,982,930       428,255       1,250  

 

(1)The distribution paid per share of Class S common stock is net of deferred selling commissions.

  

ITEM 7.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with the “Selected Financial Data” above and our accompanying consolidated financial statements and the notes thereto. Also, see “Forward-Looking Statements” preceding Part I of this Annual Report on Form 10-K and Part I, Item 1A “Risk Factors” herein.

 

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Overview

 

Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated audited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“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.

 

The following are some, but not all, of the assumptions, risks, uncertainties and other factors that could cause our actual results to differ materially from those presented in our forward-looking statements:

 

·We may be unable to renew leases, lease vacant space or re-lease space as leases expire on favorable terms or at all.
·We are subject to risks associated with tenant, geographic and industry concentrations with respect to our properties.
·Our properties, intangible assets and other assets may be subject to impairment charges.
·We could be subject to unexpected costs or unexpected liabilities that may arise from potential dispositions and may be unable to dispose of properties on advantageous terms.
·We are subject to competition in the acquisition and disposition of properties and in the leasing of our properties and we may be unable to acquire, dispose of, or lease properties on advantageous terms.
·We could be subject to risks associated with bankruptcies or insolvencies of tenants or from tenant defaults generally.
·We have substantial indebtedness, which may affect our ability to pay distributions, and expose us to interest rate fluctuation risk and the risk of default under our debt obligations.
·We may be affected by the incurrence of additional secured or unsecured debt.
·We may not be able to maintain profitability.
·The only source of cash for distributions to investors will be cash flow from our operations (including sales of properties) or waiver or deferral of reimbursements to our Sponsor or fees paid to our Advisor and proceeds from the sale of our common stock, only up to the amount of any rent abatements where we were able to negotiate a reduced purchase price.
·We may not generate cash flows sufficient to pay our distributions to stockholders or meet our debt service obligations.
·We may be affected by risks resulting from losses in excess of insured limits.
·We may fail to qualify as a REIT for U.S. federal income tax purposes.
·We are dependent upon our Advisor which has the right to terminate the Advisory Agreement upon 60 days’ written notice without cause or penalty.

 

We were formed on May 14, 2015 as a Maryland corporation that elected to be treated as a REIT beginning with the taxable year ended December 31, 2016 and we intend to continue to operate in such a manner. We intend to invest primarily in single tenant income-producing corporate properties which are leased to creditworthy tenants under long-term net leases. Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in entities that own and operate real estate. We will make substantially all acquisitions of our real estate investments directly through our Operating Partnership or indirectly through limited liability companies or limited partnerships, including through other REITs, or through investments in joint ventures, partnerships, tenants-in-common, co-tenancies or other co-ownership arrangements with other owners of properties, affiliates of our Advisor or other persons.

 

We consider our Company to be a perpetual-life investment vehicle because we have no finite date for liquidation and no intention to list our shares of common stock for trading on a national securities exchange or other over-the-counter trading market. Although we have registered a fixed number of shares for the Registered Offering, we intend to effectively conduct a continuous offering of an unlimited amount of our shares of common stock over an unlimited time period by conducting an uninterrupted series of additional public offerings, subject to regulatory approval of our filings for such additional offerings. This perpetual-life structure is aligned with our overall objective of investing in real estate assets with a long-term view towards making regular cash distributions and generating capital appreciation.

 

Subject to certain restrictions and limitations, our business is externally managed by our Advisor, Rich Uncles NNN Operator, LLC, a limited liability company wholly owned by Brix, pursuant to the Advisory Agreement. Our Advisor manages our operations and our portfolio of core real estate properties and real estate related assets. Our Advisor also provides asset-management, and other administrative services on our behalf and is paid certain fees as set forth in the Notes to our Consolidated Financial Statements included herein.

 

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We have investor relations personnel, but all expenses are reimbursed by our Sponsor as part of the organizational and offering services they provide to us to manage our organization and the Offerings and provide to administrative investor relations services. However, our Sponsor is then entitled to include the reimbursement of such expenses as part of our reimbursement to them of organizational and offering costs, but reimbursement shall not exceed an amount equal to 3% of gross offering proceeds.

 

We expect to use substantially all of the net proceeds from the Offerings to acquire and manage a portfolio of real estate investments. We intend to invest primarily in single tenant income-producing corporate properties which are leased to creditworthy tenants under long-term net leases. While our focus is on single tenant net leased properties, we plan to diversify our portfolio by geography, investment size and investment risk with the goal of acquiring a portfolio of income-producing real estate investments that provides attractive and stable returns to our stockholders. Our investment objectives and policies may be amended or changed at any time by our board of directors. Although we have no plans at this time to change any of our investment objectives, our board of directors may change any and all such investment objectives, including our focus on single tenant properties, if it believes such changes are in the best interests of our stockholders.

 

Through December 31, 2017, the Company had sold 9,055,175 shares of its Class C common stock pursuant to the Registered Offering for aggregate gross offering proceeds of $90,551,752 and 3,000 shares of its Class S common stock pursuant to the Class S Offering for aggregate gross offering proceeds of $30,000.

 

Rich Uncles NNN REIT Operator, LLC, our Advisor, will make recommendations on all investments to our board of directors. All proposed real estate investments must be approved by at least a majority of our board of directors subject to guidelines established by our board of directors.

 

As we accept subscriptions for shares in the Offerings, we will transfer substantially all of the net proceeds of the Offerings to our Operating Partnership as a capital contribution in exchange for units of general partnership and/or limited partnership interest that will be held by our wholly-owned subsidiary, Rich Uncles NNN LP, LLC; however, we will be deemed to have made capital contributions to the Operating Partnership in the amount of the gross offering proceeds received from investors. The REIT will be deemed to have simultaneously reimbursed the Sponsor for the costs associated with the Offerings, subject to a maximum of 3% of the gross offering proceeds.

 

Because we plan to conduct substantially all of our operations through the Operating Partnership, we are considered an Umbrella Partnership Real Estate Investment Trust, or UPREIT. Using an UPREIT structure may give us an advantage in acquiring properties from persons who might not otherwise sell their properties because of unfavorable tax results. Generally, a sale of property directly to a REIT, or a contribution in exchange for REIT shares, is a taxable transaction to the selling property owner. However, in an UPREIT structure, a seller of a property who desires to defer taxable gain on the sale of property may transfer the property to the Operating Partnership in exchange for partnership interests in the Operating Partnership without recognizing gain for tax purposes.

 

We intend to present our financial statements and Operating Partnership income, expenses and depreciation on a consolidated basis. All items of income, gain, deduction (including depreciation), loss and credit flow through the Operating Partnership to us as all subsidiary entities are disregarded for federal tax purposes. These tax items do not generally flow through us to our stockholders. Rather, our net income and net capital gain effectively flow through us to our stockholders as and when we pay distributions.

 

Liquidity and Capital Resources

 

The Company’s proceeds from shares sold in the Offerings have been, and will continue to be, primarily for (i) property acquisitions; (ii) capital expenditures; (iii) payment of principal on our outstanding indebtedness and (iv) payment of fees to Advisor. Our cash needs for the purchase of real estate properties and other real estate investments will be funded primarily from the sale of our shares, including those offered for sale through our dividend reinvestment plan, and from debt proceeds.

 

We expect that once we have fully invested the proceeds of the Offerings and other potential subsequent offerings, our debt financing and other liabilities, including our pro rata share of the debt financing of entities in which we invest, will be approximately 50% of the cost of our tangible assets (before deducting depreciation or other non-cash reserves and without taking into account borrowings relating to the initial acquisition of properties that are outstanding under a revolving credit facility or similar agreement). Our aggregate borrowings, secured and unsecured, must be reasonable in relation to our net assets. We intend to limit our leverage to 50% of the cost of acquiring our tangible assets (before deducting depreciation or other non-cash reserves and without taking into account borrowings relating to the initial acquisition of properties that are outstanding under a revolving credit facility or similar agreement). This is an overall target. Our borrowings on one or more individual properties may exceed 50% of their individual cost, so long as our overall leverage does not exceed 50%. Our charter limits our borrowing to 50% of our net assets (equivalent to 50% of the cost of our assets) unless any excess borrowing is approved by a majority of our conflicts committee and is disclosed to our stockholders in our next quarterly report, along with the justification for such excess. When calculating our use of leverage, we will not include borrowings relating to the initial acquisition of properties and that are outstanding under a revolving credit facility (or similar agreement). There is no limitation on the amount we may borrow for the purchase of any single asset.

 

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We may borrow amounts from our Advisor or Sponsor if such loan is approved by a majority of our directors, including a majority of our conflicts committee, not otherwise interested in the transaction, as being fair, competitive, commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties under the circumstances. Any such loan will be included in determining whether we have complied with the borrowing limit in our charter. Neither our Advisor nor our Sponsor has any obligation to make any loans to us.

 

Debt financing for acquisitions and investments may be obtained at the time an asset is acquired or an investment is made or at such later time as determined to be appropriate. In addition, debt financing may be used from time to time for property improvements, lease inducements, tenant improvements and other working capital needs.

 

As of December 31, 2017, the outstanding principal balance of the Company’s mortgage notes payable and the unsecured credit facility was $62,228,409 and $12,000,000, respectively. The unsecured credit facility matured on January 26, 2018. On February 1, 2018, the Company entered into a new $9,000,000 unsecured credit facility that matures on January 26, 2019. See Note 6 of the Notes to our Consolidated Financial Statements for additional information regarding our outstanding indebtedness. As of December 31, 2017, the Company’s pro rata share (approximately 4.4%) of REIT I’s mortgage notes payable was $2,794,426. As of December 31, 2017, the Company’s pro rata share (approximately 72.7%) of the TIC’s mortgage note payable was $10,515,557.

 

Generally, our policy is to pay distributions from cash flow from operations. During our offering stage, when we may raise capital more quickly than we acquire income producing assets, and from time to time during our operational state, we way not pay distributions from operations. In these cases, distributions may be pain in whole or in part from the waiver or deferral of fees otherwise due to our Advisor, if so elected by our Advisor. Historically, the sources of cash used to pay our distributors have been from net rental income received and the waiver and deferral of management fees. The leases for certain of our real estate acquisitions may provide for rent abatements. These abatements are an inducement for the tenant to enter into or extend the term of its lease. In connection with the acquisition of some properties, we may be able to negotiate a reduced purchase price for the acquired property in an amount that equals the previously agreed-upon rent abatement. During the period of any rent abatement on properties that we acquire, we may be unable to fully fund our distributions from net rental income received and waivers or deferrals of Advisor asset management fees. In that event, we may expand the sources of cash used to fund out stockholder distributions to include proceeds for the sale of our common stock, but only during the periods, and up to the amounts, of any rent abatements where we are able to negotiate a reduced purchase price.

 

Generally, we expect to make payments of principal and interest on any indebtedness we incur from our cash flows from operating activities, including the proceeds from the sale of assets. We expect that our cash flows from normal operations not involving the sale of assets will be sufficient to make regularly scheduled payments of principal and interest. We will seek to structure our financing for acquisitions of assets such that any balloon payments or maturity dates involving extraordinary payments of principal are timed to match our expected receipt of funds from ownership and operation of the assets or the disposition by us of such assets. If cash flow from ownership and operation of an asset is not expected to be sufficient to make such payments of principal, and we do not anticipate that we will sell the asset at the time the principal payment comes due, we intend to make payments of principal out of proceeds from the refinancing of such indebtedness or out of cash flow from operation of our other assets or from our reserves. We may also use proceeds to pay down principal on indebtedness, including any balloon or monthly mortgage payments.

 

Our Advisor will establish working capital reserves from net offering proceeds, out of cash flow generated by operating assets or out of proceeds from the sale of assets. Working capital reserves are typically utilized to fund tenant improvements, leasing commissions and major capital expenditures. Our lenders also may require working capital reserves.

 

Portfolio Information

 

Our wholly owned real estate investments are as follows:

 

   December 31, 
   2017   2016 
Number of Properties:        
Retail   8    7 
Office   6    1 
Industrial   4    1 
Total   18    9 
           
Leasable Square Feet:          
Retail   140,384    68,443 
Office   320,179    63,000 
Industrial   324,616    45,465 
Total   785,179    176,908 

 

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The above table does not include an approximate 72.7% interest in the tenant-in-common entity that owns 91,740 square feet of office property. Also, the above table does not include our approximate 4.4% interest in an affiliated REIT.

 

Cash Flow Summary

 

The following table summarizes our cash flow activity for the years ended December 31:

 

    2017     2016  
Net cash provided by (used in) operating activities   $

3,790,837

    $ (672,132 )
Net cash used in investing activities   $ (115,593,935 )   $ (37,155,065 )
Net cash provided by financing activities   $ 112,308,480     $ 41,303,755  

 

Cash Flows from Operating Activities

 

We have a limited operating history. As of December 31, 2017, we had only acquired 18 properties and one tenant-in-common real estate investment in which we have an approximate 72.7% interest and one real estate investment in an affiliated REIT in which we have an approximate 4.4% interest, as described in Item 2. Properties. Therefore, we have limited operations and independent financing. During the year ended December 31, 2017, net cash provided by operating activities was $3,790,837. We expect that our cash flows from operating activities will increase in future periods as a result of anticipated future acquisitions of real estate and the related operations from such investments as well as from operations for an entire year of the properties that were acquired in 2017.

 

Cash Flows from Investing Activities

 

Net cash used in investing activities was $115,593,935 for the year ended December 31, 2017 and consisted primarily of the following:

 

  · $100,458,868 for the acquisition of nine real estate investments;
  · $685,160 for improvements to real estate;
  · $3,935,884 for payment of acquisition fees to affiliate; and
  · $10,542,594 investments in unconsolidated entities (TIC investment in a property located in Santa Clara, CA).

 

Net cash used in investing activities was $37,155,065 for the year ended December 31, 2016 and consisted primarily of the following:

 

  · $32,754,452 for the acquisition of nine real estate investments;
  · $231,408 for payment of acquisition fees to affiliates;
  · $3,640,634 for the investment in Rich Uncles Real Estate Investment Trust I (Rich Uncles REIT I); and
  · $500,000 received for escrow deposits for future real estate purchases.

 

Cash Flows from Financing Activities

 

Net cash provided by financing activities was $112,308,480 for the year ended December 31, 2017 and consisted primarily of the following:

 

  · $60,505,707 of net cash provided by the issuance of common stock and investor deposits related to our Offerings, net of payments of organization and offering costs of $2,049,847;
  · $55,390,000 from borrowings from our unsecured credit facility, partially offset by payments on unsecured credit facility of $53,547,803;
  · $53,165,056 of net cash provided by debt financing as a result from mortgage notes payable of $55,369,988, partially offset by principal payments of $407,725, refundable loan deposits of $40,000, deferred financing costs to third parties of $1,430,607, and financing fees to affiliates of $326,600.
  · $2,472,571 net cash used in repurchases of shares of our Class C common stock under the share repurchase program; and
  · $731,209 of cash distributions, after giving effect to distributions reinvested by stockholders of $3,066,828.

 

Net cash provided by financing activities was $41,303,755 for the year ended December 31, 2016 and consisted primarily of the following:

 

  · $24,183,028 of net cash provided by the issuance of common stock and investor deposits related to our ongoing Registered Offering, net of payments of organizational and offering costs of $651,670;
  · $24,215,000 proceeds from borrowings from our unsecured credit facility, partially offset by payments in unsecured credit facility of $14,057,197;

 

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  · $7,092,932 of net cash provided by debt financing as a result from mortgage notes payable of $7,319,700, partially offset by principal payments of $53,555 and deferred financing costs of $173,213;
  · $83,843 net cash used in repurchases of shares of Class C common stock under the share repurchase program; and
  · $46,165 of cash distributions, after giving effect to distributions reinvested by stockholders of $124,996.

 

Capital Resources

 

Generally, cash needs for property acquisitions, debt payments, capital expenditures, development and other investments will be funded by equity and debt offerings, bank borrowings, and to a lesser extent, by internally generated funds. Cash needs for operating and interest expense and dividends will generally be funded by internally generated funds. If available, future sources of capital include proceeds from the Offerings or future offerings of the Company’s equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of properties, as well as undistributed funds from operations.

 

Results of Operations

 

The SEC declared the registration statement for the Registered Offering effective on June 1, 2016 and we commenced our Registered Offering on July 17, 2016. During the period from May 14, 2015 to June 15, 2016, we had been formed but had not yet commenced any significant operations. As a result, we had no material results of operations for those periods.

 

The Company owned nine properties and an approximate 4.4% interest in an affiliated REIT at December 31, 2016. The Company acquired nine additional properties in 2017. In addition, during the year ended December 31, 2017, the Company acquired an approximate 72.7% interest in a TIC. We expect that the rental income, tenant reimbursements, depreciation and amortization expense, interest expense and asset management fees to affiliates to each increase in future periods as a result of owning the nine properties acquired in 2017 for an entire period and anticipated future acquisitions of real estate investments. The Company expects that its income from investments in unconsolidated entities will increase in future periods as a result of the tenant-in-common investment that was made in September 2017. Our results of operations for the year ended December 31, 2017 are not indicative of those expected in future periods as we are continuing to raise capital through the Offerings and acquire additional properties.

 

Comparison of the year ended December 31, 2017 to the year ended December 31, 2016

 

 The increases in rental income, tenant recoveries, general and administrative expenses, depreciation and amortization, interest expense and property expense from the applicable prior-year periods were primarily due to properties acquired after December 31, 2016, as well as a complete year of operations from properties acquired.

 

Rental Income

 

Rental income for the years ended December 31, 2017 and 2016 was $6,140,444 and $709,982 respectively. The annualized rental income of the properties owned as of December 31, 2017 was $10,547,530.

 

Tenant Recoveries

 

Tenant recoveries were $1,249,762 and $151,762 for the years ended December 31, 2017 and 2016 respectively. Pursuant to most of our lease agreements, tenants are required to pay all or a portion of the property operating expenses.

 

Fees to Affiliate

 

Expensed acquisition fees and management fees to affiliate for the years ended December 31, 2017 and 2016, were $872,281 and $591,073, respectively. Upon adopting ASU 2017-01 on October 1, 2016, acquisition fees have been capitalized as the Company’s investments were asset acquisitions. Acquisition fees totaling $3,661,684 and $505,608 were capitalized during the year ended December 31, 2017 and the three months ended December 31, 2016, respectively.

 

Subordinated participation fees to affiliates were $315,802 and $0 for the years ended December 31, 2017 and 2016, respectively.

 

The following fees for affiliates are included in other expense line items:

 

·The asset management fees are equal to 1.2% per annum of the Company’s total investment value. Of the asset management fees, $143,540, and $27,051 of such fees were waived for the years ended December 31, 2017 and 2016, respectively. As of December 31, 2017, the cumulative amount of deferred asset management fees was $567,661. The Company expects that some of the deferred asset management fees will be paid in 2018.

 

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·Property management feed to affiliates for the years ended December 31, 2017 and 2016 were $20,251 and $0, respectively.
·There were no disposition fees to affiliate in the years ended December 31, 2017 or 2016.

 

General and Administrative

 

General and administrative expenses for the years ended December 31, 2017 and 2016 were $3,742,896 and $1,276,535, respectively.

 

General and administrative expenses increased $2,466,361 for the year ended December 31, 2016 to $3,742,896 for the year ended December 31, 2017. These general and administrative expenses consisted primarily of investor relations payroll expense, professional legal and accounting fees, office supplies, bank services charges, and expense related to the shares issued to the board of directors for their compensation. We expect general and administrative costs to increase in the future as a result of anticipated future acquisitions of real estate investments.

 

Depreciation and Amortization

 

Depreciation and amortization expenses for the years ended December 31, 2017 and 2016 were $3,081,554 and $493,185, respectively. The purchase price of the acquired properties is allocated to tangible assets, identifiable intangibles and assumed liabilities and depreciated or amortized over their estimated useful lives.

 

Interest Expense

 

Interest expense for the years ended December 31, 2017 and 2016 were $1,637,984 and $395,110, respectively. See Note 6 of the Notes to our Consolidated Financial Statements included herein for the detail of the components of interest expense.

 

Property Expense

 

Property expense for the years ended December 31, 2017 and 2016 were $1,282,759 and $171,063, respectively. These expenses primarily relate to property taxes, insurance and repairs and maintenance expenses.

 

Expenses Reimbursed/Fees Waived by Sponsor or Affiliate

 

Expenses reimbursed/fees waived by Sponsor or affiliate for the years ended December 31, 2017 and 2016 were $2,468,138 and $979,102, respectively. The expenses reimbursed by the Sponsor for the years ended December 31, 2017 and 2016, of $2,324,598 and $951,601, respectively were payroll costs related to Company employees that answer questions from prospective stockholders.

 

Waived asset management fees for the years ended December 31, 2017 and 2016, were $143,540 and $27,501, respectively. The Company currently expects that no asset management fees will be waived in future years.

 

Other Income

 

Interest income for the years ended December 31, 2017 and 2016 were $7,215 and $977, respectively.

 

Income (losses) from investments in unconsolidated entities for the years ended December 31, 2017 and 2016 were $199,233 and ($79,271), respectively. This represents the Company’s approximately 4.4% share of the results of operations of Rich Uncles Real Estate Investment Trust I, including the recognition of certain amounts related to previous periods as described in Note 5 of the Notes to our Consolidated Financial Statements included herein and the Company’s approximately 72.7% share of the results of operations of the TIC for the period from September 28, 2017 through December 31, 2017.

 

Organizational and Offering Costs

 

Our organizational and offering costs are paid by our Sponsor on our behalf. Offering costs include all expenses incurred in connection with the Offering, including investor relations payroll costs. Other organizational and offering costs include all expenses incurred in connection with our formation, including, but not limited to legal fees, federal and state filing fees, and other costs to incorporate.

 

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During the primary Offerings, we are obligated to reimburse our Sponsor for organizational and offering costs related to the Offerings paid by them on our behalf provided such reimbursement would not exceed 3% of gross offering proceeds raised in the Offerings as of the date of the reimbursement.

 

As of December 31, 2017, the Company had not directly incurred any organizational and offering costs related to the Offerings as all such costs had been funded by our Sponsor. As a result, these organizational and offering costs related to the Offerings are not recorded in our financial statements as of December 31, 2017 other than to the extent of 3% of the gross offering proceeds. Through December 31, 2017, our Sponsor had incurred organizational and offering costs on our behalf in connection with the Offerings of $6,954,932. As of December 31, 2017, the Company had recorded $2,723,462 of organizational and offering costs, of which $15,945 was payable to the Sponsor or affiliates.

 

Distributions

 

During our offering stage, when we may raise capital more quickly than we acquire income producing assets, and from time to time during our operational stage, we way not pay distributions from operations. In these cases, distributions may be paid in whole or in part from the waiver or deferral of fees otherwise due to our Advisor, if so elected by our Advisor. Historically, the sources of cash used to pay our distributors have been from net rental income received and the waiver and deferral of management fees. The leases for certain of our real estate acquisitions may provide for rent abatements. These abatements are an inducement for the tenant to enter into or extend the term of its lease. In connection with the acquisition of some properties, we may be able to negotiate a reduced purchase price for the acquired property in an amount that equals the previously agreed-upon rent abatement. During the period of any rent abatement on properties that we acquire, we may be unable to fully fund our distributions from net rental income received and waivers or deferrals of Advisor asset management fees. In that event, we may expand the sources of cash used to fund out stockholder distributions to include proceeds for the sale of our common stock, but only during the periods, and up to the amounts, of any rent abatements where we are able to negotiate a reduced purchase price.

 

A table of distributions declare, distributions paid out, the impact on cash flows from operations and the source of distribution payments is disclosed in PART II, ITEM 5. under Distribution Information.

 

Going forward, we expect our board of directors to continue to declare cash distributions based on daily record dates and to pay the distributions on a monthly basis, and after our Offerings, to continue to declare stock distributions based on a single record date as of the end of the month, and to pay these distributions on monthly basis. Cash distributions will be determined by our board of directors based on our financial condition and such other factors as our board of directors deems relevant. Our board of directors has not pre-established a percentage rate of return for stock dividends or cash distributions to stockholders. We have not established a minimum dividend or distribution level, and our charter does not require that we make dividends or distributions to our stockholders other than as necessary to meet IRS REIT qualification standards.

 

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Properties

 

We have a very limited operating history. As of December 31, 2017, we had only acquired 18 properties and one tenant-in-common real estate investment in which we have an approximate 72.7% interest and one real estate investment in an affiliated REIT in which we have an approximate 4.4% interest, as described in Item 2. Properties. Therefore, we have limited operations and independent financing. In evaluating these properties as a potential acquisition, including the determination of an appropriate purchase price to be paid for the properties, we considered a variety of factors, including the condition and financial performance of the properties, the terms of the existing leases and the creditworthiness of the tenants, property location, visibility and access, age of the properties, physical condition and curb appeal, neighboring property uses, local market conditions, including vacancy rates, area demographics, including trade area population and average household income and neighborhood growth patterns and economic conditions. We do not currently have plans to incur any significant costs to renovate, improve or develop the properties, other than as discussed below, and we believe that the properties are adequately insured. The Company has four tenants with leases that provide for tenant improvement allowances totaling $1,899,485, including an 72.7% share of the tenant improvement allowance for the Santa Clara property. We expect that the related improvements will be completed during the 2018 calendar year. There are restricted cash deposits of $944,582 that are available to be used to pay for these improvements. The remainder will be funded from operating cash flow or offering proceeds.

 

In addition, the Company has identified approximately $450,000 of roof replacement, exterior painting and sealing and parking lot repairs/restriping that are expected to be completed in 2018 and 2019. Approximately $115,000 of these improvements are expected to be recoverable from the tenant through their operating expense recoveries. However, the Company will have to pay for the improvements and the recoveries will be billed over an extended period of time. The remaining costs of approximately $335,000 are not recoverable from tenants. These improvements will be funded from operating cash flows or offering proceeds.

 

More information on our properties and investments can be found in Item 2. Properties of this Annual Report.

 

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 commercial mortgage backed securities (“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, borrowings on a line of credit, 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 commercial property 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.

 

Critical Accounting Policies

 

Below is a discussion of the accounting policies that management believes are or will be critical to our operations. We consider these policies critical in that they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may have utilized different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.

 

Real Estate

 

Real Estate Acquisition Valuation

 

The Company records acquisitions that meets the definition of a business as a business combination. If the acquisition does not meet the definition of a business, the Company records the acquisition as an asset acquisition. Under both methods, all assets acquired and liabilities assumed are measured based on their acquisition-date fair values. Transaction costs that are related to a business combination are charged to expense as incurred. Transaction costs that are related to an asset acquisition are capitalized as incurred.

 

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The Company assesses the acquisition date fair values of all tangible assets, identifiable intangibles, and assumed liabilities using methods similar to those used by independent appraisers, generally utilizing a discounted cash flow analysis that applies appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors, including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it were vacant.

 

The Company records above-market and below-market in-place lease values for acquired properties based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining noncancelable term of above-market in-place leases and for the initial term plus any extended term for any leases with below-market renewal options. The Company amortizes any recorded above-market or below-market lease values as a reduction or increase, respectively, to rental income over the remaining noncancelable terms of the respective lease, including any below-market renewal periods.

 

The Company estimates the value of tenant origination and absorption costs by considering the estimated carrying costs during hypothetical expected lease-up periods, considering current market conditions. In estimating carrying costs, the Company includes real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease up periods.

 

The Company amortizes the value of tenant origination and absorption costs to depreciation and amortization expense over the remaining noncancelable term of the respective lease.

 

Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities require the Company to make significant assumptions to estimate market lease rates, property-operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property will be held for investment. The use of inappropriate assumptions would result in an incorrect valuation of the Company’s acquired tangible assets, identifiable intangibles and assumed liabilities, which would impact the amount of the Company’s net income (loss).

 

Impairment of Real Estate and Related Intangible Assets

 

The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable. When indicators of potential impairment are present that indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, management assesses whether the carrying value of the assets will be recovered through the future undiscounted operating cash flows expected from the use of and eventual disposition of the property. If, based on the analysis, the Company does not believe that it will be able to recover the carrying value of the asset, the Company will record an impairment charge to the extent the carrying value exceeds the estimated fair value of the asset.

 

Revenue Recognition

 

The Company recognizes rental income from tenants under operating leases on a straight-line basis over the noncancelable term of the lease when collectability of such amounts is reasonably assured. Recognition of rental income on a straight-line basis includes the effects of rental abatements, lease incentives and fixed and determinable increases in lease payments over the lease term. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or by us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance (including amounts that the tenant can take in the form of cash or a credit against its rent) that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

 

·whether the lease stipulates how a tenant improvement allowance may be spent;

 

·whether the amount of a tenant improvement allowance is in excess of market rates;

 

·whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

 

·whether the tenant improvements are unique to the tenant or general-purpose in nature; and

 

·whether the tenant improvements are expected to have any residual value at the end of the lease.

 

Tenant reimbursements of real estate taxes, insurance, repairs and maintenance, and other operating expenses are recognized as revenue in the period the expenses are incurred and presented gross if the Company is the primary obligor and, with respect to purchasing goods and services from third-party suppliers, has discretion in selecting the supplier and bears the associated credit risk.

 

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The Company evaluates the collectability of rents and other receivables on a regular basis based on factors including, among others, payment history, the operations, the asset type and current economic conditions. If the Company’s evaluation of these factors indicates it may not recover the full value of the receivable, it provides a reserve against the portion of the receivable that it estimates may not be recovered. This analysis requires the Company to determine whether there are factors indicating a receivable may not be fully collectable and to estimate the amount of the receivable that may not be collected.

 

Unconsolidated Entities

 

The Company accounts for investments in entities over which it has the ability to exercise significant influence under the equity method of accounting. Under the equity method of accounting, an investment is initially recognized at cost and is subsequently adjusted to reflect the Company’s share of earnings or losses of the investee. The investment is also increased for additional amounts invested and decreased for any distributions received from the investee. Equity method investments are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the investment might not be recoverable. If an equity method investment is determined to be other-than-temporarily impaired, the investment is reduced to fair value and an impairment charge is recorded through earnings.

 

Fair Value of Financial Instruments

 

Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other non-financial and financial assets at fair value on a non-recurring basis (e.g., carrying value of impaired long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:

 

Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;

 

Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

 

Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.

 

When available, the Company utilizes quoted market prices from independent third-party sources to determine fair value and classifies such items in Level 1 or Level 2. In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require the Company to make a significant adjustment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third party may rely more on models with inputs based on information available only to that independent third party. When the Company determines the market for a financial instrument owned by the Company to be illiquid or when market transactions for similar instruments do not appear orderly, the Company uses several valuation sources (including internal or external valuations, discounted cash flow analysis and quoted market prices) and establishes a fair value by assigning weights to the various valuation sources. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach.

 

Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.

 

The Company considers the following factors to be indicators of an inactive market: (i) there are few recent transactions, (ii) price quotations are not based on current information, (iii) price quotations vary substantially either over time or among market makers (for example, some brokered markets), (iv) indexes that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability, (v) there is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the Company’s estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the asset or liability, (vi) there is a wide bid-ask spread or significant increase in the bid-ask spread, (vii) there is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities, and (viii) little information is released publicly (for example, a principal-to-principal market).

 

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The Company considers the following factors to be indicators of non-orderly transactions: (i) there was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions, (ii) there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant, (iii) the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced), and (iv) the transaction price is an outlier when compared with other recent transactions for the same or similar assets or liabilities.  

 

Income Taxes

 

The Company elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and intends to operate as such beginning with its taxable year ended December 31, 2016. The Company expects to have little or no taxable income prior to electing REIT status. 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 its 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 to the extent it distributes qualifying 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 intends to organize and operate in such a manner as to qualify for treatment as a REIT.

 

Recent Accounting Pronouncements

 

See Note 2 of the Notes to our Consolidated Financial Statements included herein.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2017, we had no material off-balance sheet arrangements that had or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity or capital resources.

 

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable as the Company is a Smaller Reporting Company.

 

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

See the Index to Consolidated Financial Statements at page F-1 of this Annual Report.

 

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

Not applicable.

 

ITEM 9A.CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

In accordance with Rule 13a-15(b) and Rule 15d-15(b) of the Exchange Act, our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded, as of the end of such period, that our disclosure controls and procedures are effective.

 

 61 

 

  

Management’s Annual Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. Under Rule 13a-15(c), management must evaluate, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness, as of the end of each calendar year, of our internal control over financial reporting. The term internal control over financial reporting is defined as a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedure that:

 

1)Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

 

2)Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with the authorization of management and trust managers of the issuer; and

 

3)Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions of that the degree of compliance with the policies or procedures may deteriorate.

 

In the course of preparing this Annual Report on Form 10-K and the consolidated financial statements included herein, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017 using the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commissions (COSO) in the Internal Control-Integrated Framework (2013). Based on that evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2017.

 

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm as we are an emerging growth company as of December 31, 2017, as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act.

 

Changes in Internal Control Over Financial Reporting

 

During the fiscal quarter ended December 31, 2017, we completed the execution of our remediation plan, as further described below. In connection with the evaluation required by Rule 13a-15(d), we identified the execution of this remediation plan as having materially affected, or being reasonably likely to materially affect, our internal control over financial reporting. Other than the execution of the remediation plan, there are no other changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 Remediation of Material Weaknesses

 

We, with the concurrence and oversight of the audit committee of our board of directors, executed our remediation plan described in our Quarterly Report on Form 10-Q filed with the SEC on November 14, 2017 during the quarter ended December 31, 2017, as part of the remediation plan, management:

 

·Completed our review and documentation of the financial close and related processes; and

 

·Tested the design and implementation of key controls related to the financial close and related processes.

 

We verified that the aforementioned controls were appropriately designed and implemented as of December 31, 2017. We will continue to monitor and test, as applicable, the ongoing operating effectiveness of its new and enhanced controls.

 

Our internal controls over financial reporting are designed to provide reasonable assurance of achieving the desired control objectives. We recognize that any control system, no matter how well designed and operated is based upon certain judgements and assumptions and cannot provide absolute assurances that its objectives will be met. Similarly, an evaluation of controls cannot provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected.

 

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ITEM 9B.OTHER INFORMATION

 

Not applicable.

 

PART III

 

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Except as provided below, the information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our Proxy Statement for our 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the year ended December 31, 2017.

 

Code of Business Conduct and Ethics

 

On March 10, 2017, our board of directors approved and adopted our Code of Business Conduct and Ethics (the “Code”) which was filed as an Exhibit to our Annual Report on Form 10-K for the year ended December 31, 2016. The Code is also posted in the NNN REIT Corporate Governance section of our website at www.richuncles.com. To the extent required by SEC rules, we intend to promptly disclose future amendments to certain provisions of the Code, or waivers of such provisions granted to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, in the Corporate Governance section of our website.

 

ITEM 11.EXECUTIVE COMPENSATION

 

The information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our Proxy Statement for our 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the year ended December 31, 2017.

 

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our Proxy Statement for our 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the year ended December 31, 2017.

 

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

The information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our Proxy Statement for our 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the year ended December 31, 2017.

  

ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES

 

The information required by this item will be included in an amendment to this Annual Report on Form 10-K or incorporated by reference from our Proxy Statement for our 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the year ended December 31, 2017.

 

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PART IV

 

ITEM 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES

 

(a)Financial Statement Schedules

 

See the Index to Consolidated Financial Statements at page F-1 of this Annual Report.

  

The following financial statement schedule is included herein at pages F-29 through F-30 of this Annual Report: Schedule III - Real Estate Assets and Accumulated Depreciation and Amortization.

  

(b)Exhibits

 

EXHIBITS LIST

 

Exhibit   Description
2.1   Agreement for Purchase and Sale of 2210-2260 Martin Avenue, Santa Clara, California, dated August 25, 2017, between San Tomas Income Partners LLC and Rich Uncles NNN Operating Partnership, LP (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on October 4, 2017)
2.2   Purchase Agreement, dated December 18, 2017, between Reasons Aviation, LLC and Rich Uncles NNN Operating Partnership, LP (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K/A (File No. 000-55776) filed with the Securities and Exchange Commission on January 8, 2018)
3.1   Articles of Amendment and Restatement of the Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Pre-Effective Amendment No. 8 to the Registration Statement on Form S-11 (File No. 333-205684) filed with the Securities and Exchange Commission on May 23, 2016)
3.2   Articles of Amendment to the Articles of Incorporation of RW Holdings NNN REIT, Inc. to increase the authorized number of shares of our stock (incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q (File No. 000-55776) filed with the Securities and Exchange Commission on August 15, 2017)
3.3   Articles of Amendment to the Articles of Incorporation of RW Holdings NNN REIT, Inc. to change the name and designation of our stock (incorporated by reference to Exhibit 3.3 to our Quarterly Report on Form 10-Q (File No. 000-55776) filed with the Securities and Exchange Commission on August 15, 2017)
3.4   Articles of Amendment to the Articles of Incorporation of RW Holdings NNN REIT, Inc. to change our name to RW Holdings NNN REIT, Inc. (incorporated by reference to Exhibit 3.4 to our Quarterly Report on Form 10-Q (File No. 000-55776) filed with the Securities and Exchange Commission on August 15, 2017)
3.5   Articles Supplementary of RW Holdings NNN REIT, Inc. reclassifying 100,000,000 unissued shares of Class C common stock as Class S common stock (incorporated by reference to Exhibit 3.5 to our Quarterly Report on Form 10-Q (File No. 000-55776) filed with the Securities and Exchange Commission on August 15, 2017)
3.6   Certificate of Notice, dated August 11, 2017 (incorporated by reference to Exhibit 3.4 to our Current Report on Form 8-K (File No. 000-55776), filed August 17, 2017)
3.7   Bylaws of RW Holdings NNN REIT, Inc. (incorporated by reference to Exhibit 3.2 to our Registration Statement on Form S-11 (File No. 333-205684) filed with the Securities and Exchange Commission on July 15, 2015)
4.1   Form of Subscription Agreement for Class C Shares (Direct Investors) (incorporated by reference to Appendix A-1 to our Pre-Effective Amendment No. 2 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11/A (File No. 333-205684) filed with the Securities and Exchange Commission on March 21, 2018)
4.2   Form of Subscription Agreement for Class C Shares (Registered Investment Advisors) (incorporated by reference to Appendix A-2 to our Pre-Effective Amendment No. 2 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11/A (File No. 333-205684) filed with the Securities and Exchange Commission on March 21, 2018)
4.3   Distribution Reinvestment Plan (Class C common stock) (incorporated by reference to Appendix C to our Pre-Effective Amendment No. 2 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11/A (File No. 333-205684) filed with the Securities and Exchange Commission on March 21, 2018)
4.4   Share Repurchase Program (Class C common stock) (incorporated by reference to Exhibit 4.4 to our Pre-Effective Amendment No. 1 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11/A (File No. 333-205684) filed with the Securities and Exchange Commission on February 20, 2018)
4.5   Dividend Reinvestment Plan (Class S common stock) (incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on August 17, 2017)
4.6   Share Repurchase Program (Class S common stock) (incorporated by reference to Exhibit 99.2 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on August 17, 2017)
10.1   Second Amended and Restated Advisory Agreement between RW Holdings NNN REIT, Inc., Rich Uncles NNN REIT Operator, LLC and Rich Uncles, LLC, effective August 11, 2017 (incorporated by reference to Exhibit 10.1 to our Pre-Effective Amendment No. 1 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11/A (File No. 333-205684) filed with the Securities and Exchange Commission on February 20, 2018)
10.2   Director and Officer Indemnification Agreement (incorporated by reference to Exhibit 10.3 to our Amendment No. 1 to Post-Effective Amendment No. 2 to the Registration Statement on Form S-11 (File No. 333-205684) filed with the Securities and Exchange Commission on February 16, 2017)

 

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10.3

  Non-Solicitation Agreement between RW Holdings NNN REIT, Inc., Rich Uncles, LLC and Rich Uncles NNN REIT Operator, LLC (incorporated by reference to Exhibit 10.4 to our Annual Report on Form 10-K (File No. 333-205684) filed with the Securities and Exchange Commission on April 3, 2017)
10.4   Code of Business Conduct and Ethics (incorporated by reference to Exhibit 10.5 to our Annual Report on Form 10-K (File No. 333-205684) filed with the Securities and Exchange Commission on April 3, 2017)
10.5   Commercial Earnest Money Contract (Real Estate Purchase Agreement) for Texas Harley-Davidson property, dated February 9, 2017 between Rich Uncles NNN Operating Partnership, LP and ANS Real Estate Ltd (incorporated by reference to Exhibit 10.2 to our Amendment No. 1 to Post-Effective Amendment No. 2 to the Registration Statement on Form S-11 (File No. 333-205684) filed with the Securities and Exchange Commission on February 16, 2017)
10.6   Business Loan Agreement, dated as of February 1, 2018 and executed on February 28, 2018, by and between RW Holdings NNN REIT, Inc., Rich Uncles NNN Operating Partnership, L.P., Rich Uncles NNN LP, LLC and Pacific Mercantile Bank (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on March 5, 2018)
10.7   Promissory Note, dated February 1, 2018, made by RW Holdings NNN REIT, Inc., Rich Uncles NNN Operating Partnership, L.P. and Rich Uncles NNN LP, LLC and payable to the order of Pacific Mercantile Bank (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on March 5, 2018)
10.8   Purchase and sale agreement and addendum for Maitland, Florida property acquisition (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K (File No. 333-205684) filed with the Securities and Exchange Commission on March 2, 2017)
10.9   Purchase and sale agreement and addendum for Melbourne, Florida property acquisition (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K (File No. 333-205684) filed with the Securities and Exchange Commission on March 2, 2017)
10.10   Purchase and sale agreement and addendum for Dallas/Fort Worth, Texas property acquisition (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K (File No. 333-205684) filed with the Securities and Exchange Commission on March 2, 2017)
10.11   Amended and Restated Agreement of Limited Partnership of Rich Uncles NNN Operating Partnership, LP between RW Holdings NNN REIT, Inc. and Rich Uncles NNN LP, LLC, dated August 11, 2017 (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K (File No. 000-55776) filed with the Securities and Exchange Commission on August 17, 2017)
21.1   Subsidiaries*
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1   Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
101.INS   XBRL INSTANCE DOCUMENT
101.SCH   XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
101.CAL   XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
101.DEF   XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
101.LAB   XBRL TAXONOMY EXTENSION LABELS LINKBASE
101.PRE   XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE

 

* Filed herewith.

** Furnished herewith.

 

ITEM 16.FORM 10-K SUMMARY

 

None.

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Consolidated Financial Statements  
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets as of December 31, 2017 and 2016 F-3
Consolidated Statements of Operations for the Years Ended December 31, 2017 and 2016 F-4
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2017 and 2016 F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016 F-6
Notes to Consolidated Financial Statements F-7
   
Financial Statement Schedule  
Schedule III ─ Real Estate Assets and Accumulated Depreciation and Amortization F-29

 

All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.

 

 F-1 

 

  

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of

RW Holdings NNN REIT, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of RW Holdings NNN REIT, Inc. (the Company) as of December 31, 2017 and 2016, the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended, and the related notes and financial statement schedule listed in the Index at Item 15(a), Schedule III - Real Estate Assets and Accumulated Depreciation and Amortization (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

Adoption of ASU No. 2017-01

 

As discussed in Note 2 to the consolidated financial statements, the Company changed its method for determining whether acquisitions of real estate properties constitute a business combination effective October 1, 2016 as a result of the early adoption of the amendments to the FASB Accounting Standards Codification resulting from Accounting Standards Update No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Ernst & Young LLP  
   
We have served as the Company’s auditor since 2016.  
   
Irvine, California  

April 3, 2018

 

 

 F-2 

 

  

RW Holdings NNN REIT, Inc.

Consolidated Balance Sheets

 

    December 31,  
    2017     2016  
             
ASSETS                
Real estate investments:                
Land   $ 21,878,768     $ 5,369,238  
Building and improvements     108,590,813       24,243,072  
Tenant origination and absorption costs     8,340,774       3,632,731  
Total investments in real estate property     138,810,355       33,245,041  
Accumulated depreciation and amortization     (3,574,739 )     (493,185 )
Total investments in real estate property, net     135,235,616       32,751,856  
  Investments in unconsolidated entities (Note 5)     14,524,022       3,523,809  
Real estate investments, net     149,759,638       36,275,665  
                 
Cash and cash equivalents     3,238,173       3,431,769  
Restricted cash     944,582       245,604  
Tenant receivables     1,263,095       114,320  
Above-market leases, net     681,293       148,577  
Due from affiliates (Note 9)     34,194       108,433  
Purchase and other deposits     40,000       500,000  
Prepaid expenses and other assets     1,104,573       478,192  
Interest rate swap derivatives     7,899       -  
TOTAL ASSETS   $ 157,073,447     $ 41,302,560  
                 
LIABILITIES & STOCKHOLDERS' EQUITY                
Mortgage notes payable, net   $ 60,487,303     $ 7,113,701  
Unsecured credit facility, net     12,000,000       10,156,685  
Accounts payable, accrued and other liabilities     2,411,484       470,236  
Below-market leases, net     1,584,229       150,767  
Due to affiliates (Note 9)     907,377       383,422  
Investor deposits     -       582,516  
Share repurchases payable     386,839       17,467  
TOTAL LIABILITIES     77,777,232       18,874,794  
                 
Commitments and contingencies (Note 10)                
                 
Redeemable common stock     46,349       196,660  
                 
Preferred stock, $0.001 par value, 50,000,000 shares authorized, no shares issued and outstanding     -       -  
Class C common stock $0.001 par value, 300,000,000 and 200,000,000 shares authorized, 8,838,002 and 2,458,881 shares issued and outstanding as of December 31, 2017 and December 31, 2016, respectively     8,838       2,458  
Class S common stock $0.001 par value, 100,000,000 shares authorized, 3,032 and 0 shares issued and outstanding as of December 31, 2017 and December 31, 2016, respectively     3       -  
Additional paid-in-capital     85,324,921       23,643,435  
Cumulative distributions and net losses     (6,083,896 )     (1,414,787 )
TOTAL STOCKHOLDERS' EQUITY     79,249,866       22,231,106  
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY   $ 157,073,447     $ 41,302,560  

 

See accompanying notes to consolidated financial statements

 

 F-3 

 

   

RW Holdings NNN REIT, Inc.

Consolidated Statements of Operations

 

    Years Ended December 31,  
    2017     2016  
Revenues:            
Rental income   $ 6,140,444     $ 709,982  
Tenant reimbursements     1,249,762       151,762  
Total revenues     7,390,206       861,744  
                 
Expenses:                
Fees to affiliates (Note 9)     1,188,083       591,073  
General and administrative     3,742,896       1,276,535  
Depreciation and amortization     3,081,554       493,185  
Interest expense     1,637,984       395,110  
Property expenses     1,282,759       171,063  
Acquisition costs     -       73,027  
Total expenses     10,933,276       2,999,993
Less:  Expenses reimbursed/fees waived by Sponsor or affiliates (Note 9)     (2,468,138 )     (979,102 )
Net expenses     8,465,138       2,020,891  
                 
Other income (loss):                
Interest income      7,215       977  
Income (losses) from investments in unconsolidated entities      199,233       (79,271 )
Total other (loss) income     206,448       (78,294 )
                 
Net loss   $ (868,484 )   $ (1,237,441 )
                 
Net loss per common share, basic and diluted  (Note 2)   $ (0.15 )   $ (2.89 )
                 
Weighted-average number of common shares outstanding, basic and diluted     5,982,930       428,255  

 

See accompanying notes to consolidated financial statements

 

 F-4 

 

 

RW Holdings NNN REIT, Inc.

Consolidated Statements of Stockholders' Equity

For the Years Ended December 31, 2017 and 2016

 

                       Cumulative     
   Common Stock   Additional   Distributions   Total 
   Class C   Class S   Paid-in   and Net   Stockholders' 
   Shares   Amounts   Shares   Amounts   Capital   Losses   Equity 
Balance, December 31, 2015   20,000   $20    -   $-   $199,980   $(6,185)  $193,815 
                                    
Issuance of common stock   2,437,718    2,438    -    -    24,374,740    -    24,377,178 
Offering costs   -    -    -    -    (731,315)   -    (731,315)
Distributions declared   -    -    -    -    -    (171,161)   (171,161)
Stock compensation expense   9,800    10    -    -    97,990    -    98,000 
Redemption of common stock   (8,637)   (10)   -    -    (83,833)   -    (83,843)
Net loss   -    -    -    -    -    (1,237,441)   (1,237,441)
Reclassification to redeemable common stock   -    -    -    -    (214,127)   -    (214,127)
Balance, December 31, 2016   2,458,881    2,458    -    -    23,643,435    (1,414,787)   22,231,106 
                                    
Issuance of common stock   6,617,457    6,617    3,032    3    66,198,278    -    66,204,898 
Offering costs   -    -    -    -    (1,988,397)   -    (1,988,397)
Distributions declared   -    -    -    -    -    (3,800,625)   (3,800,625)
Stock compensation expense   16,300    16    -    -    162,984    -    163,000 
Redemption of common stock   (254,636)   (253)   -    -    (2,472,318)   -    (2,472,571)
Net loss   -    -    -    -    -    (868,484)   (868,484)
Reclassification to redeemable common stock   -    -    -    -    (219,061)   -    (219,061)
Balance, December 31, 2017   8,838,002   $8,838    3,032   $3   $85,324,921   $(6,083,896)  $79,249,866 

 

See accompanying notes to consolidated financial statements

 

 F-5 

 

 

RW Holdings NNN REIT, Inc.

Consolidated Statements of Cash Flows

   Years Ended December 31, 
   2017   2016 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net loss  $(868,484)  $(1,237,441)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
Depreciation and amortization   3,081,554    493,185 
Stock compensation expense   163,000    98,000 
Straight-line rents   (965,846)   28,335 
Amortization of lease incentives   130,689    58,310 
Tenant reimbursement used for rent credit   (51,459)   (290,850)
Amortization of deferred financing costs   169,664    19,651 
Amortization of above-market leases   83,770    17,209 
Amortization of below-market leases   (68,699)   - 
Unrealized gain on interest rate swap valuation   (7,899)   - 
(Income) losses from investments in unconsolidated entities   (199,233)   79,271 
Distributions from investments in unconsolidated entities   367,686    37,554 
Changes in operating assets and liabilities:          
Tenant receivables   (182,929)   - 
Due from affiliate   45,668    (79,862)
Prepaid expenses and other assets   (91,871)   (143,657)
Accounts payable, accrued and other liabilities   1,323,371    225,586 
Due to affiliate   861,855    22,577 
Net cash provided by (used in) operating activities   3,790,837    (672,132)
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Acquisition of real estate investments   (100,458,868)   (32,754,452)
Improvements to real estate   (685,160)   - 
Payments of acquisition fees to affiliate   (3,935,884)   (231,408)
Repayment (funding) of amounts due to (from) affiliate   28,571    (28,571)
Investments in unconsolidated entities   (10,542,594)   (3,640,634)
Refundable purchase deposits and other acquisition costs   -    (500,000)
Net cash used in investing activities   (115,593,935)   (37,155,065)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Borrowings from unsecured credit facility   55,390,000    24,215,000 
Repayments of unsecured credit facility   (53,547,803)   (14,057,197)
Proceeds from mortgage notes payable   55,369,988    7,319,700 
Principal payments on mortgage notes payable   (407,725)   (53,555)
Refundable loan deposits   (40,000)   - 
Payments of deferred financing costs to third parties   (1,430,607)   (173,213)
Payments of financing fees to affiliates   (326,600)   - 
Proceeds from issuance of common stock and investor deposits   62,555,554    24,834,698 
Payment of offering costs   (2,049,847)   (651,670)
Payment of Class S commissions   (700)   - 
Redemption of common stock   (2,472,571)   (83,843)
Distributions paid to common stockholders   (731,209)   (46,165)
Net cash provided by financing activities   112,308,480    41,303,755 
           
Net increase in cash, cash equivalents and restricted cash   505,382    3,476,558 
           
Cash, cash equivalents and restricted cash, beginning of year   3,677,373    200,815 
           
Cash, cash equivalents and restricted cash, end of year  $4,182,755   $3,677,373 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $1,285,716   $349,120 
           
Supplemental disclosure of noncash flow information:          
Transfers to redeemable common stock  $219,061   $214,127 
Distributions paid to common stockholders through common stock issuance pursuant to the dividend reinvestment plan  $3,067,095   $124,996 
Increase in deferred commission payable to S Class distributor  $2,300   $- 
Increase in lease incentive obligation  $858,389   $535,500 
Reinvested distributions to investment in Rich Uncles REIT I  $-   $2,885 
Tax withholding on distributions  $267   $- 
Purchase deposits applied to acquisition of real estate  $500,000   $- 
Increase in share repurchases payable  $369,372   $17,467 
Increase in other offering costs due to affiliate  $-   $79,645 
Capitalized acquisition fee payable  $-   $274,200 

 

See accompanying notes to consolidated financial statements

 

 F-6 

 

  

RW HOLDINGS NNN REIT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. BUSINESS AND ORGANIZATION

 

Rich Uncles NNN REIT, Inc. (the “Company”) was incorporated on May 14, 2015 as a Maryland corporation. The Company was originally incorporated under the name Rich Uncles Real Estate Investment Trust, Inc., but changed its name on October 19, 2015 to Rich Uncles NNN REIT, Inc. and again on August 14, 2017 to RW Holdings NNN REIT, Inc. The Company has the authority to issue 450,000,000 shares of stock, consisting of 50,000 shares of preferred stock, $0.001 par value per share, 300,000,000 shares of Class C common stock, $0.001 par value per share, and 100,000,000 shares of Class S common stock, $0.001 par value per share. The Company was formed to primarily invest, directly or indirectly through investments in real estate owning entities, in single-tenant income-producing corporate properties located in the United States, which are leased to credit worthy tenants under long-term net leases. The Company’s goal is to generate current income for investors and long-term capital appreciation in the value of its properties.

 

The Company holds its investments in real property through special purpose wholly owned limited liability companies which are wholly owned subsidiaries of Rich Uncles NNN Operating Partners, L.P., a Delaware limited partnership (the “Operating Partnership”). The Operating Partnership was formed on January 28, 2016. The Company is the sole general partner of and owns a 99% partnership interest in the Operating Partnership. Rich Uncles NNN LP, LLC, a Delaware limited liability company formed on May 13, 2016 (“NNN LP”), owns the remaining 1% interest in the Operating Partnership and is its sole limited partner (“Limited Partner”). Rich Uncles NNN LP, LLC is wholly owned by the Company. The Company has no significant operations prior to its purchase of real estate properties in June 2016.

 

The Company is externally managed by its advisor, Rich Uncles NNN REIT Operator, LLC (the “Advisor”), a Delaware limited liability company pursuant to an advisory agreement, as amended (the “Advisory Agreement”). The Advisor is wholly owned by the Company’s sponsor, BrixInvest, LLC (f/k/a Rich Uncles, LLC) (the “Sponsor”), a Delaware limited liability company whose members include Harold Hofer and Ray Wirta. On each of June 24, 2015 and December 31, 2015, the Company issued 10,000 shares of its Class C common stock to the Sponsor at a purchase price of $10.00 per share.

  

On July 15, 2015, the Company filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to register an initial public offering of its common stock to offer a maximum of $900,000,000 in shares of common stock for sale to the public (the “Primary Offering”). The Company also registered a maximum of $100,000,000 of common stock pursuant to the Company’s distribution reinvestment plan (the “Registered DRP Offering”) and, together with the Primary Offering (the “Registered Offering”). The SEC declared the Company’s registration statement effective on June 1, 2016 and on July 20, 2016, the Company began offering shares to the public. Pursuant to its securities offering registered with the SEC, the Company sells shares of “Class C” common stock directly to investors, initially at a purchase price of $10.00 per share, with a minimum investment in shares of $500. Commencing in August 2017, the Company began selling shares of its Class C common stock only to U.S. persons as defined under Rule 903 promulgated under the Securities Act of 1933, as amended (the “Securities Act”).

 

On August 11, 2017, the Company began offering up to 100,000,000 shares of Class S common stock exclusively to non-U.S. Persons as defined under Rule 903 promulgated under the Securities Act pursuant to an exemption from the registration requirements of the Securities Act and in accordance with Regulation S of the Securities Act (the “Class S Offering”) and, together with the Registered Offering (the “Offerings”). The Class S common stock has similar features and rights as the Class C common stock, including with respect to voting and liquidation except that the Class S common stock offered in the Class S offering may be sold through brokers or other persons who may be paid upfront and deferred selling commissions and fees. On January 18, 2018, the Company’s board of directors approved and established an estimated NAV per share of the Company’s common stock of $10.05. Effective January 19, 2018, the purchase price per share of the Company’s common stock is $10.05.

 

Through December 31, 2017, the Company had sold 9,055,175 shares of “Class C” common stock in the Registered Offering, including 319,150 shares of Class C common stock sold under its Registered DRP Offering, for aggregate gross offering proceeds of $90,551,753, and 3,032 shares of Class S common stock in the Class S Offering for aggregate gross offering proceeds of $30,324, including 32 shares of Class S common stock sold under its distribution reinvestment plan.