Item 1.
Business.
The use of the words “we,” “us” or “our” refers to Grubb & Ellis Apartment REIT, Inc. and its subsidiaries, including Grubb & Ellis Apartment REIT Holdings, L.P., except where the context otherwise requires.
OUR COMPANY
Grubb & Ellis Apartment REIT, Inc. (formerly known as NNN Apartment REIT, Inc.), a Maryland corporation, was incorporated on December 21, 2005. We were initially capitalized on January 10, 2006 and therefore we consider that our date of inception. We seek to purchase and hold a diverse portfolio of quality apartment communities with strong, stable cash flows and growth potential in select U.S. metropolitan areas. We may also invest in real estate related securities. We focus primarily on investments that produce current income. We qualified to be taxed as a real estate investment trust, or REIT, for federal income tax purposes for our taxable year ended December 31, 2006 and we intend to continue to be taxed as a REIT.
We are conducting a best efforts initial public offering, or our Offering, in which we are offering up to 100,000,000 shares of our common stock for $10.00 per share and 5,000,000 shares of our common stock pursuant to our distribution reinvestment plan, or the DRIP, at $9.50 per share, aggregating up to $1,047,500,000.
We conduct substantially all of our operations through Grubb & Ellis Apartment REIT Holdings, L.P. (formerly known as NNN Apartment REIT Holdings, L.P.), or our operating partnership. We are externally advised by Grubb & Ellis Apartment REIT Advisor, LLC (formerly known as NNN Apartment REIT Advisor, LLC), or our advisor, pursuant to an advisory agreement, or the Advisory Agreement, between us and our advisor. Grubb & Ellis Realty Investors, LLC, or Grubb & Ellis Realty Investors (formerly known as Triple Net Properties, LLC), is the managing member of our advisor. The Advisory Agreement had an initial one-year term that expired on July 18, 2007 and is subject to successive one-year renewals upon the mutual consent of the parties. On June 12, 2007, our board of directors and our advisor approved the renewal of the Advisory Agreement for an additional one-year term, which expires on July 18, 2008. Our advisor supervises and manages our day-to-day operations and selects the properties and securities we acquire, subject to the oversight and approval by our board of directors. Our advisor also provides marketing, sales and client services on our behalf. Our advisor is affiliated with us in that we and our advisor have common officers, some of whom also own an indirect equity interest in our advisor. Our advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, and Grubb & Ellis Residential Management, Inc., or Residential Management, to provide various services to us, including property management services.
On December 7, 2007, NNN Realty Advisors, Inc., or NNN Realty Advisors, which previously served as our sponsor, merged with and into a wholly owned subsidiary of Grubb & Ellis Company, or Grubb & Ellis. The transaction was structured as a reverse merger whereby stockholders of NNN Realty Advisors received shares of common stock of Grubb & Ellis in exchange for their NNN Realty Advisors shares of common stock and, immediately following the merger, former NNN Realty Advisor stockholders held approximately 59.5% of the common stock of Grubb & Ellis. As a result of the merger, we consider Grubb & Ellis to be our sponsor. Following the merger, NNN Apartment REIT, Inc., NNN Apartment REIT Holdings, L.P., NNN Apartment REIT Advisor, LLC, NNN Apartment Management, LLC, Triple Net Properties, LLC, NNN Residential Management, Inc. and NNN Capital Corp. changed their names to Grubb & Ellis Apartment REIT, Inc., Grubb & Ellis Apartment REIT Holdings, L.P., Grubb & Ellis Apartment REIT Advisor, LLC, Grubb & Ellis Apartment Management, LLC, Grubb & Ellis Realty Investors, LLC, Grubb & Ellis Residential Management, Inc. and Grubb & Ellis Securities, Inc., respectively.
Developments during 2007 and 2008
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On February 22, 2007, our board of directors approved a 7.0% per annum distribution to be paid to stockholders. The increased distribution began with the March 2007 monthly distribution, which was paid on April 15, 2007. Distributions are paid to stockholders on a monthly basis.
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On November 1, 2007, we entered into a loan agreement with Wachovia Bank, National Association, or Wachovia, for a loan in the principal amount of up to $10,000,000, or the Wachovia Loan, which matures on November 1, 2008 and has an option to extend for one year subject to satisfaction of certain conditions.
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As of December 31, 2007, we owned interests in six properties in Texas consisting of 1,819 apartment units, one property in North Carolina consisting of 160 apartment units, and two properties in Virginia consisting of 394 apartment units for a total of 2,373 apartment units.
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As of March 14, 2008, we had received and accepted subscriptions in our Offering for 9,710,660 shares of our common stock, or $97,015,000, excluding shares issued under the DRIP.
Our Structure
The following is a summary of our organizational structure as of December 31, 2007:
The following is a summary of entities affiliated with our advisor as of December 31, 2007:
Our principal executive offices are located at 1551 N. Tustin Avenue, Suite 300, Santa Ana, California 92705 and the telephone number is (714) 667-8252. Our sponsor maintains a web site at www.gbe-reits.com at which there is additional information about us and our affiliates. The contents of that site are not incorporated by reference in, or otherwise a part of, this filing. We make our periodic and current reports available at www.gbe-reits.com as soon as reasonably practicable after such materials are electronically filed with the Securities and Exchange Commission, or the SEC. They are also available for printing by any stockholder upon request.
CURRENT INVESTMENT OBJECTIVES AND POLICIES
General
Our objective is to acquire quality apartment communities so we can provide our stockholders with:
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stable cash flow available for distribution;
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preservation and protection of capital; and
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growth of income and principal without undue risk.
Additionally, we intend to:
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invest in income producing real property generally through equity investments in a manner which permits us to qualify as a REIT for federal income tax purposes; and
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realize capital appreciation upon the ultimate sale of our properties.
We cannot assure our stockholders that we will attain these objectives or that our capital will not decrease. Our board of directors may change our investment objectives if it determines it is advisable and in the best interests of our stockholders.
Decisions relating to the purchase or sale of investments are made by our advisor, subject to the oversight and approval by our board of directors. See Item 10. Directors, Executive Officers and Corporate Governance for a description of the background and experience of our directors and officers, as well as the officers of our advisor.
Business Strategies
We believe the following will be key factors for our success in meeting our objectives.
Following Demographic Trends and Population Shifts to Find Attractive Tenants in Quality Apartment Community Markets
According to the United States, or U.S., Census Bureau, nearly one half of total U.S. population growth between 2000 and 2030 will occur in three states: Florida, California and Texas, with each state gaining more than 12 million people in total during that period. Included in the top five growth states are Arizona and North Carolina, projected to add 5.6 million and 4.2 million people, respectively.
We focus on property acquisitions in regions of the U.S. that seem likely to benefit from the ongoing population shift and/or are poised for strong economic growth. We further believe that these markets will likely attract quality tenants who have good income and strong credit profiles and choose to rent an apartment rather than buy a home because of their life circumstances. For example, tenants may be baby-boomers or retirees who desire freedom from home maintenance costs and property taxes or they may be service employees who have recently moved to the area and chosen not to make a long-term commitment to the area because of the itinerant nature of their employment. Tenants may also be individuals in transition who need housing while awaiting selection or construction of a home. We believe that attracting and retaining quality tenants strongly correlates with the likelihood of providing stable cash flow to our stockholders as well as increasing the value of our properties.
Fluctuations in interest rates and the economy can benefit our business model by making it more difficult for many people to buy a home, especially a first home. We believe that as the pool of potential renters increases, the demand for apartments is also likely to increase. With this increased demand, we believe that in the future it may be possible to raise rents and decrease rental concessions at apartment communities we acquire.
Leveraging the Experience of Our Management
We believe that a critical factor for success in property acquisitions lies in possessing the flexibility to move quickly when an opportunity presents itself to buy or sell a property. We believe that employing highly qualified industry professionals will allow us to better achieve this objective.
Each of our key executives has considerable experience building successful real estate companies. As an example, Stanley J. Olander, our chief executive officer, president and chairman of the board, has been responsible for the acquisition and financing of approximately 40,000 apartment units, has been an executive in the real estate industry for more than 25 years, and previously served as president and chief financial officer and a member of the board of directors of Cornerstone Realty Income Trust, Inc., or Cornerstone. Likewise, Gus G. Remppies, our executive vice president and chief investment officer, and David L. Carneal, our executive vice president and chief operating officer, are the former chief investment officer and chief operating officer, respectively, of Cornerstone, where they oversaw the growth of that company.
Decisions relating to the purchase or sale of properties are made by our advisor subject to oversight and approval by our board of directors.
Our board of directors has established written policies on investment objectives and borrowing. Our board is responsible for monitoring the administrative procedures, investment operations and performance of our company and our advisor to ensure such policies are carried out. Our board of directors generally may change our policies or investment objectives at any time without a vote of our stockholders. The independent directors will review our investment policies at least annually to determine that our policies are in the best interests of our stockholders and will set forth their determinations in the minutes of our board of directors meetings. Our stockholders will have no voting rights with respect to implementing our investment objectives and policies, all of which are the responsibility of our board of directors and may be changed at any time.
Acquisition Strategies
Types of Investments
We invest primarily in Class A apartment communities. To the extent that it is in the best interests of our stockholders, we strive to invest in a geographically diversified portfolio of apartment communities that will satisfy our primary investment objectives of providing our stockholders with stable cash flow, preservation of capital and growth of income and principal without undue risk. Because a significant factor in the valuation of income-producing real estate is their potential for future income, the majority of properties we acquire will have both the potential for growth in value and providing cash distributions to stockholders.
We typically acquire properties with cash and mortgage or other debt, but we may acquire properties free and clear of mortgage indebtedness by paying the entire purchase price for such property in cash or in units of limited partnership interest in our operating partnership. With respect to properties purchased on an all-cash basis, if favorable financing terms are available, we may later incur mortgage indebtedness by obtaining loans secured by selected properties. The proceeds from such loans would be used to acquire additional properties and increase our cash flow.
We anticipate that 88.5% of offering proceeds, excluding acquisition fees and expense reimbursements of up to 6.0% of the purchase price of the properties, will be used to acquire real estate and the balance will be used to pay various fees and expenses.
We anticipate that aggregate borrowings, both secured and unsecured, will not exceed 65.0% of all of our properties’ and real estate related securities’ combined fair market values, as determined at the end of each calendar year beginning with our first full year of operations. For these purposes, the fair market value of each asset will be equal to the purchase price paid for the asset or, if the asset was appraised subsequent to the date of purchase, then the fair market value will be equal to the value reported in the most recent independent appraisal of the asset. Our policies do not limit the amount we may borrow with respect to any individual asset. As of December 31, 2007, our aggregate borrowings were 71.7% of all of our properties’ and real estate
related securities’ combined fair market values due to short-term financing we incurred to purchase our two most recently acquired properties.
Although our focus is on apartment communities, our charter and bylaws do not preclude us from acquiring other types of properties. We may acquire other real estate assets, including, but not limited to, income producing commercial properties such as retail shopping centers and office buildings. The purchase of any apartment community or other property type will be based upon the best interests of our company and our stockholders as determined by our board of directors. Regardless of the mix of properties we may own, our primary business objectives are to maximize stockholder value by acquiring apartment communities that have strong, stable cash flows and growth potential and to preserve capital.
We may also invest in real estate related securities.
We do not intend to enter into purchase and sale-leaseback transactions, under which we would purchase a property from an entity and lease the property back to such entity under a net lease. Additionally, we do not intend to purchase interests in hedge funds.
Acquisition Standards
We generally invest in metropolitan areas that are projected to have population growth rates in excess of the national average and that we believe will continue to perform well economically over time. While our acquisitions are not limited to any state or geographic region, we intend to capitalize on income opportunities that may result from shifts of population and assets. Areas and states we will especially focus on include, but are not limited to, Florida, Texas, Nevada, and other metropolitan areas in the mid-Atlantic, southeast and southwest regions of the United States that seem likely to benefit from the ongoing population shift and/or are poised for strong economic growth.
Our primary investment focus is on existing Class A apartment communities that produce immediate income. However, we may acquire newly developed communities with some risk related to non-rented space if we believe the investment will result in long-term benefits for our stockholders. We generally purchase newer properties, less than five years old, with reduced capital expenditure requirements and high occupancy rates. However, we may purchase older properties, including properties that need capital improvements or lease-up to maximize their value and enhance stockholder returns. These properties may have short-term decreases in income during the lease-up or renovation phase, but will only be acquired if management believes in the long-term growth potential of the investment after completing such lease-up or renovations. We do not anticipate a significant focus on such properties.
We seek to acquire well located and well constructed properties where the average income of the tenants generally exceeds the average income for the metropolitan area in which the community is located. All of our anticipated apartment communities will lease to their tenants under similar lease terms, which range from month-to-month to 12 month leases. We believe that the relatively short lease terms that are customary in most markets may allow us to aggressively raise rental rates in appropriate circumstances.
We may also consider purchasing apartment communities that include land or development opportunities as part of the purchase package. Such acquisitions will be no more than 10.0% of our aggregate portfolio value, and our intent is to transfer development risks to the developer. Acquisitions of this type, while permitted, are not anticipated and do not represent a primary objective of our acquisition strategy. Further, such acquisitions would require special consideration by our board of directors because of their increased risk and their potential to represent purchasing conflicts for and between other of our affiliate entities for whom these purchases would be more appropriate given their portfolio allowances for the assumption of more risk.
While real estate investing involves considerable risk, the owners and officers of our advisor possess considerable experience in the apartment housing sector, which we believe helps enable us to identify appropriate properties to meet our objectives and goals. Overall, we focus on providing our stockholders with stable cash flow and income, a stable asset base and a strategy for growth consistent with preservation of capital.
We believe that our strategy for apartment community acquisitions will benefit our stockholders for the following reasons:
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We seek to preserve capital through selective acquisitions and professional management, whereby we intend to increase rental rates, maintain high occupancy rates, reduce tenant turnover, make value-enhancing and income producing capital improvements, where appropriate, and control operating costs and capital expenditures.
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We seek to acquire premier Class A apartment properties in growth markets, at attractive prices relative to replacement cost, that provide the opportunity to improve operating performance through professional management, marketing and selective leasing and renovation programs.
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We seek to acquire apartment communities at favorable prices and obtain immediate income from tenant rents, with the potential for appreciation in value over time.
We believe, based on our advisor’s prior real estate experience, that we have the ability to identify quality properties capable of meeting our investment objectives. In evaluating potential acquisitions, the primary factor we consider is the property’s current and projected cash flow. We also consider a number of other factors, including a property’s:
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geographic location and type;
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construction quality and condition;
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potential for capital appreciation;
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the general credit quality of current and potential tenants;
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the potential for rent increases;
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the interest rate environment;
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potential for economic growth;
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the tax and regulatory environment of the community in which the property is located;
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potential for expanding the physical layout of the property;
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occupancy and demand by tenants for properties of a similar type in the same geographic vicinity;
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prospects for liquidity through sale, financing or refinancing of the property;
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competition from existing properties and the potential for the construction of new properties in the area; and
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treatment under applicable federal, state and local tax and other laws and regulations.
Our advisor has substantial discretion with respect to the selection of specific properties, subject to the oversight and approval of our board of directors.
We will not close the acquisition of any property unless and until we obtain an environmental assessment, a minimum of Phase I review, for each potential property to be acquired and are generally satisfied with the environmental status of the property, as determined by our advisor.
We may also enter into arrangements with the seller or developer of a property whereby the seller or developer agrees that if, during a stated period, the property does not generate a specified cash flow, the seller or developer will pay us in cash a sum necessary to reach the specified cash flow level, subject in some cases to negotiated dollar limitations.
In determining whether to acquire a particular property, we may, in accordance with customary practices, obtain an option on such property. The amount paid for an option, if any, is normally surrendered if the property is not acquired, and is normally credited against the purchase price if the property is acquired.
We anticipate that the purchase price of properties we acquire will vary widely depending on a number of factors, including size and location. In addition, the cost of a property will vary based on the amount of debt we incur in connection with financing the acquisition. If we do not raise significant proceeds from our Offering, we may not be able to acquire a diversified portfolio of properties. If we raise significant proceeds from our Offering, we will likely acquire a substantial number of properties; however, it is difficult to predict with precision the actual number of properties that we will actually acquire because the purchase prices of properties varies widely and our investment in each will vary based on the amount of leverage we incur.
Property Acquisition
We primarily acquire real property through wholly-owned subsidiaries of our operating partnership. In addition to fee simple interests, we may acquire properties subject to long-term ground leases. Other methods of acquiring a property may be used when advantageous. For example, we may acquire properties through a joint venture or the acquisition of substantially all of the interests of an entity that in turn owns a real property.
We may commit to acquire properties subject to completion of construction in accordance with terms and conditions specified by our advisor. In such cases, we will be obligated to acquire the property at the completion of construction, provided that (1) the construction conforms to definitive plans, specifications and costs approved by us in advance and embodied in the construction contract and (2) an agreed upon percentage of the property is leased. We will receive a certificate from an architect, engineer or other appropriate party, stating that the property complies with all plans and specifications. Our intent is to transfer development risk to the developer. Acquisitions of this type, while permitted, are not anticipated and do not represent a primary objective of our acquisition strategy
If remodeling is required prior to the acquisition of a property, we will pay a negotiated maximum amount either upon completion or in installments commencing prior to completion. Such amount will be based on the estimated cost of such remodeling. In such instances, we will also have the right to review the seller’s books during and following completion of the remodeling to verify actual costs. In the event of substantial disparity between estimated and actual costs, an adjustment in purchase price may be negotiated.
We are not specifically limited in the number or size of properties we may acquire or on the percentage of net proceeds of our Offering which we may invest in a single property. The number and mix of properties we acquire depends upon real estate and market conditions and other circumstances existing at the time we are acquiring our properties and the amount of proceeds we raise in our Offering.
Joint Venture Investments
We may invest in general partnerships and joint venture arrangements with other real estate programs formed by, sponsored by or affiliated with our advisor or an affiliate of our advisor if a majority of our independent directors who are not otherwise interested in the transaction approve the transaction as being fair and reasonable to our company and our stockholders and on substantially the same terms and conditions as those received by the other joint venturers. We may also invest with non-affiliated third parties by following the general procedures to obtain board of director approval of an acquisition. However, we will not acquire interests in properties that are the subject of tenant-in-common syndications.
We will invest in general partnerships or joint venture arrangements with our advisor and its affiliates only when:
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there are no duplicate property management or other fees;
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each entity’s investment is on substantially the same terms and conditions; and
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we have a right of first refusal if our advisor or its affiliates wish to sell its interest in the property held in such arrangement.
We may invest in general partnerships or joint venture arrangements with our advisor and its affiliates to allow us to increase our equity participation in such venture as additional proceeds of our Offering are
received, with the result that we will own a larger equity percentage of the property. In addition, we will have the right to enter into joint venture arrangements with entities unaffiliated with our advisor and its affiliates.
There is a potential risk that we or our joint venture partner will be unable to agree on a matter material to the joint venture and we may not control the outcome of the decision with respect to such matter. Furthermore, we cannot assure our stockholders that we will have sufficient financial resources to exercise any right of first refusal.
Operating Strategies
Our primary operating strategy is to acquire suitable properties that meet our acquisition standards and to enhance the performance and value of those properties through management strategies designed to address the needs of current and prospective tenants. Our management strategies include:
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aggressively leasing available space through targeted marketing;
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emphasizing regular maintenance and periodic renovation to meet the needs of tenants and to maximize long-term returns; and
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financing acquisitions and refinancing properties when favorable terms are available to increase cash flow.
Disposition Strategies
Our advisor and our board of directors will determine whether a particular property should be sold or otherwise disposed of after consideration of the relevant factors, including performance or projected performance of the property and market conditions, with a view toward achieving our principal investment objectives.
While it is our intention to hold each property we acquire for a minimum of four years, circumstances might arise which could result in the early sale of some properties. A property may be sold before the end of the expected holding period if:
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in the judgment of our advisor, the value of a property might decline substantially;
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an opportunity has arisen to improve other properties;
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we can increase cash flow through the disposition of the property; or
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in our judgment, the sale of the property is in our best interests and the best interests of our stockholders.
The determination of whether a particular property should be sold or otherwise disposed of will be made after consideration of the relevant factors, including prevailing economic conditions, with a view to achieving maximum capital appreciation. We cannot assure our stockholders that this objective will be realized. The selling price of a property is determined in large part by the amount of rent payable under the gross leases for the property. If a tenant has a repurchase option at a formula price or if operating expenses increase without a commensurate increase in rent under our gross leases, we may be limited in realizing any appreciation.
When appropriate to minimize our tax liabilities, we may structure the sale of a property as a “like-kind exchange” under the federal income tax laws so that we may acquire qualifying like-kind replacement property meeting our investment objectives without recognizing taxable gain on the sale. Furthermore, our general policy will be to reinvest in additional properties from the sale, financing, refinancing or other disposition proceeds from properties that represent our initial investment in such property or, secondarily, to use such proceeds for the maintenance or repair of existing properties or to increase our reserves for such purposes. The objective of reinvesting such portion of the sale, financing and refinancing proceeds is to increase the total value of real estate assets that we own, and the cash flow derived from such assets to pay distributions to our stockholders.
Despite this policy, our board of directors, in its discretion, may distribute to our stockholders all or a portion of the proceeds from the sale, financing, refinancing or other disposition of properties. In determining whether any of such proceeds should be distributed to our stockholders, our board of directors will consider, among other factors, the desirability of properties available for purchase, real estate market conditions and compliance with the REIT distribution requirements. Because we may reinvest such portion of the proceeds from the sale, financing or refinancing of our properties, we could hold our stockholders’ capital indefinitely. However, the affirmative vote of stockholders controlling a majority of the outstanding shares of our common stock may force us to liquidate our assets and dissolve.
In connection with a sale of a property, our general preference will be to obtain an all-cash sales price. However, we may take a purchase money obligation secured by a mortgage on the property as partial payment. There are no limitations or restrictions on our taking such purchase money obligations. The terms of payment upon sale will be affected by industry custom in the area in which the property being sold is located and the then prevailing economic conditions. To the extent we receive notes, securities or other property instead of cash from sales, such proceeds, other than any interest payable on such proceeds, will not be included in net sales proceeds available for distribution until and to the extent the notes or other property are actually paid, sold, refinanced or otherwise disposed of. Thus, the distribution of the proceeds of a sale to our stockholders, to the extent contemplated by our board of directors, may be delayed until such time. In such cases, we will receive payments in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years.
We are not a mortgage bank or portfolio lender. We do not intend to engage in the business of originating, warehousing or servicing mortgages. If we engage in any such activities, it will be only as an ancillary result of our main business of investing in real estate properties. We may provide seller financing on certain properties if, in our judgment, it is prudent to do so. However, our main business is not investing in mortgages or mortgage-backed securities. If we do invest directly in mortgages, they will be mortgages secured by apartment communities or other commercial properties.
FINANCING POLICIES
When we think it is appropriate, we will borrow funds to acquire or finance properties. We may later refinance or increase mortgage indebtedness by obtaining additional loans secured by selected properties, if favorable financing terms are available. We will use the proceeds from such loans to acquire additional properties for the purpose of increasing our cash flow and providing further diversification.
We anticipate that aggregate borrowings, both secured and unsecured, will not exceed 65.0% of all of our properties’ and real estate related securities’ combined fair market values, as determined at the end of each calendar year beginning with our first full year of operation. As of December 31, 2007, our aggregate borrowings were 71.7% of all of our properties’ and real estate related securities’ combined fair market values due to short-term financing we incurred to purchase our two most recently acquired properties.
Our board of directors reviews our aggregate borrowings at least quarterly to ensure that such borrowings are reasonable in relation to our net assets. The maximum amount of such borrowings in relation to our net assets will not exceed 300.0%, unless any excess in such borrowing is approved by a majority of our independent directors and is disclosed in our next quarterly report along with the justification for such excess. Net assets for purposes of this calculation are defined as our total assets (other than intangibles), valued at cost prior to deducting depreciation, reserves for bad debts and other non-cash reserves, less total liabilities. The preceding calculation is generally expected to approximate 75.0% of the sum of (1) the aggregate cost of our properties before non-cash reserves and depreciation and (2) the aggregate cost of our securities assets.
As a result of the acquisition of our first two properties on October 31, 2006 and December 28, 2006, our leverage exceeded 300.0%. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources for a further discussion. In connection with each of these acquisitions, a majority of our directors, including a majority of our independent directors, approved our leverage exceeding 300.0%, in accordance with our charter. Our board of directors determined that for each
acquisition, the excess leverage was justified because it enabled us to purchase the properties during the initial stages of our Offering, thereby improving our ability to meet our goal of acquiring a diversified portfolio of properties to generate current income for investors and preserve investor capital. As of December 31, 2007, our leverage did not exceed 300.0%.
We may also incur indebtedness to finance improvements to properties and, if necessary, for working capital needs or to meet the distribution requirements applicable to REITs under the federal income tax laws.
If we incur mortgage indebtedness, we will endeavor to obtain level payment financing, meaning that the amount of debt service payable would be substantially the same each year, although some mortgages are likely to provide for one large payment and we may incur floating or adjustable rate financing when our board of directors determines it to be in our best interest.
Our board of directors controls our policies with respect to borrowing and may change such policies at any time without stockholder approval.
BOARD REVIEW OF OUR INVESTMENT OBJECTIVES AND POLICIES
As required by our charter, our independent directors have reviewed our policies outlined above and determined that they are in the best interest of our stockholders because: (1) they increase the likelihood that we will be able to acquire a diversified portfolio of income producing properties, thereby reducing risk in our portfolio; (2) there are sufficient property acquisition opportunities with the attributes that we seek; (3) our executive officers, directors and affiliates of our advisor have expertise with the type of real estate investments we seek; and (4) our borrowings have enabled us to purchase assets and earn rental income more quickly than otherwise would be possible, thereby increasing our likelihood of generating income for our stockholders and preserving stockholder capital.
TAX STATUS
We made an election to be taxed as a REIT for fiscal year 2006 under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Code, and we intend to continue to be taxed as a REIT. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90.0% of our ordinary taxable income to stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our results of operations and net cash available for distribution to our stockholders.
DISTRIBUTION POLICY
In order to qualify as a REIT, we are required to distribute at least 90.0% of our annual ordinary taxable income to our stockholders. The amount of any cash distributions is determined by our board of directors and depends on the amount of distributable funds, current and projected cash requirements, tax considerations, any limitations imposed by the terms of indebtedness we may incur and other factors. If our investments produce sufficient cash flow, we expect to pay distributions to our stockholders on a monthly basis. Because our cash available for distribution in any year may be less than 90.0% of our taxable income for the year, we may be required to borrow money, use proceeds from the issuance of securities or sell assets to pay out enough of our taxable income to satisfy the distribution requirement. See Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Distributions for a further discussion on distribution rates approved by our board of directors.
COMPETITION
The residential apartment community industry is highly competitive. This competition could reduce occupancy levels and revenues at our apartment communities, which would adversely affect our operations. We face competition from many sources. We face competition from other apartment communities both in the immediate vicinity and the geographic market where our apartment communities are and will be located. Overbuilding of apartment communities may occur in geographic markets where our properties are located. If so, this will increase the number of apartment units available and may decrease occupancy and apartment rental rates. In addition, increases in operating costs due to inflation may not be offset by increased apartment rental rates.
We also face competition for real estate investment opportunities. These competitors may be other REITs and other entities that have substantially greater financial resources than we do. We also face competition for investors from other residential apartment community REITs and real estate entities.
Other entities managed by affiliates of our advisor also own property interests in the same region in which we own property interests. Our properties may face competition in this geographic region from such other properties owned, operated or managed by our advisor’s affiliates. Our advisor’s affiliates have interests that may vary from our interests in such geographic markets.
GOVERNMENT REGULATIONS
Many laws and governmental regulations are applicable to our properties and changes in these laws and regulations, or their interpretation by agencies and the courts, occur frequently.
Costs of Compliance with the Americans with Disabilities Act. Under the Americans with Disabilities Act of 1990, as amended, or the ADA, all public accommodations must meet federal requirements for access and use by disabled persons. Although we believe that we are in substantial compliance with present requirements of the ADA, none of our properties have been audited, nor have investigations of our properties been conducted to determine compliance. Additional federal, state and local laws also may require modifications to our properties or restrict our ability to renovate our properties. We cannot predict the cost of compliance with the ADA or other legislation. We may incur substantial costs to comply with the ADA or any other legislation.
Costs of Government Environmental Regulation and Private Litigation. Environmental laws and regulations hold us liable for the costs of removal or remediation of certain hazardous or toxic substances which may be on our properties. These laws could impose liability without regard to whether we are responsible for the presence or release of the hazardous materials. Government investigations and remediation actions may have substantial costs and the presence of hazardous substances on a property could result in personal injury or similar claims by private plaintiffs. Various laws also impose liability on a person who arranges for the disposal or treatment of hazardous or toxic substances and such person often must incur the cost of removal or remediation of hazardous substances at the disposal or treatment facility. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. As the owner and operator of our properties, we may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances.
Use of Hazardous Substances by Some of Our Residents. Some of our residents may handle hazardous substances and wastes on our properties as part of their routine operations. Environmental laws and regulations subject these residents, and potentially us, to liability resulting from such activities. We require our residents, in their leases, to comply with these environmental laws and regulations and to indemnify us for any related liabilities. We are unaware of any material noncompliance, liability or claim relating to hazardous or toxic substances or petroleum products in connection with any of our properties.
Other Federal, State and Local Regulations. Our properties are subject to various federal, state and local regulatory requirements, such as state and local fire and life safety requirements. If we fail to comply with these various requirements, we may incur governmental fines or private damage awards. While we believe that our properties are currently in material compliance with all of these regulatory requirements, we do not know
whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will adversely affect our ability to make distributions to our stockholders. We believe, based in part on engineering reports which are generally obtained at the time we acquire the properties, that all of our properties comply in all material respects with current regulations. However, if we were required to make significant expenditures under applicable regulations, our financial condition, results of operations, cash flow and ability to satisfy our debt service obligations and to pay distributions could be adversely affected.
EMPLOYEES
We have no employees and our executive officers are all employees of affiliates of our advisor. We cannot determine at this time if or when we might hire any employees, although we do not anticipate hiring any employees for the next twelve months. Our executive officers and key employees of affiliates of our advisor are compensated by affiliates of our advisor and will not receive any compensation from us for their services. However, our executive officers and key employees of affiliates of our advisor will be eligible for awards under our 2006 Incentive Award Plan. As of December 31, 2007, no awards had been granted to our executive officers or our advisor’s key employees under this plan.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
We internally evaluate all of our properties and interests therein as one industry segment and, accordingly, we do not report segment information.
Item 1A.
Item 1A.
Risk Factors.
Limited Operating History
We and our advisor have limited business operations, which makes our future performance and the performance of an investment in our common stock difficult to predict.
We were incorporated and our advisor was organized in December 2005. We and our advisor have limited operating histories. Our business is subject to the risks inherent in the establishment of a new business enterprise, including an inability to raise proceeds in our Offering, to implement our investment strategy and being unable to adequately manage our operations and growth. Because we and our advisor were only recently formed and have engaged in limited operations, we can provide our stockholders with only limited financial information with respect to us or our advisor or any properties that would be available from an institution with a history of operations. Therefore, our future performance and the performance of an investment in our common stock are difficult to predict. We cannot assure our stockholders that we will ever operate profitably.
We have only identified ten specific investments to make with the net proceeds as of March 28, 2008.
As of March 28, 2008, we have purchased nine real estate properties and have only identified one additional potential property to acquire. Other than these ten properties, our stockholders are unable to evaluate the manner in which the net proceeds are invested and the economic merits of our investments prior to purchasing shares of our common stock. Additionally, our stockholders do not have the opportunity to evaluate the transaction terms or other financial or operational data concerning other investment properties or real estate related securities.
If we are unable to find suitable investments, we may not be able to achieve our investment objectives.
Our stockholders must rely on our advisor and board of directors to evaluate our investment opportunities; and our advisor may not be able to achieve our investment objectives, may make unwise decisions or may make decisions that are not in our best interest because of conflicts of interest. Further, we cannot assure our stockholders that acquisitions of real estate or real estate related securities made using the
proceeds of our Offering will produce a return on investment or will generate cash flow to enable us to make distributions to our stockholders.
We face competition from other apartment communities and for other investment opportunities, which may limit our profitability and returns to our stockholders.
The residential apartment community industry is highly competitive. This competition could reduce occupancy levels and revenues at our apartment communities, which would adversely affect our operations. We face competition from many sources. We face competition from other apartment communities both in the immediate vicinity and the geographic market where our apartment communities are and will be located. Overbuilding of apartment communities may occur. If so, this will increase the number of apartment units available and may decrease occupancy and apartment rental rates. In addition, increases in operating costs due to inflation may not be offset by increased apartment rental rates.
We also face competition for other investment opportunities. These competitors may be other REITs and other entities that have substantially greater financial resources than we do. We also face competition for investors from other residential apartment community REITs and real estate entities.
There may be delays in our investments in real property, and this delay may decrease the return to stockholders.
We may experience delays in finding suitable apartment communities to acquire. Pending investment of the proceeds of our Offering in real estate, and to the extent the proceeds are not invested in real estate, the proceeds will be invested in permitted temporary investments such as U.S. government securities, certificates of deposit or commercial paper. The rate of return on those investments has fluctuated in recent years and may be less than the return obtainable from real estate or other investments.
Limited Working Capital
We have limited sources of working capital and may not be able to obtain capital on acceptable terms or at all, decreasing the value of your investment.
We may not be able to fund our working capital needs. As a REIT, we are required to distribute at least 90% of our taxable income (excluding net capital gains) to our stockholders in each taxable year. However, depending on the size of our operations, we will require a minimum amount of capital to fund our daily operations. We may have to obtain financing from either affiliated or unaffiliated sources to meet such cash needs. This financing may not be available to us on acceptable terms or at all, which could adversely affect our operations and decrease the value of your investment in us.
Lack of Investment Diversification
We are not diversified and are dependent on our investment in a single asset class, making our performance more vulnerable to economic downturns in the apartment industry than if we had diversified investments.
Our current strategy is to acquire interests primarily in apartment communities in select metropolitan areas throughout the United States. As a result, we are subject to the risks inherent in investing in a single asset class. A downturn in demand for residential apartments may have more pronounced effects on the amount of cash available to us for distribution or on the value of our assets than if we had diversified our investments across different asset classes.
The effect of adverse conditions at specific properties will be magnified to the extent we are able to acquire only a limited number of properties.
A lack of diversity in the properties in which we invest could increase risk to our stockholders. If we fail to raise significant proceeds under our Offering, we will not be able to purchase a diverse portfolio of properties and may only be able to purchase a limited number of properties. In that event, our performance
will depend directly on the success of those limited number of properties. Adverse conditions at those limited number of properties or in the location in which the properties exist would have a direct negative impact on our performance.
Acquisition Risks
Our inability to obtain funding for acquisitions could prevent us from realizing our objectives and would adversely impact the distributions we pay to our stockholders and the value of an investment in shares of our common stock.
We may not be able to obtain financing to acquire additional properties, which would limit the number of properties we could acquire and subject an investment in our common stock to further risk. As a REIT, we are required to distribute at least 90.0% of our taxable income (excluding net capital gains) to our stockholders in each taxable year, and thus our ability to retain internally generated cash is limited. Accordingly, our ability to acquire properties or to make capital improvements to or remodel properties depends on our ability to obtain debt or equity financing from third parties or the sellers of properties.
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 properties, we run the risk of being unable to refinance the properties when the loans become due, or of being unable to refinance on favorable terms, if at all. If interest rates are higher when we refinance the properties, our income could be reduced. If any of these events occur, our cash flow would be reduced. This, in turn, would reduce cash available for distribution to our stockholders and may hinder our ability to raise more capital.
Further, we cannot assure our stockholders that we will receive any proceeds from the DRIP or, if we do, that such proceeds will be available or adequate to acquire properties.
We are likely to incur mortgage and other indebtedness, which may increase our business risks.
Significant borrowings by us increase the risks of an investment in our common stock. If there is a shortfall between the cash flow from properties and the cash flow needed to service our indebtedness, then the amount available for distributions to our stockholders may be reduced. In addition, incurring mortgage debt increases the risk of loss 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, thus reducing the value of an investment in shares of our common stock. If any mortgages or other indebtedness contain cross-collateralization or cross-default provisions, a default on a single loan could affect multiple properties.
Additionally, 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 documents we enter into may contain covenants that limit our ability to further mortgage the property, merge with another company, discontinue insurance coverage, or replace our advisor. These or other limitations may limit our flexibility and our ability to achieve our operating plans. Our failure to meet these restrictions and covenants could result in an event of default and result in the foreclosure of some or all of our properties.
Furthermore, we may give full or partial guarantees to lenders of mortgage 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 are responsible to the lender for satisfaction of the debt if it is not paid by such entity.
Competition with entities that have greater financial resources could make it more difficult for us to acquire attractive properties and achieve our investment objectives.
We compete for investment opportunities with entities with substantially greater financial resources. These entities may be able to accept more risk than our board of directors believes is in our best interests. This competition may limit the number of suitable investment opportunities offered to us. This competition also may increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire properties. In addition, we believe that competition from entities organized for purposes similar to ours may increase in the future.
Distributions May be Paid with Offering Proceeds or Borrowed Funds and May Include a Return of Capital
We may not have sufficient cash available from operations to pay distributions. As a result, distributions may be paid with offering proceeds or borrowed funds and may include a return of capital.
The amount of the distributions to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT. As a result, our distribution rate and payment frequency may vary from time to time. During the early stages of our operations, we may not have sufficient cash available from operations to pay distributions. Therefore, we may need to use proceeds from our Offering or borrow funds to make cash distributions in order to maintain our status as a REIT, which may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds. Further, if the aggregate amount of cash distributed in any given year exceeds the amount of our REIT taxable income generated during the year, the excess amount will be deemed a return of capital.
On February 22, 2007, our board of directors approved a 7.0% per annum distribution to be paid to stockholders beginning with the March 2007 monthly distribution, which was paid on April 15, 2007. For the year ended December 31, 2007, we paid distributions of $3,115,000, of which $2,195,000 was paid from cash flow from operations for the period. The distributions paid in excess of our cash flow from operations was paid using proceeds from our Offering. As of December 31, 2007, we had an amount payable of $353,000 to our advisor and its affiliates for operating expenses, on-site personnel payroll and asset and property management fees, which will be paid from cash flow from operations in the future as they become due and payable by us in the ordinary course of business consistent with our past practice.
Our advisor and its affiliates have no obligations to defer or forgive amounts due to them. As of December 31, 2007, no amounts due to our advisor or its affiliates have been deferred or forgiven. In the future, if our advisor or its affiliates do not defer or forgive amounts due to them and our cash flow from operations is less than the distributions to be paid, we would be required to pay our distributions, or a portion thereof, with proceeds from our Offering or borrowed funds. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds.
We have not paid distributions with funds from operations, or FFO. For the year ended December 31, 2007, our FFO was $(194,000).
No Market for Our Common Stock
The absence of a public market for our common stock makes it difficult for our stockholders to sell their shares.
Our stockholders should view our common stock as illiquid and must be prepared to hold their shares of our common stock for an indefinite length of time. There currently is no public market for our common stock, and initially we do not expect a market to develop. We have no current plans to cause shares of our common stock to be listed on any securities exchange or quoted on any market system or in any established market either immediately or at any definite time in the future. While we, acting through our board of directors, may attempt to cause shares of our common stock to be listed or quoted if our board of directors determines this action to be in our stockholders’ best interests, there can be no assurance that this event will ever occur. Stockholders may be unable to resell their shares of our common stock at all, or may be able to resell them only at a later date at a substantial discount from the purchase price. Thus, shares of our common stock should be considered a long-term investment. In addition, there are restrictions on the transfer of shares of our common stock. In order to qualify as a REIT, shares of our common stock must be beneficially owned by 100 or more persons and no more than 50.0% of the value of our issued and outstanding shares may be owned directly or indirectly by five or fewer individuals. Our charter provides that no person may own more than 9.9% of the issued and outstanding shares of our common stock or more than 9.9% in value or in number of
shares, whichever is more restrictive, of the issued and outstanding shares of our common stock. Any purported transfer of our shares that would result in a violation of either of these limits will result in such shares being transferred to a trust for the benefit of a charitable beneficiary or such transfer being declared null and void.
The per-share offering price of our common stock has been arbitrarily established by us and may not reflect the true value of shares of our common stock; therefore stockholders may have paid more for a share of our common stock than such share is actually worth.
If we were to list the shares of our common stock on a national securities exchange or national market system, the share price of our common stock might drop below our stockholder’s original investment. Our stockholders should not assume that the per share offering price of our common stock reflects the intrinsic or realizable value of the common stock or otherwise reflects our value, earnings or other objective measures of worth.
Conflicts of Interest
Throughout this filing, references to affiliates of a person generally mean:
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any person directly or indirectly owning, controlling or holding, with the power to vote, 10.0% or more of the outstanding voting securities of such other person;
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any person 10.0% or more of whose outstanding voting securities are directly or indirectly owned, controlled or held, with the power to vote, by such other person;
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any person directly or indirectly controlling, controlled by or under common control with such other person;
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any executive officer, director, manager, trustee or general partner of such other person; and
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any legal entity for which such person acts as an executive officer, director, manager, trustee or general partner.
The conflicts of interest described below may mean we are not managed solely in our stockholders’ best interests, which may adversely affect our results of operations and the value of an investment in our common stock.
Many of our officers and non-independent directors and our advisor’s officers have conflicts of interest in managing our business and properties. Thus, they may make decisions or take actions that do not solely reflect our stockholders’ interests. Our officers and directors and the owners and officers of our advisor are also involved in the advising and ownership of other REITs and various real estate entities, which may give rise to conflicts of interest. In particular, certain of the owners and officers of our advisor are involved in the management and advising of Grubb & Ellis Realty Investors, G REIT Liquidating Trust (successor of G REIT, Inc.), T REIT Liquidating Trust (successor of T REIT, Inc.), NNN 2002 Value Fund, LLC, NNN 2003 Value Fund, LLC and Grubb & Ellis Healthcare REIT, Inc. They may compete with us for the time and attention of these executives, as well as other private entities that may compete with us or otherwise have similar business interests. Additionally, some of our officers and directors are also owners and officers of our advisor and affiliates of our advisor with whom we do business.
Stanley J. Olander, Jr. is our chief executive officer, president and chairman of the board of our company; the chief executive officer and president of our advisor; the executive vice president, Multifamily Division of Grubb & Ellis and the president and chairman of the board of Residential Management. Mr. Olander owns less than 1.0% of the common stock of our sponsor. Mr. Olander is also a member of ROC REIT Advisors, LLC, or ROC REIT Advisors, which owns a 25.0% membership interest in our advisor.
David L. Carneal is our executive vice president and chief operating officer and the executive vice president and chief operating officer of our advisor. Mr. Carneal is also a member of ROC REIT Advisors.
Mr. Carneal owns less than 1.0% of the common stock of our sponsor. Mr. Carneal also serves as executive vice president of Residential Management.
Gus G. Remppies is our executive vice president and chief investment officer and the executive vice president and chief investment officer of our advisor. Mr. Remppies is also a member of ROC REIT Advisors. Mr. Remppies owns less than 1.0% of the common stock of our sponsor. Mr. Remppies also serves as executive vice president of Residential Management.
Scott D. Peters is our executive vice president and a director; the executive vice president and chief financial officer of our advisor; the chief executive officer, president and a director of our sponsor; the chief executive officer, president and chairman of the board of NNN Realty Advisors; and the chief executive officer of Grubb & Ellis Realty Investors. Mr. Peters is also a member of Grubb & Ellis Apartment Management, LLC, which owns a 25.0% membership interest in our advisor. Mr. Peters owns approximately 2.0% of the common stock of our sponsor. Mr. Peters also serves as a director of Residential Management.
Shannon K S Johnson is our chief financial officer and a financial reporting manager of Grubb & Ellis Realty Investors. Ms. Johnson owns less than 1.0% of the common stock of our sponsor.
Andrea R. Biller is our secretary; the general counsel of our advisor; the general counsel, executive vice president and secretary of our sponsor; the general counsel, executive vice president, secretary and a director of NNN Realty Advisors; and the general counsel and executive vice president of Grubb & Ellis Realty Investors. Ms. Biller owns less than 1.0% of the common stock of our sponsor. Ms. Biller is also a member of Grubb & Ellis Apartment Management, LLC.
As officers, directors, managers and partial owners of entities with which we do business or with interests in competition with our own interests, these individuals experience conflicts between their fiduciary obligations to us and their fiduciary obligations to, and pecuniary interests in, our advisor and their affiliated entities. These conflicts of interest could limit the time and services that some of our officers devote to our company and the affairs of our advisor, because they will be providing similar services to Grubb & Ellis, NNN Realty Advisors, Grubb & Ellis Realty Investors, G REIT Liquidating Trust, T REIT Liquidating Trust, Grubb & Ellis Healthcare REIT, Inc., NNN 2002 Value Fund, LLC, NNN 2003 Value Fund, LLC and other real estate entities.
The key executives of our advisor devote only as much of their time to our business as they determine is reasonably required, which may be substantially less than their full time. Further, during times of intense activity in other programs, those executives may devote less time and fewer resources to our business than are necessary or appropriate to manage our business. Poor or inadequate management of our business would adversely affect our results of operations and the value of an investment in shares of our common stock.
If our advisor or its affiliates breach their fiduciary or contractual obligations to us, or do not resolve conflicts of interest, we may not meet our investment objectives, which could reduce our expected cash available for distribution to our stockholders. For example, our advisor has a duty to us to present us with the first opportunity to purchase any Class A income-producing apartment communities placed under contract by our advisor or its affiliates that satisfy our investment objectives. If our advisor did not comply with our right of first opportunity, this may result in some attractive properties not being presented to us for acquisition. This may adversely affect our results of operations and financial condition.
Fees payable to our dealer manager and our advisor or their affiliates during our organizational stage are based upon the gross offering proceeds and not on our or our properties’ performance.
The absence of arm’s-length bargaining may mean that our agreements are not as favorable to our stockholders as they otherwise would have been.
Any existing or future agreements between us and our advisor, our dealer manager or their affiliates were not and will not be reached through arm’s-length negotiations. Thus, such agreements may require us to pay more than we would if we were using unaffiliated third parties. The Advisory Agreement, the Dealer Manager Agreement, the property management agreements with Realty and Residential Management and the terms of
the compensation to our advisor and our dealer manager were not arrived at through arm’s-length negotiations. The terms of such agreements and compensation may not solely reflect our stockholders’ interests and may be overly favorable to the other party to such agreements, including in terms of the substantial compensation to be paid to these parties under these agreements. For example, the asset management fee payable to our advisor is based upon our average invested assets, including any property-related debt, which could influence the amount of portfolio leverage our advisor recommends to our board of directors.
Our advisor may be entitled to receive significant compensation in the event of our liquidation or in connection with a termination of the Advisory Agreement.
In the event of a partial or full liquidation of our assets, our advisor will be entitled to receive an incentive distribution equal to 15.0% of the net proceeds of the liquidation, after we have received and paid to our stockholders the sum of the capital invested in our operating partnership, and any shortfall in an 8.0% annual cumulative, non-compounded return to stockholders. In the event of a termination of the Advisory Agreement in connection with the listing of our common stock, the Advisory Agreement provides that our advisor will receive an incentive distribution equal to 15.0% of the amount, if any, by which (1) the market value of our outstanding stock plus distributions paid by us prior to listing, exceeds (2) the sum of the amount of capital we invested in our operating partnership plus an 8.0% annual cumulative, non-compounded return on such invested capital. Upon our advisor’s receipt of the incentive distribution upon listing, our advisor’s special limited partnership units will be redeemed and our advisor will not be entitled to receive any further incentive distributions upon sales of our properties. Further, in connection with the termination of the Advisory Agreement other than due to a listing of our shares on a national securities exchange or national market system or due to the internalization of our advisor in connection with our conversion to a self-administered REIT, we may choose to redeem our advisor as a special limited partner in our operating partnership, which would entitle it to receive cash or, if agreed by us and our advisor, shares of our common stock or units of limited partnership interests in our operating partnership equal to the amount that would be payable as an incentive distribution upon sales of properties, which equals 15.0% of the net proceeds if we liquidated all of our assets at fair market value, after we have received and paid to our stockholders the sum of the capital invested in the operating partnership and any shortfall in the 8.0% return to stockholders. Finally, upon the termination of the Advisory Agreement as a result of the internalization of our advisor into us, the Advisory Agreement provides that a special committee, comprised of all of our independent directors, and our advisor will negotiate the compensation to be payable to our advisor pursuant to such termination. In determining such compensation, the special committee will consider factors including, but not limited to, our advisor’s performance compared to the performance of other advisors for similar entities that the special committee believes are relevant in making the determination, any available valuations for such advisors and independent legal and financial advice. Any amounts to be paid to our advisor pursuant to the Advisory Agreement cannot be determined at the present time.
Borrowings may Increase Our Business Risks
As we incur indebtedness, we increase the expenses of our operations, which could result in a decrease in cash available for distribution to our stockholders.
The risk associated with an investment in shares of our common stock depends upon, among other factors, the amount of debt we incur. We intend to continue to incur indebtedness in connection with our acquisition of properties. We may also borrow for the purpose of maintaining our operations or funding our working capital needs. Lenders may require restrictions on future borrowings, distributions and operating policies. We also may incur indebtedness if necessary to satisfy the federal income tax requirement that we distribute at least 90.0% of our taxable income (excluding net capital gains) to our stockholders in each taxable year. We may incur debt up to 300.0% of our net assets, or more if such excess in borrowing is approved by a majority of our independent directors and is disclosed in our next quarterly report along with justification for such excess. Net assets for purposes of this calculation are defined to be our total assets (other than intangibles), valued at cost prior to deducting depreciation or other non-case reserves, less total liabilities. Generally speaking, the preceding calculation is expected to approximate 75.0% of the sum of (1) the
aggregate cost of our real property investments before non-cash reserves and depreciation and (2) the aggregate cost of our investments in real estate related securities.
Borrowing increases our business risks.
Debt service increases the expense of operations since we are responsible for retiring the debt and paying the attendant interest, which may result in decreased cash available for distribution to our stockholders. In the event the fair market value of our properties were to increase, we could incur more debt without a commensurate increase in cash flow to service the debt. In addition, our directors can change our policy relating to the incurrence of debt at any time without stockholder approval.
We may incur indebtedness secured by our properties, which subjects those properties to foreclosure.
Incurring mortgage indebtedness increases the risk of possible loss. Most of our borrowings to acquire properties will be secured by mortgages on our properties. If we default on our secured indebtedness, the lender may foreclose and we could lose our entire investment in the properties securing such loan which could adversely affect distributions to stockholders. For federal tax purposes, any such foreclosure 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 and, if the outstanding balance of the debt secured by the mortgage exceeds our basis of the property, there could be taxable income upon a foreclosure. To the extent lenders require us to cross-collateralize our properties, or our loan agreements contain cross-default provisions, a default under a single loan agreement could subject multiple properties to foreclosure.
Increases in interest rates could increase the amount of our debt payments and adversely affect our ability to make cash distributions to our stockholders.
Higher interest rates could increase debt service requirements on variable rate debt and could reduce the amounts available for distribution to our stockholders. Additionally, such change in economic conditions could cause the terms on which borrowings become available to be unfavorable. In such circumstances, if we are in need of capital to repay indebtedness in accordance with its terms or otherwise, we could be required to liquidate one or more of our investments in properties at times which may not permit realization of the maximum return on such investments.
To the extent we borrow at fixed rates or enter into fixed interest rate swaps we will not benefit from reduced interest expense if interest rates decrease.
We are exposed to the effects of interest rate changes primarily as a result of borrowings used to maintain liquidity and fund expansion and refinancing of our real estate investment portfolio and operations. To limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk, we may borrow at fixed rates or variable rates depending upon prevailing market conditions. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. To the extent we borrow at fixed rates or enter into fixed interest rate swaps we will not benefit from reduced interest expense if interest rates decrease.
Restrictions on Share Repurchase Plan
Our stockholders are limited in their ability to sell their shares pursuant to our share repurchase plan, and repurchases are made at our sole discretion.
Our board of directors has approved our share repurchase plan, which became effective on July 19, 2006. However, our board of directors could choose to amend its terms without stockholder approval.
Our share repurchase plan includes numerous restrictions that would limit our stockholders’ ability to sell their shares. Our stockholders must hold their shares for at least one year, present at least 25.0% of their shares for repurchase and until three years following our Offering, repurchases will be made for less than our
stockholders paid, among other restrictions and limitations. Our board of directors may waive the one-year holding period in the event of the death or disability of a stockholder. Shares are redeemed quarterly, at our discretion, on a pro rata basis, and are limited during any calendar year to 5.0% of the weighted average number of shares outstanding during the prior calendar year. Funds for the repurchase of shares come exclusively from the proceeds we receive from the sale of shares under the DRIP. In addition, our board of directors reserves the right to amend, suspend or terminate our share repurchase plan at any time. Therefore, in making a decision to purchase shares, our stockholders should not assume that they will be able to sell any of their shares back to us pursuant to our share repurchase plan, and they also should understand that the repurchase prices during the first three years following our Offering will not correlate to the value of our real estate holdings or other assets. If our board of directors terminates our share repurchase plan, our stockholders may not be able to sell their shares even if they deem it necessary or desirable to do so.
Our stockholders’ interests may be diluted in various ways, which may result in lower returns to our stockholders.
Our board of directors is authorized, without stockholder approval, to cause us to issue additional shares of our common stock or to raise capital through the issuance of preferred stock, options, warrants and other rights, on terms and for consideration as our board of directors in its sole discretion may determine, subject to certain restrictions in our charter in the instance of options and warrants. Any such issuance could result in dilution of the equity of the stockholders. Our board of directors may, in its sole discretion, authorize us to issue common stock or other equity or debt securities, (1) to persons from whom we purchase apartment communities, as part or all of the purchase price of the community, or (2) to our advisor in lieu of cash payments required under the Advisory Agreement or other contract or obligation. Our board of directors, in its sole discretion, may determine the value of any common stock or other equity or debt securities issued in consideration of apartment communities or services provided, or to be provided, to us, except that while shares of our common stock are offered by us to the public, the public offering price of the shares will be deemed their value.
We have adopted the 2006 Incentive Award Plan under which we may grant stock options, restricted stock and other performance awards to our officers, employees, consultants and independent directors. The effect of these grants, including the subsequent exercise of stock options, could be to dilute the value of the stockholders’ investments.
In addition, our board of directors authorized, without stockholder approval, the DRIP in connection with our Offering, involving the issuance of additional shares of our common stock by us at $9.50 per share of common stock. Shares sold pursuant to the DRIP are dilutive to the value of the stockholders’ investments.
Federal Income Tax Requirements
The requirement to distribute at least 90.0% of our taxable income may require us to borrow, sell assets or issue additional securities for cash, which would increase the risks associated with an investment in shares of our common stock.
In order to qualify as a REIT, we must distribute each calendar year to our stockholders at least 90.0% of our taxable income, other than any net capital gain. To the extent that we distribute at least 90.0%, but less than 100%, of our taxable income in a calendar year, we will incur no federal corporate income tax on our distributed taxable income. In addition, we will incur a 4.0% nondeductible excise tax if the actual amount we distribute to our stockholders in a calendar year is less than a minimum amount specified under federal income tax law. We intend to distribute at least 90.0% of our taxable income to our stockholders each year so that we will satisfy the distribution requirement and avoid corporate income tax and the 4.0% excise tax. However, we could be required to include earnings in our taxable income before we actually receive the related cash. That timing difference could require us to borrow funds to meet the distribution requirement and avoid corporate income tax and the 4.0% excise tax in a particular year.
The REIT minimum distribution requirements may require us to borrow, sell assets or issue additional securities for cash to make required distributions, which would increase the risks associated with an investment in our common stock.
Our failure to continue to qualify as a REIT would subject us to corporate income tax and would materially impact our earnings.
We intend to operate in a manner so as to continue to qualify as a REIT for federal income tax purposes. Qualifying as a REIT requires us to meet several tests regarding the nature of our assets and income on an ongoing basis. A number of the tests established to qualify as a REIT for tax purposes are factually dependent. Therefore, our stockholders should be aware that while we intend to continue to qualify as a REIT, it is not possible at this stage to assess our ability to satisfy these various tests. Therefore, we cannot assure our stockholders that we will in fact continue to qualify as a REIT.
If we fail to qualify as a REIT in any year, we would 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 to be distributed to our stockholders. In addition, we no longer would be required to distribute substantially all of our taxable income to our stockholders. Unless our failure to qualify as a REIT is excused under relief provisions of the federal income tax laws, we could not re-elect REIT status until the fifth calendar year following the year in which we failed to qualify.
SEC Investigation of Triple Net Properties, LLC
The ongoing SEC investigation of Triple Net Properties, LLC could adversely impact our advisor’s ability to perform its duties to us.
On September 16, 2004, Triple Net Properties, LLC learned that the SEC Los Angeles Enforcement Division, or the SEC Staff, is conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC Staff has requested information from Triple Net Properties, LLC relating to disclosure in certain public and private securities offerings sponsored by Triple Net Properties, LLC and its affiliates during 1998 through 2004, or the Triple Net securities offerings. The SEC Staff also has requested information from NNN Capital Corp., the dealer manager for the Triple Net securities offerings and the dealer manager for our Offering. The SEC Staff has requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents from each of Triple Net Properties and NNN Capital Corp.
Triple Net Properties and NNN Capital Corp., are engaged in settlement negotiations with the SEC staff regarding this matter. The settlement negotiations are continuing, and any settlement negotiated with the SEC staff must be approved by the Commissioners. Since the matter is not concluded, it remains subject to risk that the SEC Staff may seek additional remedies, including substantial fines and injunctive relief that, if obtained, could materially adversely affect our advisor’s ability to conduct our Offering. Additionally, any resolution of this matter that reflects negatively on the reputation of Triple Net Properties or NNN Capital Corp., could materially and adversely affect the willingness of potential investors to invest in our Offering. The matters that are subject of this investigation could also give rise to claims against Triple Net Properties by investors in its programs. As this time, Triple Net Properties cannot assess the outcome of the investigation by the SEC. The SEC investigation could adversely impact our advisor’s ability to perform its duties to us, because our advisor is controlled by Triple Net Properties.
Risks Related to Our Advisor and its Affiliates
Our ability to operate profitably depends upon the ability of our advisor and its management team.
We rely on our advisor to manage our business and assets. Our advisor makes all decisions with respect to our day-to-day management. Thus, the success of our business depends in large part on the ability of our advisor to manage us. Any adversity experienced by our advisor or problems in our relationship with our
advisor could adversely impact the operation of our properties and, consequently, our cash flow and ability to make distributions to our stockholders.
Our advisor may terminate the Advisory Agreement, which would require us to find a new advisor.
Either we or our advisor can terminate the Advisory Agreement upon 60 days written notice to the other party. However, if the Advisory Agreement is terminated in connection with the listing of our common stock on a national securities exchange or national market system, the Advisory Agreement provides that our advisor will receive an incentive distribution equal to 15.0% of the amount, if any, by which (1) the market value of our outstanding stock plus distributions paid by us prior to listing, exceeds (2) the sum of the amount of capital we invested in our operating partnership plus an 8.0% annual cumulative, non-compounded return on such invested capital. Upon our advisor’s receipt of the incentive distribution upon listing, our advisor’s special limited partnership units will be redeemed and our advisor will not be entitled to receive any further incentive distributions upon sales of our properties. Further, in connection with the termination of the Advisory Agreement other than due to a listing of our shares on a national securities exchange or national market system or due to the internalization of our advisor in connection with our conversion to a self-administered REIT, we may choose to redeem our advisor’s interest as a special limited partner in our operating partnership, which would entitle it to receive cash or, if agreed by we and our advisor, shares of our common stock or units of limited partnership interest in our operating partnership equal to the amount that would be payable to our advisor pursuant to the incentive distribution upon sales if we liquidated all of our assets for their fair market value. Finally, upon the termination of the Advisory Agreement as a result of our advisor’s internalization into us, the Advisory Agreement provides that a special committee, comprised of all of our independent directors, and our advisor will agree on the compensation payable to our advisor pursuant to such termination. In determining such compensation, the special committee will consider factors including, but not limited to, our advisor’s performance compared to the performance of other advisors for similar entities that the special committee believes are relevant in making the determination, any available valuations for such advisors and independent legal and financial advice. Any amounts to be paid to our advisor pursuant to the Advisory Agreement cannot be determined at the present time.
If our advisor was to terminate the Advisory Agreement, we would need to find another advisor to provide us with day-to-day management services or have employees to provide these services directly to us. There can be no assurances that we would be able to find a new advisor or employees or enter into agreements for such services on acceptable terms.
If our advisor cannot retain the services of its key executives, their replacements may not manage us as effectively.
We depend on our advisor to retain its key executives. Our advisor’s key executives are Stanley J. Olander, Jr., Gus G. Remppies, David L. Carneal, Scott D. Peters, Andrea R. Biller, and Shannon K S Johnson. The loss of any or all of Messrs. Olander, Remppies, Carneal or Peters or Ms. Biller or Ms. Johnson, and our advisor’s inability to find, or any delay in finding, a replacement with equivalent skill and experience, could adversely impact our ability to acquire properties and the operation of our properties.
Our advisor and its affiliates have no obligation to defer or forgive fees or loans or advance any funds to us, which could reduce our ability to make investments or pay distributions.
In the past, Grubb & Ellis Realty Investors or its affiliates have, in certain circumstances, deferred or forgiven fees and loan payables by programs sponsored or managed by Grubb & Ellis Realty Investors. Our advisor and its affiliates, including our sponsor, have no obligation to defer or forgive fees owed by us to our advisor or its affiliates or to advance any funds to us. As a result, we may have less cash available to make investments or pay distributions.
Advisor’s Broad Discretion in Allocating Proceeds
Stockholders have little, if any, control over how the proceeds from our Offering are spent.
Our advisor is responsible for our day-to-day management and has broad discretion over the use of proceeds from our Offering. Accordingly, our stockholders should not purchase shares of our common stock unless they are willing to entrust all aspects of the day-to-day management to our advisor, who manages us in accordance with the Advisory Agreement. In addition, our advisor may retain independent contractors to provide various services for us, including administrative services, transfer agent services and professional services, and our stockholders should note that such contractors have no fiduciary duty to them and may not perform as expected or desired. Any such services provided by independent contractors will be paid for by us as an operating expense.
Investment Company Act
Our stockholders’ investment returns may be reduced if we are required to register as an investment company under the Investment Company Act.
We do not intend to register as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act including, but not limited to:
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limitations on capital structure;
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restrictions on specified investments;
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prohibitions on transactions with affiliates; and
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compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations.
In order to maintain our exemption from regulation under the Investment Company Act, we must engage primarily in the business of buying real estate and real estate related securities, and these investments must be made within a year after our Offering ends. If we are unable to invest a significant portion of the proceeds of our Offering in properties and/or real estate related securities within one year of the termination of our Offering, we may avoid being required to register as an investment company by temporarily investing any unused proceeds in government securities with low returns. This would reduce the cash available for distribution to our stockholders and possibly lower their returns.
To maintain compliance with the Investment Company Act exemption, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forego opportunities to acquire interests in properties that we would otherwise want to acquire and would be important to our investment strategy. 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.
Joint Venture Arrangements
Any joint venture arrangements may not solely reflect our stockholders’ best interests.
The terms of any joint venture arrangements in which we acquire or hold properties or other investments may not solely reflect our stockholders’ interests. We may acquire an interest in a property through a joint venture arrangement with our advisor, one or more of our advisor’s affiliates or unaffiliated third parties. In joint venture arrangements with our advisor or its affiliates, our advisor will have fiduciary duties to both us and its affiliate participating in the joint venture. The terms of such joint venture arrangement may be more favorable to the other joint venturer than to our stockholders.
Investing in properties through joint ventures subjects that investment to increased risk.
Such joint venture investments may involve risks not otherwise present, including, for example:
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the risk that our co-venturer or partner in an investment might become bankrupt;
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the risk that such co-venturer or partner may at any time have economic or business interests or goals which are inconsistent with our business interests or goals; or
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the risk that such co-venturer or partner may be in a position to take action contrary to our instructions or requests are contrary to our policies or objectives, such as selling a property at a time when it would have adverse consequences for our stockholders.
Actions by such a co-venturer or partner might have the result of subjecting the applicable property to liabilities in excess of those otherwise contemplated and may have the effect of reducing our cash available for distribution. It also may be difficult for us to sell our interest in any such joint venture or partnership in such property.
Our Ability to Change Policies without a Stockholder Vote; Limitation on Debt
Most of our policies, including the limits on debt, may be changed or eliminated by our board of directors at any time without a vote of the stockholders.
Most of our major policies, including policies intended to protect our stockholders and the policies with respect to acquisitions, financing, limitations on debt and investment limitations, have been determined by our board of directors and can be changed at any time without a vote of our stockholders. Therefore, these policies and limitations may not be meaningful to protect our stockholders’ interests.
Possible Adverse Consequences of Limits on Ownership and Transfer of Our Shares of Our Common Stock
The limitation on ownership of our common stock prevents a stockholder from acquiring more than 9.9% of our stock or more than 9.9% of our common stock and may force him or her to sell stock back to us.
Our charter limits direct and indirect ownership of our common stock by any single stockholder to 9.9% of the value of outstanding shares of our common stock and 9.9% of the value or number (whichever is more restrictive) of outstanding shares of our common stock. We refer to these limitations as the ownership limits. These ownership limits do not apply to our advisor. Our charter also prohibits transfers of our stock that would result in (1) our common stock being beneficially owned by fewer than 100 persons, (2) five or fewer individuals, including natural persons, private foundations, specified employee benefit plans and trusts, and charitable trusts, owning more than 50.0% of our common stock, applying broad attribution rules imposed by the federal income tax laws, (3) directly or indirectly owning 9.9% or more of one of our tenants, or (4) before our common stock qualifies as a class of “publicly-offered securities,” 25.0% or more of our common stock being owned by Employee Retirement Income Security Act of 1974, or ERISA, investors. If a stockholder acquires shares in excess of the ownership limits or in violation of the restrictions on transfer, we:
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may consider the transfer to be null and void;
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will not reflect the transaction on our books;
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may institute legal action to enjoin the transaction;
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will not pay dividends or other distributions to him or her with respect to those excess shares;
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will not recognize his or her voting rights for those excess shares; and
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may consider the excess shares held in trust for the benefit of a charitable beneficiary.
If such shares are transferred to a trust for the benefit of a charitable beneficiary, he or she will be paid for such excess shares a price per share equal to the lesser of the price he or she paid or the “market price” of our stock. Unless shares of our common stock are then traded on a national securities exchange or quoted on a
national market system, the market price of such shares will be a price determined by our board of directors in good faith. If shares of our common stock are traded on a national securities exchange or quoted on a national market system, the market price will be the average of the last sales prices or the average of the last bid and ask prices for the five trading days immediately preceding the date of determination.
If a stockholder acquires our stock in violation of the ownership limits or the restrictions on transfer described above:
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he or she may lose his or her power to dispose of the stock;
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he or she may not recognize profit from the sale of such stock if the “market price” of the stock increases; and
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he or she may incur a loss from the sale of such stock if the “market price” decreases.
Potential Anti-Takeover Effects
Limitations on share ownership and transfer may deter a sale of our common stock in which our stockholders could profit.
The limits on ownership and transfer of our equity securities in our charter may have the effect of delaying, deferring or preventing a transaction or a change in control that might involve a premium price for our stockholders’ common stock. The ownership limits and restrictions on transferability will continue to apply until our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT.
Our ability to issue preferred stock may include a preference in distributions superior to our common stock and also may deter or prevent a sale of shares of our common stock in which our stockholders could profit.
Our ability to issue preferred stock and other securities without our stockholders’ approval also could deter or prevent someone from acquiring us, even if a change in control were in our stockholder’s best interests. Our charter authorizes our board of directors to issue up to 50,000,000 shares of preferred stock. Our board of directors may establish the preferences and rights, including a preference in distributions superior to our common stockholders, of any issued preferred stock designed to prevent, or with the effect of preventing, someone from acquiring control of us.
Maryland takeover statutes may deter others from seeking to acquire us and prevent our stockholders from making a profit in such transaction.
Maryland law contains many provisions, such as the business combination statute and the control share acquisition statute, that are designed to prevent, or with the effect of preventing, someone from acquiring control of us. Our bylaws exempt us from the control share acquisition statute (which eliminates voting rights for certain levels of shares that could exercise control over us) and our board of directors has adopted a resolution opting out of the business combination statue (which prohibits a merger or consolidation with a 10.0% stockholder for a period of time) with respect to our affiliates. However, if the bylaw provisions exempting us from the control share acquisition statute or our board resolution opting out of the business combination statute were repealed, these provisions of Maryland law could delay or prevent offers to acquire us and increase the difficulty of consummating any such offers, even if such a transaction would be in our stockholders’ best interests.
Dilution
Upon investment in our common stock, our stockholders experience an immediate dilution of $1.00 per share.
The offering price for our common stock is $10.00 per share. After the payment of selling commissions, marketing allowance and accountable due diligence expense reimbursement, we receive $9.00 per share. As a
result of these expenses, our stockholders experience immediate dilution of $1.00 in book value per share or 10.0% of the offering price, not including other organizational and offering expenses. Other organizational and offering expenses include advertising and sales expenses, legal and accounting expenses, printing costs, formation costs, SEC, Financial Industry Regulatory Authority, or FINRA, and blue sky filing fees, investor relations and other administrative expenses. We estimate the organizational and offering expenses equal approximately 1.5% of the gross proceeds of our Offering. To the extent that our stockholders do not participate in any future issuance of our securities, they experience dilution of their ownership percentage.
Several dilutive potential events could cause the fair market and book value of an investment in our common stock to decline.
An investment in our common stock could be diluted by a number of factors, including:
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future offerings of our securities, including issuances under the DRIP and up to 50,000,000 shares of any preferred stock that our board may authorize;
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private issuances of our securities to other investors, including institutional investors;
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issuances of our securities under our 2006 Incentive Award Plan; or
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redemptions of units of limited partnership interest in our operating partnership in exchange for shares of our common stock.
Dilution and Our Operating Partnership
Our advisor may receive economic benefits from its status as a special limited partner without bearing any of the investment risk.
Our advisor is a special limited partner in our operating partnership. The special limited partner is entitled to receive an incentive distribution equal to 15.0% of net sales proceeds of properties after we have received and paid to our stockholders a return of their invested capital and an 8.0% annual cumulative, non-compounded return. We bear all of the risk associated with the properties but, as a result of the incentive distributions to our advisor, we are not entitled to all of our operating partnership’s proceeds from a property sale.
Our Seller Financing may Delay Liquidation or Reinvestment
Our stockholders may not receive any profits resulting from the sale of our properties, or receive such profits in a timely manner, because we may provide financing for the purchaser of such properties.
Our stockholders may experience a delay before receiving their share of the proceeds of such liquidation. In liquidation, we may sell our properties either subject to or upon the assumption of any then outstanding mortgage debt or, alternatively, may provide financing to purchasers. We may take a purchase money obligation secured by a mortgage as partial payment. We do not have any limitations or restrictions on our taking such purchase money obligations. To the extent we receive promissory notes or other property instead of cash from sales, such proceeds, other than any interest payable on those proceeds, will not be included in net sale proceeds until and to the extent the promissory notes or other property are actually paid, sold, refinanced or otherwise disposed of. In many cases, we will receive initial down payments in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years. Therefore, our stockholders may experience a delay in the distribution of the proceeds of a sale until such time.
Negative Characteristics of Real Estate Investments
We depend upon our tenants to pay rent, and their inability to pay rent may substantially reduce our revenues and cash available for distribution to our stockholders.
Our investments in residential apartment properties are subject to varying degrees of risk that generally arise from the ownership of real estate. The underlying value of our properties and the ability to make distributions to our stockholders depend upon the ability of the tenants of our properties to generate enough income to pay their rents in a timely manner. Their inability to do so may be impacted by employment and other constraints on their personal finances, including debts, purchases and other factors. Changes beyond our control may adversely affect our tenants’ ability to make lease payments and consequently would substantially reduce both our income from operations and our ability to make distributions to our stockholders. These changes include, among others, the following:
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changes in national, regional or local economic conditions;
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changes in local market conditions; and
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changes in federal, state or local regulations and controls affecting rents, prices of goods, interest rates, fuel and energy consumption.
Due to these changes or others, tenants and lease guarantors, if any, may be unable to make their lease payments. A default by a tenant, the failure of a tenant’s guarantor to fulfill its obligations or other premature termination of a lease could, depending upon the size of the leased premises and our advisor’s ability to successfully find a substitute tenant, have a materially adverse effect on our revenues and the value of our common stock or our cash available for distribution to our stockholders.
If we are unable to find tenants for our properties, or find replacement tenants when leases expire and are not renewed by the tenants, our revenues and cash available for distribution to our stockholders will be substantially reduced.
A default by a mortgagor on any mortgage loan we hold may reduce our revenues and cash available for distribution to our stockholders.
We may make or invest in mortgage loans from time to time. If a mortgagor under such a mortgage loan defaulted on its payment obligations or otherwise triggered a default of the loan, we would likely seek any available remedies, including foreclosure. A monetary default by a mortgagor would reduce our revenues and cash available for distribution to our stockholders. Further, seeking available remedies could be a time-consuming and expensive process and would increase the costs associated with holding such mortgage, reducing our cash available for distribution to our stockholders.
Increased construction of similar properties that compete with our properties in any particular location could adversely affect the operating results of our properties and our cash available for distribution to our stockholders.
We may acquire properties in locations which experience increases in construction of properties that compete with our properties. This increased competition and construction could:
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make it more difficult for us to find tenants to lease units in our apartment communities;
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force us to lower our rental prices in order to lease units in our apartment communities; and
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substantially reduce our revenues and cash available for distribution to our stockholders.
Lack of diversification and liquidity of real estate could make it difficult for us to sell underperforming properties or recover our investment in one or more properties.
Our business is subject to risks associated with investment solely in real estate investments. Real estate investments are relatively illiquid. Our ability to vary our portfolio in response to changes in economic and
other conditions is limited. We cannot assure our stockholders that we will be able to dispose of a property when we want or need to. Consequently, the sale price for any property may not recoup or exceed the amount of our investment.
Lack of geographic diversity may expose us to regional economic downturns that could adversely impact our operations or our ability to recover our investment in one or more properties.
Geographic concentration of properties exposes us to economic downturns in the areas where our properties are located. Because we intend to acquire apartment communities in select metropolitan areas in the mid-Atlantic, southeast and southwest regions of the United States, our portfolio of properties may not be geographically diversified, particularly with respect to our early stages of when we may have acquired only a limited number of properties. Additionally, if we fail to raise significant proceeds under our Offering, we may not be able to geographically diversify our portfolio. A regional recession in any of these areas could adversely affect our ability to generate or increase operating revenues, attract new tenants or dispose of unproductive properties.
Costs required to become compliant with the ADA at our properties may affect our ability to make distributions to our stockholders.
We may acquire properties that are not in compliance with the Americans with Disabilities Act of 1990, as amended, or the ADA. We would be required to pay for improvement to the properties to effect compliance with the ADA. Under the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. The ADA requirements could require removal of access barriers and could result in the imposition of fines by the federal government or an award of damages to private litigants. We could be liable for violations of such laws and regulations by us or our tenants. State and federal laws in this area are constantly evolving. The U.S. Department of Justice is expected to issue new ADA regulations that could impact existing buildings. Any such changes in state or federal laws in this area could place a greater cost or burden on us as landlord of the properties we acquire. In addition, although we generally do not expect to engage in substantial renovation or construction work, any new construction at a property would need to be ADA compliant and a certain percentage of the construction costs may need to be allocated to the property’s overall ADA compliance.
Discovery of previously undetected environmentally hazardous conditions may decrease our revenues and the return on an investment in our common stock.
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 to remove or remediate 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 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 release of and exposure to hazardous substances, including asbestos-containing materials into the air. Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could reduce the amounts available for distribution to our stockholders.
Losses for which we either could not or did not obtain insurance, and lender requirements to obtain terrorism insurance, will adversely affect our earnings.
We could suffer a loss due to the cost to repair any damage to properties that are not insured or are underinsured. There are types of losses, generally of a catastrophic nature, such as losses due to terrorism,
wars, earthquakes or acts of God that are either uninsurable or not economically insurable. We may acquire properties that are located in areas where there exists a risk of hurricanes, earthquakes, floods or other acts of God. Generally, we will not obtain insurance for hurricanes, earthquakes, floods or other acts of God unless required by a lender or our advisor determines that such insurance is necessary and may be obtained on a cost-effective basis. If such a catastrophic event were to occur, or cause the destruction of one or more of our properties, we could lose both our invested capital and anticipated profits from such property.
In addition, in light of the threat of terrorist actions against the U.S., certain lenders have required additional insurance covering acts of terrorism without regard to the reasonableness of any related premiums or the likelihood of a particular property to be the target of any such threats or actions. If we are required by a lender to obtain such coverage, the cost of coverage may have an adverse effect on our ability to acquire, and pay the premiums for, the required insurance. Additionally, obtaining such insurance would increase the costs associated with owning a property and could have a material adverse effect on the net income from the property, and, thus, the cash available for distribution to our stockholders.
Dramatic increases in insurance rates could adversely affect our cash flow and our ability to make distributions to our stockholders.
Due to recent natural disasters resulting in massive property destruction, prices for insurance coverage have been increasing dramatically. We cannot assure that we will be able to obtain our insurance premiums at reasonable rates. As a result, our cash flow could be adversely impacted by increased premiums.
An investment in unimproved real property will take longer to produce returns and will be riskier than investments in developed property.
Our board of directors has the discretion to invest up to 10.0% of our total assets in unimproved land. In addition to the risks of real estate investments in general, an investment in unimproved real property is subject to additional risks, including the expense and delay which may be associated with rezoning the land for a higher use and the development and environmental concerns of governmental entities and/or community groups.
Effects of ERISA Regulations
Our common stock may not be a suitable investment for qualified pension and profit-sharing trusts.
When considering an investment in our common stock with a portion of the assets of a qualified pension or profit-sharing trust, one should consider:
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whether the investment satisfies the diversification requirements of ERISA,
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or other applicable restrictions imposed by ERISA; and
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whether the investment is prudent and suitable, since we anticipate that initially there will be no market in which our stockholders can sell or otherwise dispose of our shares.
We have not evaluated, and will not evaluate, whether an investment in our common stock is suitable for any particular employee benefit plan, but, subject to restrictions described in “ERISA Considerations,” in our Offering prospectus, we accept such entities as stockholders if an entity otherwise meets the suitability standards.
If we are considered a “pension-held REIT,” an investment in our common stock may produce unrelated business taxable income for a qualified pension or profit sharing trust, which may cause a qualified pension or profit sharing trust holding 10.0% or more of our stock to pay federal income tax on a portion of the distributions it receives from us.
In addition to considering their fiduciary responsibilities under ERISA and the prohibited transaction rules of ERISA and the federal tax laws, advisors to employee benefit plans also should consider the effect of the “plan asset” regulations issued by the Department of Labor. To avoid being subject to those regulations,
our charter prohibits ERISA investors from owning 25.0% or more of our common stock prior to the time that the common stock qualifies as a class of “publicly-offered securities.” However, we cannot assure our stockholders that those provisions in our charter are effective.
Item 1B.
Item 1B.
Unresolved Staff Comments
Not Applicable.
Item 2.
Item 2.
Properties.
As of December 31 2007, we have not entered into any leases for our principal executive offices located at 1551 N. Tustin Avenue, Suite 300, Santa Ana, California 92705. We do not have an address separate from our advisor, Grubb & Ellis Realty Investors, or our sponsor Grubb & Ellis. Since we pay our advisor fees for its services, we do not pay rent for the use of its space.
Real Estate Investments
The following table presents certain additional information about our properties as of December 31, 2007:
(1)
Annual rent is based on contractual base rent from leases in effect as of December 31, 2007.
(2)
Physical occupancy as of December 31, 2007.
(3)
Average effective annual rent per leased unit as of December 31, 2007.
As of December 31, 2007, we owned fee simple interests in all of our properties.
The following information generally applies to our properties:
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we believe all of the properties are adequately covered by insurance and are suitable for their intended purposes;
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we have no plans for any material renovations, improvements or development of the properties, except in accordance with planned budgets; and
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our properties are located in markets where we are subject to competition for attracting new tenants and retaining current tenants.
Indebtedness
As of December 31, 2007 and 2006, mortgage loan payables were $140,251,000 ($139,318,000, net of discount) and $19,218,000, respectively. As of December 31, 2007, we had nine fixed rate mortgage loans with a weighted-average effective interest rate of 5.60% per annum. As of December 31, 2006, we had one fixed rate mortgage loan with an effective interest rate of 5.34% per annum.
In addition, as of December 31, 2007 and 2006, our unsecured note payables to affiliate were $7,600,000 and $10,000,000, respectively. The unsecured notes bore interest at a fixed rate of 7.46% and 6.86% as of December 31, 2007 and 2006, respectively, and required monthly interest-only payments for the terms of the unsecured notes.
As of December 31, 2006, borrowings under our line of credit totaled $21,585,000 and bore interest at a weighted-average interest rate of 6.88% per annum. As of December 31, 2007, there were no outstanding borrowings under the line of credit. As of December 31, 2007 and 2006, there were no outstanding borrowings under the mezzanine line of credit.
As of December 31, 2007 and 2006, there was $10,000,000 and $0, respectively, outstanding under the Wachovia Loan. Borrowings under the Wachovia Loan bear interest at a variable rate, at a weighted-average interest rate of 9.84% per annum as of December 31, 2007.
See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements, Note 6 to Consolidated Financial Statements, Mortgage Loan Payables and Unsecured Note Payables to Affiliate, and Note 7 to Consolidated Financial Statements, Lines of Credit for a further discussion of our indebtedness.
Item 3.
Item 3.
Legal Proceedings.
None.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth quarter of 2007.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is no established public trading market for shares of our common stock.
Stockholders
As of March 14, 2008, we had 3,214 stockholders of record.
Distributions
Our board of directors approved a 6.0% per annum distribution to be paid to stockholders beginning on October 5, 2006, the date we reached our minimum offering of $2,000,000. On February 22, 2007, our board of directors approved a 7.0% per annum distribution to be paid to stockholders. The increased distribution began with the March 2007 monthly distribution, which was paid on April 15, 2007. Distributions are paid to stockholders on a monthly basis.
The amount of the distributions to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT under the Code.
We have, and intend to continue to make distributions each taxable year equal to at least 90.0% of our taxable income. One of our primary goals is to pay regular monthly distributions to our stockholders. We expect to calculate our monthly distributions based upon daily record and distribution declaration dates so stockholders may be entitled to distributions immediately upon purchasing our shares.
If distributions are in excess of our taxable income, such distributions will result in a return of capital to our stockholders.
For the year ended December 31, 2007, we paid distributions of $3,115,000, of which $2,195,000 was paid from cash flow from operations for the period. The distributions paid in excess of our cash flow from operations was paid using proceeds from our Offering. As of December 31, 2007, we had an amount payable of $353,000 to our advisor and its affiliates for operating expenses, on-site personnel payroll and asset and property management fees, which will be paid from cash flow from operations in the future as they become due and payable by us in the ordinary course of business consistent with our past practice.
Our advisor or its affiliates have no obligation to defer or forgive amounts due to them. As of December 31, 2007, no amounts due to our advisor or its affiliates have been deferred or forgiven. In the future, if our advisor or its affiliates do not defer or forgive amounts due to them and our cash flow from operations is less than the distributions to be paid, we would be required to pay our distributions, or a portion thereof, with proceeds from our Offering or borrowed funds. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds.
We have not paid distributions with funds from operations, or FFO. For the year ended December 31, 2007, our FFO was $(194,000).
Securities Authorized for Issuance under Equity Compensation Plans
See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - Equity Compensation Plan Information, for a discussion of our equity compensation plan information.
Use of Public Offering Proceeds
On July 19, 2006, we commenced our Offering in which we are offering up to 100,000,000 shares of our common stock for $10.00 per share and 5,000,000 shares of our common stock pursuant to our DRIP for $9.50 per share aggregating up to $1,047,500,000. The shares offered in our Offering have been registered with the SEC on a Registration Statement on Form S-11 (File No. 333-130945) under the Securities Act of 1933, which was declared effective by the SEC on July 19, 2006. Our Offering will terminate no later than July 19, 2009.
As of December 31, 2007, we had received and accepted subscriptions for 8,365,946 shares of our common stock, or $83,570,000. As of December 31, 2007, a total of $1,278,000 in distributions were reinvested and 134,475 shares were issued under the DRIP.
As of December 31, 2007, we had incurred marketing support fees of $2,092,000, selling commissions of $5,793,000 and due diligence expense reimbursements of $111,000. We had also incurred offering expenses of $1,255,000. Such fees and reimbursements are charged to stockholders’ equity as such amounts are reimbursed from the gross proceeds of our Offering. The ratio of the cost of raising funds in our Offering to the funds raised is 11.5%.
As of December 31, 2007, we had used $68,288,000 in proceeds from our Offering to purchase our nine properties and repay debt incurred in connection with such acquisitions.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
No share repurchases were made for the year ended December 31, 2007. The share repurchase plan allows for share repurchases by us when certain criteria are met by stockholders. Share repurchases will be made at the sole discretion of our board of directors. Funds for the repurchase of shares will come exclusively from the proceeds we receive from the sale of shares under the DRIP.
Item 6.
Item 6.
Selected Financial Data.
The following should be read with Item 1A. Risk Factors and Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation and our consolidated financial statements and the notes thereto. Our historical results are not necessarily indicative of results for any future period.
The following tables present summarized consolidated financial information, including balance sheet data, statement of operations data, and statement of cash flows data in a format consistent with our consolidated financial statements under Item 15. Exhibits, Financial Statement Schedules of this annual report on Form 10-K.
(1) Net loss per share is based upon the weighted-average number of shares of our common stock outstanding. Distributions by us of our current and accumulated earnings and profits for federal income tax purposes are taxable to stockholders as ordinary income. Distributions in excess of these earnings and profits generally are treated as a non-taxable reduction of the stockholder’s basis in the shares to the extent thereof (a return of capital for tax purposes) and, thereafter, as taxable gain. These distributions in excess of earnings and profits will have the effect of deferring taxation of the distributions until the sale of the stockholder’s common stock.
(2) One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as Funds From Operations, or FFO, which it believes more accurately reflects the operating performance of a REIT such as us. FFO is not equivalent to our net operating income or loss as determined under accounting principles generally accepted in the United States of America, or GAAP.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004. The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property but including asset impairment writedowns, plus depreciation and amortization, and after adjustments for
unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO.
We are disclosing FFO and intend to disclose FFO in future filings because we consider FFO to be an appropriate supplemental measure of a REIT’s operating performance as it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation. The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative. The use of FFO is recommended by the REIT industry as a supplemental performance measure.
Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of our performance. Our FFO reporting complies with NAREIT’s policy described above.
For additional information, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations, which includes a reconciliation of our GAAP net income available to stockholders to FFO for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The use of the words “we,” “us” or “our” refers to Grubb & Ellis Apartment REIT, Inc. and its subsidiaries, including Grubb & Ellis Apartment REIT Holdings, L.P., except where the context otherwise requires.
The following discussion should be read in conjunction with our consolidated financial statements and notes appearing elsewhere in this Annual Report on Form 10-K. Such consolidated financial statements and information have been prepared to reflect our financial position as of December 31, 2007 and 2006, together with our results of operations and cash flows for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006.
Forward-Looking Statements
Historical results and trends should not be taken as indicative of future operations. Our statements contained in this report that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Actual results may differ materially from those included in the forward-looking statements. We intend those forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “prospects,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions generally and the real estate market specifically; legislative and regulatory changes, including changes to laws governing the taxation of real estate investment trusts, or REITs; the availability of capital; changes in interest rates; competition in the real estate industry; the supply and demand for operating properties in our proposed market areas; changes in accounting principles generally accepted in the United States of America, or GAAP, policies and guidelines applicable to REITs; the availability of properties to acquire; the availability of financing; our ongoing relationship with Grubb & Ellis Company, or Grubb & Ellis, or our sponsor, and its affiliates; and litigation, including without limitation, the investigation of Grubb & Ellis Realty Investors, LLC, or Grubb & Ellis Realty Investors (formerly known as Triple Net Properties, LLC), by the Securities and Exchange Commission, or the SEC. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the SEC.
Overview and Background
Grubb & Ellis Apartment REIT, Inc. (formerly known as NNN Apartment REIT, Inc.), a Maryland corporation, was incorporated on December 21, 2005. We were initially capitalized on January 10, 2006 and therefore we consider that our date of inception. We seek to purchase and hold a diverse portfolio of quality apartment communities with strong, stable cash flows and growth potential in select U.S. metropolitan areas. We may also invest in real estate related securities. We focus primarily on investments that produce current income. We qualified to be taxed as a REIT for federal income tax purposes for our taxable year ended December 31, 2006 and we intend to continue to be taxed as a REIT.
We are conducting a best efforts initial public offering, or our Offering, in which we are offering up to 100,000,000 shares of our common stock for $10.00 per share and 5,000,000 shares of our common stock pursuant to our distribution reinvestment plan, or the DRIP, at $9.50 per share, aggregating up to $1,047,500,000. As of March 14, 2008, we had received and accepted subscriptions in our Offering for 9,710,660 shares of our common stock, or $97,015,000, excluding shares issued under the DRIP.
We conduct substantially all of our operations through Grubb & Ellis Apartment REIT Holdings, L.P. (formerly known as NNN Apartment REIT Holdings, L.P.), or our operating partnership. We are externally advised by Grubb & Ellis Apartment REIT Advisor, LLC (formerly known as NNN Apartment REIT Advisor, LLC), or our advisor, pursuant to an advisory agreement, or the Advisory Agreement, between us and our advisor. Grubb & Ellis Realty Investors is the managing member of our advisor. The Advisory Agreement had an initial one-year term that expired on July 18, 2007 and is subject to successive one-year renewals upon the mutual consent of the parties. On June 12, 2007, our board of directors and our advisor approved the renewal of the Advisory Agreement for an additional one-year term, which expires on July 18, 2008. Our advisor supervises and manages our day-to-day operations and selects the properties and securities we acquire, subject to the oversight and approval by our board of directors. Our advisor also provides marketing, sales and client services on our behalf. Our advisor is affiliated with us in that we and our advisor have common officers, some of whom also own an indirect equity interest in our advisor. Our advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, and Grubb & Ellis Residential Management, Inc., or Residential Management, to provide various services to us, including property management services.
On December 7, 2007, NNN Realty Advisors, Inc., or NNN Realty Advisors, which previously served as our sponsor, merged with and into a wholly owned subsidiary of Grubb & Ellis. The transaction was structured as a reverse merger whereby stockholders of NNN Realty Advisors received shares of common stock of Grubb & Ellis in exchange for their NNN Realty Advisors shares of common stock and, immediately following the merger, former NNN Realty Advisor stockholders held approximately of 59.5% of the commons stock of Grubb & Ellis. As a result of the merger, we consider Grubb & Ellis to be our sponsor. Following the merger, NNN Apartment REIT, Inc., NNN Apartment REIT Holdings, L.P., NNN Apartment REIT Advisor, LLC, NNN Apartment Management, LLC, Triple Net Properties, LLC, NNN Residential Management, Inc. and NNN Capital Corp. changed their names to Grubb & Ellis Apartment REIT, Inc., Grubb & Ellis Apartment REIT Holdings, L.P., Grubb & Ellis Apartment REIT Advisor, LLC, Grubb & Ellis Apartment Management, LLC, Grubb & Ellis Realty Investors, LLC, Grubb & Ellis Residential Management, Inc. and Grubb & Ellis Securities, Inc., respectively.
As of December 31, 2007, we owned interests in six properties in Texas consisting of 1,819 apartment units, one property in North Carolina consisting of 160 apartment units, and two properties in Virginia consisting of 394 apartment units for a total of 2,373 apartment units.
Business Strategies
We believe the following will be key factors for our success in meeting our objectives.
Following Demographic Trends and Population Shifts to Find Attractive Tenants in Quality Apartment Community Markets
According to the United States, or U.S., Census Bureau, nearly one half of total U.S. population growth between 2000 and 2030 will occur in three states: Florida, California and Texas, with each state gaining more than 12 million people in total. Included in the top five growth states are Arizona and North Carolina, projected to add 5.6 million and 4.2 million people, respectively.
We focus on property acquisitions in regions of the U.S. that seem likely to benefit from the ongoing population shift and/or are poised for strong economic growth. We further believe that these markets will likely attract quality tenants who have good income and strong credit profiles and choose to rent an apartment rather than buy a home because of their life circumstances. For example, tenants may be baby-boomers or retirees who desire freedom from home maintenance costs and property taxes or they may be service employees who have recently moved to the area and chosen not to make a long-term commitment to the area because of the itinerant nature of their employment. Tenants may also be individuals in transition who need housing while awaiting selection or construction of a home. We believe that attracting and retaining quality tenants strongly correlates with the likelihood of providing stable cash flow to our stockholders as well as increasing the value of our properties.
Fluctuations in interest rates and the economy can benefit our business model by making it more difficult for many people to buy a home, especially a first home. We believe that as the pool of potential renters increases, the demand for apartments is also likely to increase. With this increased demand, we believe that it may be possible to raise rents and decrease rental concessions in the future at apartment communities we acquire.
Leveraging the Experience of Our Management
We believe that a critical factor for success in property acquisition lies in possessing the flexibility to move quickly when an opportunity presents itself to buy or sell a property. We believe that employing highly qualified industry professionals will allow us to better achieve this objective.
Each of our key executives has considerable experience building successful real estate companies. As an example, Stanley J. Olander, our chief executive officer, president and chairman of the board, has been responsible for the acquisition and financing of approximately 40,000 apartment units, has been an executive in the real estate industry for more than 25 years, and previously served as president and chief financial officer and a member of the board of directors of Cornerstone Realty Income Trust, Inc., or Cornerstone. Likewise, Gus G. Remppies, our executive vice president and chief investment officer, and David L. Carneal, our executive vice president and chief operating officer, are the former chief investment officer and chief operating officer, respectively, of Cornerstone, where they oversaw the growth of that company.
We generally acquire fee simple title of our apartment communities, but may also enter into joint venture arrangements. In addition to fee simple interests, we may acquire properties subject to long-term ground leases. We seek to maximize current and long-term net income and the value of our assets. Our policy is to acquire assets where we believe opportunities exist for acceptable investment returns.
Decisions relating to the purchase or sale of properties are made by our advisor subject to the oversight and approval by our board of directors. Our board of directors has established written policies on investment objectives and borrowing. Our board of directors is responsible for monitoring the administrative procedures, investment operations and the performance of us and our advisor to ensure such policies are carried out. Our board of directors generally may change our policies or investment objectives at any time without a vote of our stockholders. The independent directors will review our investment policies at least annually to determine that our policies are in the best interests of our stockholders and will set forth their determinations in the minutes of the board meetings. Our stockholders will have no voting rights with respect to implementing our investment objectives and policies, all of which are the responsibility of our board of directors and may be changed at any time.
Acquisitions in 2006
Walker Ranch Apartment Homes - San Antonio, Texas
On October 31, 2006, we purchased Walker Ranch Apartment Homes in San Antonio, Texas, or the Walker Ranch property, from an unaffiliated third party for a purchase price of $30,750,000 plus closing costs. We financed the purchase price of the property with $22,120,000 in borrowings under our line of credit with Wachovia Bank, National Association, or Wachovia and LaSalle National Bank Association, LaSalle, which we refer to as the line of credit, and $4,740,000 in borrowings under our mezzanine line of credit with Wachovia. The balance of the purchase price was provided by funds raised through our Offering. We paid an acquisition fee of $923,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Hidden Lake Apartment Homes - San Antonio, Texas
On December 28, 2006, we purchased Hidden Lake Apartment Homes located in San Antonio, Texas, or the Hidden Lake property, from an unaffiliated third party for a purchase price of $32,030,000. We financed the purchase price of the property with $19,218,000 in borrowings under a secured mortgage loan, a $10,000,000 unsecured loan from NNN Realty Advisors and $2,500,000 in borrowings under our line of
credit. The balance was provided by funds raised through our Offering. We paid an acquisition fee of $961,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Acquisitions in 2007
Park at Northgate - Spring, Texas
On June 12, 2007, we purchased Park at Northgate, located in Spring, Texas, or the Northgate property, for a purchase price of $16,600,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property from funds raised through our Offering. We paid an acquisition fee of $498,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Residences at Braemar - Charlotte, North Carolina
On June 29, 2007, we purchased Residences at Braemar, located in Charlotte, North Carolina, or the Braemar property, for a purchase price of $15,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of an existing secured loan of $10,000,000, with an unpaid principal balance of $9,722,000, and a $3,300,000 unsecured loan from NNN Realty Advisors, with the balance of the purchase price provided by funds raised through our Offering. We paid an acquisition fee of $450,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Baypoint Resort - Corpus Christi, Texas
On August 2, 2007, we purchased Baypoint Resort, located in Corpus Christi, Texas, or the Baypoint property, for a purchase price of $33,250,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through a loan secured by the property in the principal amount of $21,612,000 and a $13,200,000 unsecured loan from NNN Realty Advisors. An acquisition fee of $998,000, or 3.0% of the purchase price, was paid to our advisor and its affiliate.
Towne Crossing Apartments - Mansfield, Texas
On August 29, 2007, we purchased Towne Crossing Apartments, located in Mansfield, Texas, or the Towne Crossing property, for a purchase price of $21,600,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of an existing secured loan of $15,760,000, with an unpaid principal balance of $15,366,000, and a $5,400,000 unsecured loan from NNN Realty Advisors. An acquisition fee of $648,000, or 3.0% of the purchase price, was paid to our advisor and its affiliate.
Villas of El Dorado - McKinney, Texas
On November 2, 2007, we purchased Villas of El Dorado, located in McKinney, Texas, or the El Dorado property, for a purchase price of $18,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of a loan secured by the property in the principal amount of $13,600,000, with an unpaid principal balance of $13,600,000, and $3,122,000 in cash proceeds from a $3,195,000 borrowing under the Wachovia Loan (See Lines of Credit - Wachovia Loan), with the balance of the purchase price provided by funds raised through our Offering. We paid an acquisition fee of $540,000, or 3.0% of the purchase price, to our Advisor and its affiliate.
The Heights at Old Towne - Portsmouth, Virginia
On December 21, 2007, we purchased The Heights at Old Towne, located in Portsmouth, Virginia, or the Heights property, for a purchase price of $17,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price through a secured loan of $10,475,000, $3,205,000 in borrowings under the Wachovia Loan proceeds of $3,208,000 from a $10,000,000 unsecured loan from NNN Realty Advisors and funds raised through our Offering. An acquisition fee of $510,000, or 3.0% of the purchase price, was paid to our Advisor and its affiliate.
The Myrtles at Old Towne - Portsmouth, Virginia
On December 21, 2007, we purchased The Myrtles at Old Towne, located in Portsmouth, Virginia, or the Myrtles property, for a purchase price of $36,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through a secured loan of $20,100,000, $6,788,000 in borrowings under the Wachovia Loan, proceeds of $6,792,000 from a $10,000,000 unsecured loan from NNN Realty Advisors and funds raised through our Offering. An acquisition fee of $1,080,000, or 3.0% of the purchase price, was paid to our Advisor and its affiliate.
Leverage
As a result of the acquisition of the Walker Ranch property on October 31, 2006, our leverage exceeded 300.0%. In addition, as a result of the acquisition of the Hidden Lake property on December 28, 2006, our leverage exceeded 300.0%. In connection with each of these acquisitions, a majority of our directors, including a majority of our independent directors, approved our leverage exceeding 300.0%, in accordance with our charter. Our board of directors determined that for each acquisition, the excess leverage was justified because it enabled us to purchase the properties during the initial stages of our Offering, thereby improving our ability to meet our goal of acquiring a diversified portfolio of properties to generate current income for investors and preserve investor capital. As of December 31, 2007, our leverage did not exceed 300.0%.
Proposed Acquisition of Arboleda Luxury Apartments
On January 29, 2008, our board of directors approved the acquisition of Arboleda Luxury Apartments, located in Cedar Park, Texas, a northern suburb of Austin, or the Arboleda property. On March 27, 2008, we entered into an assignment agreement whereby we agreed to assume, and Grubb & Ellis Realty Investors agreed to assign, the rights, title and interest in a purchase and sale agreement, as amended, for the Arboleda property for a purchase price of $29,250,000, plus closing costs, from an unaffiliated third party. We intend to finance the purchase through debt financing and proceeds raised from our offering. In connection with obtaining debt financing for the acquisition, on March 27, 2008, we entered into a commitment agreement with PNC ARCS LLC, the prospective lender, to obtain an $18,030,000 loan with a seven year term which would be secured by the Arboleda property. Pursuant to the commitment agreement, we were required to pay a commitment deposit in the amount of 2.0% of the maximum loan amount. The closing deadline for the loan is March 31, 2008. We expect to pay our advisor and its affiliate an acquisition fee of $878,000, or 3.0% of the purchase price, in connection with the acquisition.
We anticipate that the closing will occur in the first quarter of 2008; however, closing is subject to certain agreed upon conditions and there can be no assurance that we will be able to complete the acquisition of the Arboleda property.
Critical Accounting Policies
We believe that our critical accounting policies are those that require significant judgments and estimates such as those related to revenue recognition, allowance for uncollectible accounts, capitalization of expenditures, depreciation of assets, impairment of real estate, properties held for sale, purchase price allocation, and qualification as a REIT. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances.
Use of Estimates
The preparation of our consolidated financial statements in conformity with GAAP requires 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. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates, perhaps in material adverse ways, and those estimates could be different under different assumptions or conditions.
Revenue Recognition, Tenant Receivables and Allowance for Uncollectible Accounts
We lease multifamily residential apartments under operating leases primarily with terms of one year or less. Rent and other property income is recorded when due from residents and is recognized monthly as it is earned. Other property income consists primarily of utility rebillings, other expense reimbursements, and administrative, application and other fees charged to residents. Expense reimbursements are recognized and presented in accordance with Emerging Issues Task Force, or EITF, Issue 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, or Issue 99-19. Issue 99-19 requires that these reimbursements be recorded on a gross basis, as we are generally the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier and have credit risk.
Receivables are carried net of the allowances for uncollectible receivables. An allowance is maintained for estimated losses resulting from the inability of certain residents to meet their contractual obligations under their lease agreements. We determine the adequacy of this allowance by continually evaluating individual residents’ receivables considering the tenant’s financial condition and security deposits and current economic conditions.
Capitalization of Expenditures and Depreciation of Assets
The cost of operating properties includes the cost of land and completed buildings and related improvements. Expenditures that increase the service life of properties are capitalized; the cost of maintenance and repairs is charged to expense as incurred. The cost of building and improvements is depreciated on a straight-line basis over the estimated useful lives of the buildings and improvements, ranging primarily from 10 to 40 years. Land improvements are depreciated over the estimated useful lives ranging primarily from 10 to 15 years. Furniture, fixtures and equipment is depreciated over the estimated useful lives ranging primarily from five to 15 years. When depreciable property will be retired or disposed of, the related costs and accumulated depreciation will be removed from the accounts and any gain or loss reflected in operations.
Impairment
Our properties are carried at the lower of historical cost less accumulated depreciation or fair value. We assess the impairment of a real estate asset when events or changes in circumstances indicate that the net book value may not be recoverable. Indicators we consider important and that we believe could trigger an impairment review include the following:
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significant negative industry or economic trends;
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a significant underperformance relative to historical or projected future operating results; and
•
a significant change in the manner in which the asset is used.
In the event that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that would be expected to result from the use and eventual disposition of the property, we would recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property. The estimation of expected future net cash flows will be inherently uncertain and will rely on subjective assumptions dependent upon future and current market conditions and events that affect the ultimate value of the property. It will require us to make assumptions related to future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, occupancy levels, and the estimated proceeds generated from the future sale of the property.
Properties Held for Sale
We account for our properties held for sale in accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, or SFAS No. 144, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that, in a period in which a component of an entity either has been disposed of or is
classified as held for sale, the income statements for current and prior periods shall report the results of operations of the component as discontinued operations.
In accordance with SFAS No. 144, at such time as a property is held for sale, such property is carried at the lower of (1) its carrying amount or (2) fair value less costs to sell. In addition, a property being held for sale ceases to be depreciated. We classify operating properties as property held for sale in the period in which all of the following criteria are met:
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management, having the authority to approve the action, commits to a plan to sell the asset;
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the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;
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an active program to locate a buyer and other actions required to complete the plan to sell the asset has been initiated;
•
the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within one year;
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the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and
•
given the actions required to complete the plan to sell the asset, it is unlikely that significant changes to the plan would be made or that the plan would be withdrawn.
Purchase Price Allocation
In accordance with SFAS No. 141, Business Combinations, we, with assistance from independent valuation specialists, allocate the purchase price of acquired properties to tangible and identified intangible assets and liabilities based on their respective fair values. The allocation to tangible assets (building and land) is based upon our determination of the value of the property as if it were vacant. Allocations are made at the fair market value for furniture, fixtures and equipment on premises. Additionally, the purchase price of the applicable property is allocated to the above or below market value of in-place leases, the value of in-place leases, tenant relationships and above or below market debt assumed. Factors considered by us include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.
The value allocable to the above or below market component of the acquired in-place leases is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between: (1) the contractual amounts to be paid pursuant to the lease over its remaining term and (2) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above market leases, if any, would be included in the intangible assets and below market lease values, if any, would be included in intangible liabilities in our consolidated financial statements and would be amortized to rental income over the weighted average remaining term of the acquired leases with each property. As of December 31, 2007, we did not have any amounts allocated to above or below market leases.
The total amount of other intangible assets acquired is further allocated to in-place lease costs and the value of tenant relationships based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant. Characteristics considered by us in allocating these values include the nature and extent of the credit quality and expectations of lease renewals, among other factors.
The value allocable to above or below market debt is determined based upon the present value of the difference between the cash flow stream of the assumed fixed rate mortgage and the cash flow stream of a market fixed rate mortgage. The amounts allocated to above or below market debt are included in mortgage
loan payables, net on our accompanying consolidated balance sheets and are amortized to interest expense over the remaining term of the assumed mortgage.
These allocations are subject to change based on information received within one year of the purchase related to one or more events identified at the time of purchase which confirm the value of an asset or liability received in an acquisition of property.
Qualification as a REIT
We elected to be taxed as a REIT under Section 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Code, and, upon the election being made, we have been taxed as such beginning with our taxable year ended December 31, 2006. We intend to continue to qualify as a REIT. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90.0% of our REIT taxable income to stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders.
If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates starting with that year and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service were to grant us relief under certain statutory provisions. Such an event could have a material adverse effect on our results of operations and net cash available for distribution to stockholders.
Factors which may Influence Results of Operations
Rental Income
The amount of rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space, to lease currently available space and space available from unscheduled lease terminations at the existing rental rates and the timing of the disposition of the properties. Negative trends in one or more of these factors could adversely affect our rental income in future periods.
Offering Proceeds
If we fail to raise significant proceeds under our Offering, we will not have enough proceeds to invest in a diversified real estate portfolio. Our real estate portfolio would be concentrated in a small number of properties, resulting in increased exposure to local and regional economic downturns and the poor performance of one or more of our properties and, therefore, expose our stockholders to increased risk. In addition, many of our expenses are fixed regardless of the size of our real estate portfolio. Therefore, depending on the amount of offering proceeds we raise, we would expend a larger portion of our income on operating expenses. This would reduce our profitability and, in turn, the amount of net income available for distribution to our stockholders.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act, and related laws, regulations and standards relating to corporate governance and disclosure requirements applicable to public companies, have increased the costs of compliance with corporate governance, reporting and disclosure practices which are now required of us. These costs may have a material adverse effect on our results of operations and could impact our ability to continue to pay distributions at current rates to our stockholders. Furthermore, we expect that these costs will increase in the future due to our continuing implementation of compliance programs mandated by these requirements. Any increased costs may affect our ability to distribute funds to our stockholders. As part of our compliance with the Sarbanes-Oxley Act, we are providing management’s assessment of our internal control over financial reporting as of December 31, 2007.
In addition, these laws, rules and regulations create new legal bases for potential administrative enforcement, civil and criminal proceedings against us in the event of non-compliance, thereby increasing the
risks of liability and potential sanctions against us. We expect that our efforts to comply with these laws and regulations will continue to involve significant, and potentially increasing costs and, our failure to comply could result in fees, fines, penalties or administrative remedies against us.
Results of Operations
Our operating results are primarily comprised of income derived from our portfolio of apartment properties.
We are not aware of any material trends or uncertainties, other than national economic conditions affecting real estate generally, that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition, management and operation of properties, the financial impact of the downturn of the credit markets, and those risks listed in Part I, Item 1A. Risk Factors.
We had limited results of operations for the period from January 10, 2006 (Date of Inception) through December 31, 2006 and therefore our results of operations for the year ended December 31, 2007 are not comparable. Except where otherwise noted, the increase in operations is due to owning nine properties as of December 31, 2007 as compared to owning two properties as of December 31, 2006.
Revenues
For the year ended December 31, 2007, revenues were $12,705,000 as compared to $659,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. In 2007, revenue was comprised of rental income of $11,610,000 and other property revenues of $1,095,000. In 2006, revenue was comprised of rental income of $615,000 and other property revenues of $44,000.
Rental Expenses
For the year ended December 31, 2007, rental expenses were $6,223,000 as compared to $266,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. In 2007, rental expenses were comprised of real estate taxes of $2,488,000, utilities of $599,000, repairs and maintenance of $852,000, property management fees of $489,000, administration of $1,606,000 and insurance of $189,000. In 2006, rental expenses were comprised of real estate taxes of $115,000, utilities of $28,000, repairs and maintenance of $22,000, property management fees of $24,000, administration of $72,000 and insurance of $5,000.
General and Administrative
For the year ended December 31, 2007, general and administrative was $2,383,000 as compared to $294,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. In 2007, general and administrative consisted primarily of director and officer’s insurance premiums of $202,000, directors’ fees of $100,000, restricted stock compensation of $15,000, professional and legal fees of $788,000, postage and delivery of $31,000, asset management fees of $950,000 and bad debt expense of $264,000. In 2006, general and administrative consisted primarily of director and officer’s insurance premiums of $87,000, directors’ fees of $53,000, restricted stock compensation of $11,000 and professional and legal fees of $135,000. The increase in general and administrative was due to a full year of operations and increased legal and professional fees in connection with the acquisition of our seven properties, as well as asset management fees on the portfolio of nine properties.
Depreciation and Amortization
For the year ended December 31, 2007, depreciation and amortization was $5,385,000 as compared to $289,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. In 2007, depreciation and amortization was comprised of depreciation on the properties of $3,434,000, amortization of identified intangible assets of $485,000 and amortization of lease commissions of $1,466,000. In 2006, depreciation and amortization was comprised of depreciation on the properties of $188,000 and amortization of identified intangible assets of $101,000.
Interest Expense
For the year ended December 31, 2007, interest expense was $4,386,000 as compared to $339,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, interest expense related to interest on our mortgage loan payables and line of credit of $3,950,000 and $284,000, respectively, interest expense on the unsecured note payables to NNN Realty Advisors of $204,000 and $8,000, respectively, interest expense on our mezzanine line of credit of $0 and $17,000, respectively, and amortization of loan fees associated with acquiring the mortgage loan payables of $232,000 and $30,000, respectively, that are being amortized to interest expense over the terms of the related mortgage loan payables.
Interest and Dividend Income
For the year ended December 31, 2007, interest and dividend income was $91,000 as compared to $6,000 for the period from January 10, 2006 (Date of Inception) through December 31, 2006. In 2007, interest and dividend income was related primarily to interest earned on our money market accounts. The increase in interest and dividend income was due to having higher cash balances in 2007 as compared to 2006.
Net Loss
For the year ended December 31, 2007, net loss was $(5,579,000), or $(1.10) per share, as compared to $(523,000), or $(1.99) per share, for the period from January 10, 2006 (Date of Inception) through December 31, 2006. The increase in net loss was due to the factors discussed above.
Liquidity and Capital Resources
We are dependent upon the net proceeds from our Offering to conduct our proposed activities. The capital required to purchase real estate and real estate related securities will be obtained from our Offering and from any indebtedness that we may incur.
Our principal demands for funds will be for acquisitions of real estate and real estate related securities, to pay operating expenses and interest on our outstanding indebtedness and to make distributions to our stockholders. In addition, we will require resources to make certain payments to our advisor and our dealer manager, which during our Offering include payments to our advisor and its affiliates for reimbursement of certain organizational and offering expenses and to our dealer manager and its affiliates for selling commissions, non-accountable marketing support fees and due diligence expense reimbursements.
Generally, cash needs for items other than acquisitions of real estate and real estate related securities will be met from operations, borrowings, and the net proceeds of our Offering. However, there may be a delay between the sale of shares of our common stock and our investments in properties and real estate related securities, which could result in a delay in the benefits to our stockholders, if any, of returns generated from our investments’ operations. We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.
Our advisor evaluates potential additional investments and engages in negotiations with real estate sellers, developers, brokers, investment managers, lenders and others on our behalf. Until we invest the proceeds of our Offering in properties and real estate related securities, we may invest in short-term, highly liquid or other authorized investments. Such short-term investments will not earn significant returns, and we cannot predict how long it will take to fully invest the proceeds in properties and real estate related securities. The number of properties we may acquire and other investments we will make will depend upon the number of shares sold in our Offering and the resulting amount of net proceeds available for investment.
When we acquire a property, our advisor prepares a capital plan that contemplates the estimated capital needs of that investment. In addition to operating expenses, capital needs may also include costs of refurbishment, tenant improvements or other major capital expenditures. The capital plan will also set forth the anticipated sources of the necessary capital, which may include a line of credit or other loans established with
respect to the investment, operating cash generated by the investment, additional equity investments from us or joint venture partners or, when necessary, capital reserves. Any capital reserve would be established from the gross proceeds of our Offering, proceeds from sales of other investments, operating cash generated by other investments or other cash on hand. In some cases, a lender may require us to establish capital reserves for a particular investment. The capital plan for each investment will be adjusted through ongoing, regular reviews of our portfolio or as necessary to respond to unanticipated additional capital needs.
Other Liquidity Needs
In the event that there is a shortfall in net cash available due to various factors, including, without limitation, the timing of distributions or the timing of the collections of receivables, we may seek to obtain capital to pay distributions by means of secured or unsecured debt financing through one or more third parties, or our advisor or its affiliates. There are currently no limits or restrictions on the use of proceeds from our advisor or its affiliates which would prohibit us from making the proceeds available for distribution. We may also pay distributions from cash from capital transactions, including, without limitation, the sale of one or more of our properties.
We estimate that our expenditures for capital improvements will require up to $1,425,000 within the next twelve months. As of December 31, 2007, we had $180,000 of restricted cash in loan impounds and reserve accounts for such capital expenditures and any remaining expenditures will be paid with net cash from operations or gains from the sale of assets. We cannot provide assurance, however, that we will not exceed these estimated expenditure and distribution levels or be able to obtain additional sources of financing on commercially favorable terms or at all.
If we experience lower occupancy levels, reduced rental rates, reduced revenues as a result of asset sales, increased capital expenditures and leasing costs compared to historical levels due to competitive market conditions for new and renewal leases, the effect would be a reduction of net cash provided by operating activities. If such a reduction of net cash provided by operating activities is realized, we may have a cash flow deficit in subsequent periods. Our estimate of net cash available is based on various assumptions which are difficult to predict, including the levels of leasing activity at year end and related leasing costs. Any changes in these assumptions could impact the financial results and our ability to fund working capital and unanticipated cash needs. To the extent any distributions are made to stockholders in excess of accumulated earnings, the excess distributions are considered a return of capital to stockholders for federal income tax purposes. Distributions in excess of tax capital are non-taxable to the extent of tax basis. Distributions in excess of tax basis will constitute capital gains.
Cash Flows
Cash flows provided by operating activities for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 were $2,195,000 and $301,000, respectively. In 2007, cash flow provided by operating activities was primarily due to the increase in accounts payable and accrued liabilities of $2,125,000. In 2006, cash flows provided by operating activities related primarily to the increase in accounts payable and accrued liabilities and accounts payable due to affiliates, net of $669,000. We anticipate cash flows provided by operating activities to continue to increase as we purchase more properties.
Cash flows used in investing activities for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 were $126,965,000 and $63,991,000, respectively. In 2007, cash flows used in investing activities related primarily to the acquisition of seven properties in the amount of $123,657,000. These acquisitions include the Northgate property, the Braemar property, the Baypoint property, the Towne Crossing property, the El Dorado property, the Heights property and the Myrtles property. In 2006, cash flows used in investing activities related primarily to the acquisition of the Walker Ranch property and the Hidden Lake property in the amount of $63,794,000. We anticipate cash flows used in investing activities to continue to increase as we purchase more properties.
Cash flows provided by financing activities for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 were $125,010,000 and $65,144,000, respectively. In 2007, cash flows provided by financing activities related primarily to funds raised from investors of $66,796,000 and borrowings on our mortgage loan payables and unsecured note payables to affiliate of $114,382,000, partially offset by the payment of offering costs of $7,108,000 and principal repayments on borrowings in the amount of $34,437,000 on our mortgage loan payables and unsecured note payables and in the amount of $11,585,000 on our lines of credit. In 2006, such cash flows from financing activities related primarily to funds raised from investors and our advisor in the amount of $16,651,000 as well as borrowings in the amount of $50,803,000 partially offset by the payment of offering costs of $1,720,000. We anticipate cash flows provided by financing activities to increase in the future as we raise additional funds from investors and incur additional debt to purchase properties.
Distributions
The amount of the distributions to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT under the Code.
Our board of directors approved a 6.0% per annum distribution to be paid to stockholders beginning on October 5, 2006, the date we reached our minimum offering of $2,000,000. The first distribution was paid on December 15, 2006 for the period ended November 30, 2006. On February 22, 2007, our board of directors approved a 7.0% per annum distribution to be paid to stockholders. The increased distribution began with the March 2007 monthly distribution, which was paid on April 15, 2007. Distributions are paid to stockholders on a monthly basis.
If distributions are in excess of our taxable income, such distributions will result in a return of capital to our stockholders. Our distribution of amounts in excess of our taxable income have resulted in a return of capital to our stockholders. The income tax treatment for distributions reportable for the years ended December 31, 2007 and 2006 was as follows:
For the year ended December 31, 2007, we paid distributions of $3,115,000, of which $2,195,000 was paid from cash flow from operations for the period. The distributions paid in excess of our cash flow from operations was paid using proceeds from our Offering. As of December 31, 2007, we had an amount payable of $353,000 to our advisor and its affiliates for operating expenses, on-site personnel payroll and asset and property management fees, which will be paid from cash flow from operations in the future as they become due and payable by us in the ordinary course of business consistent with our past practice.
Our advisor or its affiliates have no obligation to defer or forgive amounts due to them. As of December 31, 2007, no amounts due to our advisor or its affiliates have been deferred or forgiven. In the future, if our advisor or its affiliates do not defer or forgive amounts due to them and our cash flow from operations is less than the distributions to be paid, we would be required to pay our distributions, or a portion thereof, with proceeds from our Offering or borrowed funds. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds.
We have not paid distributions with funds from operations, or FFO. For the year ended December 31, 2007, our FFO was $(194,000).
Capital Resources
Financing
We anticipate that aggregate borrowings, both secured and unsecured, will not exceed 65.0% of all of our properties’ and real estate related securities’ combined fair market values, as determined at the end of each calendar year beginning with our first full year of operations. For these purposes, the fair market value of each asset will be equal to the purchase price paid for the asset or, if the asset was appraised subsequent to the date of purchase, then the fair market value will be equal to the value reported in the most recent independent appraisal of the asset. Our policies do not limit the amount we may borrow with respect to any individual asset. As of December 31, 2007, our aggregate borrowings were 71.7% of all of our properties’ and real estate related securities’ combined fair market values due to short-term financing we incurred to purchase the Heights property and the Myrtles property.
Mortgage Loan Payables
Mortgage loan payables were $140,251,000 ($139,318,000, net of discount) and $19,218,000 as of December 31, 2007 and 2006, respectively. As of December 31, 2007, we had nine fixed rate mortgage loans with a weighted-average effective interest rate of 5.60% per annum. As of December 31, 2006, we had one fixed rate mortgage loan with an effective interest rate of 5.34% per annum. The mortgage loans secured by the Hidden Lake property, the Walker Ranch property, the Northgate property, the Baypoint property, the El Dorado property, the Heights property, and the Myrtles property have monthly interest-only payments. The mortgage loans secured by the Braemar property and the Towne Crossing property have monthly principal and interest payments. We are required by the terms of the applicable loan documents to meet certain reporting requirements. As of December 31, 2007 and 2006, we were in compliance with all such requirements.
Mortgage loan payables consisted of the following as of December 31, 2007 and 2006:
Unsecured Note Payables to Affiliate
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we entered into and subsequently paid down the following unsecured loans with NNN Realty Advisors, evidenced by unsecured promissory notes:
The unsecured notes bore interest at a fixed rate and required monthly interest-only payments for the terms of the unsecured notes. As of December 31, 2007 and 2006, the balances under the unsecured note payables to our affiliate were $7,600,000 and $10,000,000, respectively.
Because these loans were related party loans, the terms of the loans and the unsecured notes were approved by our board of directors, including a majority of our independent directors, and deemed fair, competitive and commercially reasonable by our board of directors.
Lines of Credit
Line of Credit and Mezzanine Line of Credit
We have a credit agreement, or the Credit Agreement, with Wachovia and LaSalle Bank National Association, or LaSalle, for a secured revolving line of credit with a maximum borrowing amount of $75,000,000 which matures on October 31, 2009 and may be increased to $200,000,000 subject to the terms of the Credit Agreement, or the line of credit. The line of credit has an option to extend for one year in exchange for the payment of an extension fee.
As of December 31, 2007 and 2006, borrowings under the line of credit totaled $0 and $21,585,000, respectively. Borrowings at December 31, 2006 bore interest at a weighted-average interest rate of 6.88% per annum. On April 12, 2007, we repaid the remaining outstanding borrowings and accrued interest under the line of credit.
We have a Mezzanine Credit Agreement, or the Mezzanine Credit Agreement, with Wachovia for a mezzanine secured revolving line of credit with a maximum borrowing amount of $15,000,000 which matures on October 31, 2009, or the mezzanine line of credit. As of December 31, 2007 and 2006, there were no outstanding borrowings under the mezzanine line of credit.
On March 20, 2007, we obtained waivers of certain covenants contained in the Credit Agreement and Mezzanine Credit Agreement from Wachovia and LaSalle, as applicable. The covenants were related to our non-compliance with certain debt to total asset value ratios, fixed charge coverage ratios and the implied debt service coverage ratios, or collectively the financial covenants, arising from our limited operations. As a result of the waivers, Wachovia and LaSalle waived compliance with the financial covenants through the period ending December 31, 2007. Wachovia and LaSalle currently have no obligation to fund additional amounts under either the line of credit or the mezzanine line of credit, as applicable, until we comply with the financial covenants, although they may do so in their sole discretion.
On July 10, 2007, we entered into letter agreements amending the terms of the Credit Agreement and Mezzanine Credit Agreement, or the amendment letters. Pursuant to the amendment letters, we are no longer obligated to pay nonuse fees until such times as Wachovia and LaSalle have agreed in writing to make additional loans under the Credit Agreement or the Mezzanine Credit Agreement, as applicable. Further, until Wachovia and LaSalle have agreed to make additional loans under the Credit Agreement or Mezzanine Credit Agreement, as applicable, we will not be obligated to comply with the financial covenants contained in the Credit Agreement or Mezzanine Credit Agreement, nor will we be obligated to comply with the related reporting obligations. Finally, Wachovia and LaSalle, as applicable, have agreed that we will not be obligated
to pay any reinstatement fees under the Credit Agreement or Mezzanine Credit Agreement in order for Wachovia or LaSalle to lend us funds in the future.
Wachovia Loan
On November 1, 2007, we entered into a loan agreement with Wachovia for a loan in the principal amount of up to $10,000,000 which matures on November 1, 2008, or the Wachovia Loan. The Wachovia Loan is secured by (1) a pledge of 49.0% of our partnership interests in Apartment REIT Walker Ranch L.P., Apartment REIT Hidden Lakes, L.P. and Apartment REIT Towne Crossing, L.P., (2) 100% of our partnership interests in Apartment REIT Park at North Gate, L.P. and (3) 100% of our ownership interests in entities acquiring properties in the future if financed in part by the Wachovia Loan. The Wachovia Loan may be extended for one year subject to satisfaction of certain conditions. Accrued interest under the Wachovia Loan is payable monthly and at maturity. Advances under the Wachovia Loan bear interest at the applicable LIBOR Rate, as defined in the agreement.
On November 1, 2007, we used $3,195,000 in borrowings under the Wachovia Loan agreement in connection with the acquisition of the El Dorado property. On November 19, 2007, we repaid the outstanding principal and accrued interest on the Wachovia Loan.
On December 21, 2007, we executed a First Amendment to and Waiver of Loan Agreement with Wachovia, and Grubb & Ellis Apartment REIT Holdings, L.P., our operating partnership, entered into a First Amended and Restated Pledge Agreement with Wachovia to pledge its interest in the Myrtles property and the Heights property in connection with $10,000,000 in borrowings under the Wachovia Loan to finance the acquisitions of the Myrtles property and the Heights property. As of December 31, 2007, $10,000,000 was outstanding under the Wachovia Loan.
REIT Requirements
In order to continue to qualify as a REIT for federal income tax purposes, we are required to make distributions to our stockholders of at least 90.0% of REIT taxable income. In the event that there is a shortfall in net cash available due to factors including, without limitation, the timing of such distributions or the timing of the collections of receivables, we may seek to obtain capital to pay distributions by means of secured debt financing through one or more third parties. We may also pay distributions from cash from capital transactions including, without limitation, the sale of one or more of our properties.
Commitments and Contingencies
Repairs and Maintenance Expenses
We are required by the terms of the mortgage loans secured by the Northgate property and the Baypoint property to complete certain repairs to the properties in the amount of $45,000 and $131,000, respectively, by no later than August 1, 2008. Funds of $131,000 for these expenditures are held by the lender and are included in restricted cash on our accompanying consolidated balance sheet as of December 31, 2007.
Organizational, Offering and Related Expenses
Our organizational, offering and related expenses are being paid by our advisor and its affiliates on our behalf. These organizational, offering and related expenses include all expenses (other than selling commissions and the marketing support fee which generally represent 7.0% and 2.5% of our gross offering proceeds, respectively) to be paid by us in connection with our Offering. These expenses will only become our liability to the extent selling commissions, the marketing support fee and due diligence expense reimbursements and other organizational and offering expenses do not exceed 11.5% of the gross proceeds of our Offering. As of December 31, 2007 and 2006, expenses of $2,672,000 and $1,679,000, respectively, in excess of 11.5% of the gross proceeds of our Offering, have been incurred by our advisor or Grubb & Ellis Realty Investors and these expenses are not recorded in our accompanying consolidated financial statements as of December 31, 2007 and 2006. To the extent we raise additional proceeds from our Offering, these amounts
may become our liability. See Note 9, Related Party Transactions - Offering Stage to our accompanying consolidated financial statements for a further discussion of these amounts during our offering stage.
Insurance Coverage
The insurance coverage provided through third-party insurance carriers is subject to coverage limitations. For each type of insurance coverage, should an uninsured or underinsured loss occur, we could lose all or a portion of our investment in, and anticipated cash flows from, one or more of the properties. In addition, there can be no assurance that third-party insurance carriers will be able to maintain reinsurance sufficient to cover any losses that may be incurred. However, management believes that our current insurance coverage is adequate.
Debt Service Requirements
One of our principal liquidity needs is payments of interest and principal on outstanding indebtedness. As of December 31, 2007, we had nine mortgage loans outstanding in the aggregate principal amount of $140,251,000 ($139,318,000, net of discount). The mortgage loans secured by the Hidden Lake property, the Walker Ranch property, the Northgate property, the Baypoint property, the El Dorado property, the Heights property, and the Myrtles property have monthly interest-only payments. The mortgage loans secured by the Towne Crossing property and the Braemar property have monthly principal and interest payments.
As of December 31, 2007, we had $7,600,000 outstanding under a $10,000,000 unsecured note payable to NNN Realty Advisors, at a fixed rate of 7.46% per annum. The unsecured note matures on June 20, 2008 and requires monthly interest only payments beginning on January 1, 2008 for the term of the unsecured note. Additionally, as of December 31, 2007, we had $10,000,000 outstanding under the Wachovia Loan, a one-year, variable rate, term loan, at a weighted-average interest rate of 9.84% per annum as of December 31, 2007. No amounts were outstanding under our line of credit and mezzanine line of credit as of December 31, 2007.
As of December 31, 2007, the weighted average effective interest rate on our outstanding debt was 5.96% per annum.
Contractual Obligations
The following table provides information with respect to the maturities and scheduled principal repayments of our indebtedness as of December 31, 2007. The table does not reflect any available extension options.
Off-Balance Sheet Arrangements
As of December 31, 2007 and 2006, we had no off-balance sheet transactions nor do we currently have any such arrangements or obligations.
Inflation
Substantially all of our apartment leases will be for a term of one year or less. In an inflationary environment, this may allow us to realize increased rents upon renewal of existing leases or the beginning of new leases. Short-term leases generally will minimize our risk from the adverse effects of inflation, although these leases generally permit residents to leave at the end of the lease term and therefore will expose us to the effect of a decline in market rents. In a deflationary rent environment, we may be exposed to declining rents more quickly under these shorter term leases.
Funds from Operations
One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. FFO is not equivalent to our net operating income or loss as determined under GAAP. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as FFO which it believes more accurately reflects the operating performance of a REIT such as us.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004. The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property but including asset impairment writedowns, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO.
We are disclosing FFO and intend to disclose FFO in future filings because we consider FFO to be an appropriate supplemental measure of a REIT’s operating performance as it is based on a net income analysis of property portfolio performance that excludes non-cash items such as depreciation. The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time. Since real estate values historically rise and fall with market conditions, presentations of operating results for a REIT, using historical accounting for depreciation, could be less informative. The use of FFO is recommended by the REIT industry as a supplemental performance measure.
Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income as an indication of our performance. Our FFO reporting complies with NAREIT’s policy described above.
The following is the calculation of FFO for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006.
Subsequent Events
Status of our Offering
As of March 14, 2008, we had received and accepted subscriptions in our Offering for 9,710,660 shares of our common stock, or $97,015,000, excluding shares issued under the DRIP.
Unsecured Note Payable to Affiliate
On February 20, 2008, we repaid the remaining balance due on the unsecured note payable to affiliate.
Share Repurchases
In February 2008, we repurchased 5,200 shares, or $52,000, under our share repurchase plan.
Related Party Services Agreement
We entered into a services agreement, effective January 1, 2008, with Grubb & Ellis Realty Investors for subscription agreement processing and investor services. The services agreement has an initial one-year term and shall thereafter automatically be renewed for successive one year terms. Since Grubb & Ellis Realty Investors is the managing member of our advisor, the terms of this agreement were approved and determined by a majority of our independent directors as fair and reasonable to us and at fees no greater than the cost to Grubb & Ellis Realty Investors for providing such services to us, which amount shall be no greater than that which would be paid to an unaffiliated third party for similar services. The services agreement requires Grubb & Ellis Realty Investors to provide us with a 180 day advance written notice for any termination, while we have the right to terminate upon 30 days advance written notice.
Proposed Acquisition of Arboleda Luxury Apartments
On January 29, 2008, our board of directors approved the acquisition of Arboleda Luxury Apartments, located in Cedar Park, Texas, a northern suburb of Austin, or the Arboleda property. On March 27, 2008, we entered into an assignment agreement whereby we agreed to assume, and Grubb & Ellis Realty Investors agreed to assign, the rights, title and interest in a purchase and sale agreement, as amended, for the Arboleda property for a purchase price of $29,250,000, plus closing costs, from an unaffiliated third party. We intend to finance the purchase through debt financing and proceeds raised from our offering. In connection with obtaining debt financing for the acquisition, on March 27, 2008, we entered into a commitment agreement with PNC ARCS LLC, the prospective lender, to obtain an $18,030,000 loan with a seven year term which would be secured by the Arboleda property. Pursuant to the commitment agreement, we were required to pay a commitment deposit in the amount of 2.0% of the maximum loan amount. The closing deadline for the loan is March 31, 2008. We expect to pay our advisor and its affiliate an acquisition fee of $878,000, or 3.0% of the purchase price, in connection with the acquisition.
We anticipate that the closing will occur in the first quarter of 2008; however, closing is subject to certain agreed upon conditions and there can be no assurance that we will be able to complete the acquisition of the Arboleda property.
Recently Issued Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board, or the FASB, issued SFAS No. 157, Fair Value Measurement, or SFAS No. 157. SFAS No. 157, which will be applied to other accounting pronouncements that require or permit fair value measurements, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and provides for expanded disclosure about fair value measurements. SFAS No. 157 was issued to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position SFAS No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, or FSP FAS 157-1. FSP FAS 157-1 defers the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP FAS 157-1 also excludes from the scope of SFAS No. 157 certain leasing transactions accounted for under SFAS No. 13, Accounting for Leases. We adopted SFAS No. 157 and FSP FAS 157-1 on a prospective basis on January 1, 2008. The adoption of SFAS No. 157 and FSP FAS 157-1 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. We adopted SFAS No. 159 on a prospective basis on January 1, 2008. The adoption of SFAS No. 159 did not have a material impact on our consolidated financial statements since we will not be electing to apply the fair value option for any of our eligible financial instruments or other items on the January 1, 2008 effective date.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or SFAS No. 141(R), and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51, or SFAS No. 160. These two new standards will significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS No. 141(R) requires an acquiring entity to recognize acquired assets and liabilities assumed in a transaction at fair value as of the acquisition date, changes the disclosure requirements for business combination transactions and changes the accounting treatment for certain items, including contingent consideration agreements which will be required to be recorded at acquisition date fair value and acquisition costs which will be required to be expensed as incurred. SFAS No. 160 requires that noncontrolling interests be presented as a component of consolidated stockholders’ equity, eliminates minority interest accounting such that the amount of net income attributable to the noncontrolling interests will be presented as part of consolidated net income in our accompanying consolidated statements of operations and not as a separate component of income and expense, and requires that upon any changes in ownership that result in the loss of control of the subsidiary, the noncontrolling interest be re-measured at fair value with the resultant gain or loss recorded in net income. SFAS No. 141(R) and SFAS No. 160 require simultaneous adoption and are to be applied prospectively for the first annual reporting period beginning on or after December 15, 2008. Early adoption of either standard is prohibited. We will adopt SFAS No. 141(R) and SFAS No. 160 on January 1, 2009. We are evaluating the impact of SFAS No. 141(R) and SFAS No. 160 and have not yet determined the impact the adoption will have on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, or SFAS No. 161. SFAS No. 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand
their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 achieves these improvements by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of SFAS No. 161 is not expected to have a material impact on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. In pursuing our business plan, the primary market risk to which we are exposed is interest rate risk.
We are exposed to the effects of interest rate changes primarily as a result of borrowings used to maintain liquidity and fund expansion and refinancing of our real estate investment portfolio and operations. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower overall borrowing costs while taking into account variable interest rate risk. To achieve our objectives, we borrow at fixed rates and variable rates. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes.
Our interest rate risk is monitored using a variety of techniques.
The table below presents, as of December 31, 2007, the principal amounts and weighted-average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
*
The estimated fair value of our mortgage loan payables was $137,958,000 as of December 31, 2007. The estimated fair value of the $7,600,000 unsecured note payables to an affiliate as of December 31, 2007 is not determinable due to the related party nature of the note.
The weighted-average interest rate of our mortgage loan payables as of December 31, 2007 was 5.60% per annum. As of December 31, 2007, our mortgage debt consisted of nine mortgage loan payables in the principal amount of $140,251,000, or 88.9%, of the total debt at a fixed weighted-average interest rate of 5.60% per annum. In addition, as of December 31, 2007, we had $7,600,000, or 4.8%, of the total debt outstanding under an unsecured note payable to an affiliate at a fixed rate of 7.46% per annum and $10,000,000, or 6.3%, of the total debt outstanding under the Wachovia Loan at a weighted average interest rate of 9.84% per annum.
An increase in the variable interest rate on the Wachovia Loan constitutes a market risk. As of December 31, 2007, for example a 0.50% increase in London Interbank Offered Rate, or LIBOR, would have increased our overall annual interest expense by $50,000, or 1.1%.
The table below presents, as of December 31, 2006, the principal amounts and weighted-average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
*
The estimated fair value of our mortgage loan payables was $19,218,000 as of December 31, 2006. The estimated fair value of the $10,000,000 unsecured note payables to an affiliate as of December 31, 2006 is not determinable due to the related party nature of the note. The fair value of the line of credit with Wachovia Bank, National Association, or Wachovia, and LaSalle Bank National Association, or LaSalle, which we refer to as the line of credit, as of December 31, 2006 was $21,585,000.
The weighted-average interest rate of our mortgage loan payables as of December 31, 2006 was 5.34% per annum. As of December 31, 2006, our mortgage debt consisted of one mortgage loan payable in the principal amount of $19,218,000, or 37.8%, of the total debt at a fixed interest rate of 5.34% per annum. In addition, as of December 31, 2006, we had $10,000,000, or 19.7%, of the total debt outstanding under an unsecured note payable to an affiliate at a fixed rate of 6.86% per annum and $21,585,000, or 42.5%, of the total debt outstanding under the line of credit at a weighted average interest rate of 6.88% per annum.
An increase in the variable interest rate on the Wachovia line of credit constitutes a market risk. As of December 31, 2006, for example a 0.50% increase in LIBOR would have increased our overall annual interest expense by $19,000, or 5.5%.
In addition to changes in interest rates, the value of our future properties is subject to fluctuations based on changes in local and regional economic conditions and changes in the creditworthiness of residents, which may affect our ability to refinance our debt if necessary.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
See the index at Item 15. Exhibits, Financial Statement Schedules.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A(T).
Item 9A(T).
Controls and Procedures.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.
As of December 31, 2007, an evaluation was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the chief executive officer and the chief financial officer concluded that the design and operation of these disclosure controls and procedures were effective.
(b) Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation.
Based on our evaluation under the Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.
(c) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report on Form 10-K.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The following table and biographical descriptions set forth information with respect to our officers and directors as of March 28, 2008:
There are no family relationships between any directors, executive officers or between any director and executive officer.
Stanley J. (“Jay”) Olander, Jr. has been the chief executive officer and a director of our company and the chief executive officer of Grubb & Ellis Apartment REIT Advisors, LLC, or our advisor, since December 2005. Since December 2006, he has also served as chairman of our board of directors and since April 2007, he has served as our president and president of our advisor. Mr. Olander has also been a managing member of ROC REIT Advisors, LLC, or ROC REIT Advisors, since 2006. Since July 2007, Mr. Olander has also served as chief executive officer, president and chairman of the board of Grubb & Ellis Residential Management, Inc., or Residential Management, an indirect wholly owned subsidiary of Grubb & Ellis Company, or Grubb & Ellis, or our sponsor, that provides property management services to apartment communities. Since December 2007, Mr. Olander has also served as the executive vice president, Multifamily Division of our sponsor. He served as president and chief financial officer and a member of the board of directors of Cornerstone Realty Income Trust, Inc., or Cornerstone, from 1996 until April 2005. Prior to the sale of Cornerstone in April 2005, Cornerstone’s shares were listed on the New York Stock Exchange, and it owned approximately 23,000 apartment units in five states and had a total market capitalization of approximately $1.5 billion. Mr. Olander has been responsible for the acquisition and financing of approximately 40,000 apartment units. He holds a bachelor’s degree in Business Administration from Radford University in Virginia and a master’s degree in Real Estate and Urban Land Development from Virginia Commonwealth University.
David L. Carneal has been the executive vice president and chief operating officer of our company and our advisor since December 2005. Mr. Carneal has also been a managing member of ROC REIT Advisors since 2006. Since July 2007, Mr. Carneal has also served as an executive vice president of Residential Management. From 1998 to 2003, Mr. Carneal served as senior vice president of operations of Cornerstone, and from 2003 to 2005, served as executive vice president and chief operating officer. Mr. Carneal was responsible for overseeing the property management operations of approximately 23,000 apartment units. Prior to joining Cornerstone, Mr. Carneal held management and development positions with several other multifamily property management companies including Trammell Crow Residential. Mr. Carneal holds a bachelor’s degree from the University of Virginia.
Gus G. Remppies has been the executive vice president and chief investment officer of our company and our advisor since their formation. Mr. Remppies has also been a managing member of ROC REIT Advisors since 2006. Since July 2007, Mr. Remppies has also served as an executive vice president of Residential Management. From 1995 to 2003, Mr. Remppies served as Senior Vice president of Acquisition of
Cornerstone, and from 2003 to 2005, served as executive vice president and chief investment officer. As such, he was responsible for all acquisitions, dispositions, financing and development for Cornerstone. During this tenure, Mr. Remppies oversaw the acquisition and development of approximately 30,000 apartment units. In addition, he oversaw the placement of over $500 million in debt, both secured and unsecured, with a variety of lenders. He is a graduate of the University of Richmond in Virginia, where he received his degree in Business Administration.
Scott D. Peters has served as one of our directors since April 2007 and as our executive vice president since December 2005. He also served as our chief financial officer from December 2005 through April 2006. Mr. Peters has also served as the executive vice president and chief financial officer of our advisor since December 2005. Mr. Peters has also served as the chief executive officer, president and a director of our sponsor since December 2007. He has also served as the chief executive officer and president of NNN Realty Advisors, Inc., or NNN Realty Advisors, a wholly owned subsidiary of our sponsor, since September 2006 and the chairman of the board of NNN Realty Advisors since December 2007. Mr. Peters has also served as a director of Residential Management since July 2007. Mr. Peters also has served as the chief executive officer of Grubb & Ellis Realty Investors since November 2006, having served as its executive vice president and chief financial officer from September 2004 through October 2006. From December 2005 through January 2008, Mr. Peters also served as the chief executive officer and president of G REIT, Inc. having previously served as its executive vice president and chief financial officer from September 2004 through January 2008. Mr. Peters also served as the executive vice president and chief financial officer of T REIT, Inc., from September 2004 to December 2006 and has served as chief executive officer, chairman of the board and president of Grubb & Ellis Healthcare REIT, Inc., or Grubb & Ellis Healthcare REIT, since April 2006, January 2006 and June 2007, respectively. From February 1997 to February 2007, Mr. Peters served as senior vice president, chief financial officer and a director of Golf Trust of America, Inc., a publicly traded real estate investment trust. Mr. Peters received his B.B.A. degree in accounting and finance from Kent State University in Ohio.
Shannon K S Johnson has served as our chief financial officer since April 2006. Ms. Johnson has also served as a financial reporting manager for Grubb & Ellis Realty Investors since January 2006 and has served as the chief financial officer of Grubb & Ellis Healthcare REIT since August 2006. From June 2002 to January 2006, Ms. Johnson gained public accounting and auditing experience while employed as an auditor with PricewaterhouseCoopers, LLP. Prior to joining PricewaterhouseCoopers LLP, from September 1999 to June 2002, Ms. Johnson worked as an auditor with Arthur Andersen, LLP, where she worked on the audits of a variety of public and private entities. Ms. Johnson is a Certified Public Accountant and graduated summa cum laude with her Bachelor of Arts in Business-Economics and a minor in Accounting from the University of California, Los Angeles.
Andrea R. Biller has served as our secretary and as general counsel of our advisor since December 2005. She has also served as the general counsel, executive vice president and secretary of our sponsor, since December 2007, and of NNN Realty Advisors, since September 2006 and a director of NNN Realty Advisors since December 2007. She has served as general counsel for Grubb & Ellis Realty Investors since March 2003 and as executive vice president since January 2007. Ms. Biller has also served as the secretary and executive vice president of G REIT, Inc., from June 2004 to January 2008 and December 2005 to January 2008, respectively, the secretary of T REIT, Inc., from May 2004 to July 2007 and the executive vice president and secretary of Grubb & Ellis Healthcare REIT, since April 2006. Ms. Biller practiced as a private attorney specializing in securities and corporate law from 1990 to 1995 and 2000 to 2002. She practiced at the SEC from 1995 to 2000, including two years as special counsel for the Division of Corporation Finance. Ms. Biller earned a B.A. degree in Psychology from Washington University, an M.A. degree in Psychology from Glassboro State University in New Jersey and a J.D. degree from George Mason University School of Law in Virginia in 1990, where she graduated first with distinction. Ms. Biller is a member of the California, Virginia and the District of Columbia State Bar Associations.
Glenn W. Bunting, Jr. has been a director of our company since its formation. He has been president of American KB Properties, Inc., which develops and manages shopping centers, since 1985. He has been president of G. B. Realty Corporation, which brokers shopping centers and apartment communities, since
1980. Mr. Bunting is a current director of Apple Hospitality Two, Inc., Apple Hospitality Five, Inc. and Apple REIT Six, Inc., and a former director of Cornerstone, where he served on that company’s audit committee. Mr. Bunting holds a BS in Business Administration from Campbell University in North Carolina.
Robert A. Gary, IV has been a director of our company since December 2005. He is the chairperson and financial expert for our company’s audit committee. Mr. Gary co-founded Keiter, Stephens, Hurst, Gary and Shreaves, which is an independent certified public accounting firm based in Richmond, Virginia, in 1978, where he has worked since its formation. His accounting practice focuses on general business consulting, employee benefits and executive compensation, and estate planning and administration. Mr. Gary is a former director of Cornerstone where he served as chairperson of the company’s audit committee. He holds a BS in Accounting from Wake Forest University in North Carolina and an MBA from the University of Virginia’s Darden School. He is a member of the American Institute of Certified Public Accountants and the Virginia Society of Certified Public Accountants.
W. Brand Inlow has been a director of our company since December 2005. He is a principal, co-founder, and serves as director of acquisitions for McCann Realty Partners, LLC, an apartment investment company focusing on garden apartment communities in the southeast formed in October 2004. Since November 2003, Mr. Inlow has provided professional consulting services to the multifamily industry on matters related to acquisitions, dispositions, asset management and property management operations, and through an affiliation with LAS Realty in Richmond, Virginia conducts commercial real estate brokerage. Mr. Inlow also is president of Jessie’s Wish, Inc., a Virginia non-profit corporation dedicated to awareness, education and financial assistance for patients and families dealing with eating disorders. Mr. Inlow served as president of Summit Realty Group, Inc. in Richmond, Virginia, from September 2001 through November 2003. Prior to joining Summit Realty, from December 1999 to August 2001, he was Vice president of Acquisitions for EEA Realty, LLC in Alexandria, Virginia, where he was responsible for acquisition, disposition, and financing of company assets, which were primarily garden apartment properties. Prior to joining EEA Realty, from December 1992 to November 1999, Mr. Inlow worked for United Dominion Realty Trust, Inc., a publicly traded REIT, as Assistant Vice president and Senior Acquisition Analyst, where he was responsible for the acquisition of garden apartment communities. Mr. Inlow also serves as a trustee of G REIT Liquidating Trust and as the sole trustee of T REIT Liquidating Trust.
Our Advisor
Management
The following table sets forth information with respect to our advisor’s executive officers as of March 28, 2008:
For biographical information regarding Messrs. Olander, Peters, Carneal and Remppies and Ms. Biller, see - Directors, Executive Officers and Corporate Governance, above.
Grubb & Ellis Realty Investors owns a 50.0% managing member interest in our advisor. Grubb & Ellis Apartment Management, LLC owns a 25.0% non-managing member interest in our advisor. The members of Grubb & Ellis Apartment Management, LLC include; (1) Scott D. Peters, our executive vice president and our advisor’s executive vice president and chief financial officer; (2) Andrea R. Biller, our secretary and our advisor’s general counsel; and (3) Grubb & Ellis Realty Investors for the benefit of other employees who perform services for us. Mr. Peters and Ms. Biller each own 18.0% membership interests in Grubb & Ellis Apartment Management, LLC.
ROC REIT Advisors owns a 25.0% non-managing member interest in our advisor. The members of ROC REIT Advisors, are; (1) Stanley J. Olander, Jr., our chief executive officer, president and chairman of our board of directors and our advisor’s chief executive officer; (2) Gus G. Remppies, our executive vice president and chief investment officer and our advisor’s executive vice president and chief investment officer; and (3) David L. Carneal, our executive vice president and chief operating officer and our advisor’s executive vice president and chief operating officer. Each of Mr. Olander, Mr. Remppies and Mr. Carneal own 33.3% membership interests in ROC REIT Advisors.
We rely on our advisor to manage our day-to-day activities and to implement our investment strategy. We and our advisor are parties to an advisory agreement, or the Advisory Agreement, pursuant to which our advisor performs its duties and responsibilities as our fiduciary.
Grubb & Ellis, NNN Realty Advisors and Grubb & Ellis Realty Investors
Our sponsor Grubb & Ellis, headquartered in Santa Ana, California, is one of the most recognized full-service commercial real estate services firms in the United States. Drawing on the resources of nearly 5,500 real estate professionals, including a brokerage sales force of approximately 1,800 brokers nationwide, Grubb & Ellis and its affiliates combine local market knowledge with a national service network to provide innovative, customized solutions for real estate owners, corporate occupants and investors.
On December 7, 2007, NNN Realty Advisors, which previously served as our sponsor, merged with and into a wholly owned subsidiary of Grubb & Ellis. The transaction was structured as a reverse merger whereby stockholders of NNN Realty Advisors received shares of common stock of Grubb & Ellis in exchange for their NNN Realty Advisors shares of common stock and, immediately following the merger, former NNN Realty Advisor stockholders held approximately 59.5% of the common stock of Grubb & Ellis.
The merger combines a leading full-service commercial real estate organization with a leading sponsor of commercial real estate programs to create a diversified real estate services business providing a complete range of transaction, management and consulting services, and possessing a strong platform for continued growth. Grubb & Ellis continues to use the “Grubb & Ellis” name and continues to be listed on the New York Stock Exchange under the ticker symbol “GBE.” As a result of the merger, we consider Grubb & Ellis to be our sponsor. Upon Grubb & Ellis becoming our sponsor, we changed our name from NNN Apartment REIT, Inc. to Grubb & Ellis Apartment REIT, Inc.
Grubb & Ellis Realty Investors, the parent and manager of our advisor and an indirect wholly owned subsidiary of our sponsor, offers a diverse line of investment products as well as a full-range of services including asset and property management, brokerage, leasing, analysis and consultation. Grubb & Ellis Realty Investors is also an active seller of real estate, bringing many of its investment programs full cycle.
Committees of Our Board of Directors
Our board of directors may establish committees it deems appropriate to address specific areas in more depth than may be possible at a full board meeting, provided that the majority of the members of each committee are independent directors. Our board of directors has established an audit committee. We do not plan to have a compensation committee because we do not plan to pay any compensation to our officers. However, if in the future we provide any compensation to our officers, we will establish a compensation committee comprised entirely of independent directors to determine the nature and amount of such compensation.
Acquisition Committee
Each of our acquisitions must be approved by the acquisition committee or a majority of our board of directors, including a majority of the independent directors, as being fair and reasonable to our company and consistent with our investment objectives. Currently, the acquisition committee is comprised of all members of our board of directors. Our advisor will recommend suitable properties for consideration by the acquisition committee. If the members of the acquisition committee approve a given acquisition, then our advisor will be
directed to acquire the property on our behalf, if such acquisition can be completed on terms approved by the committee. Properties may be acquired from our advisor or its affiliates or our officers and directors, provided that a majority of our board of directors, including a majority of the independent directors, not otherwise interested in the transaction, approve the transaction as being fair and reasonable to our company and at a price to our company no greater than the cost of the property to the affiliate, unless substantial justification exists for a price in excess of the cost to the affiliate and the excess is reasonable.
Audit Committee
We have an audit committee comprised of three individuals, all of whom are independent directors. Currently the audit committee includes Messrs. Gary, Bunting, and Inlow. Mr. Gary is designated as the audit committee financial expert. The audit committee:
•
makes recommendations to our board of directors concerning the engagement of independent public accountants;
•
reviews the plans and results of the audit engagement with the independent public accountants;
•
approves professional services provided by, and the independence of, the independent public accountants;
•
considers the range of audit and non-audit fees; and
•
consults with the independent public accountants regarding the adequacy of our internal accounting controls.
Incentive Award Plan
The shares of stock subject to the 2006 Incentive Award Plan will be our common stock. Under the terms of the 2006 Incentive Award Plan, the aggregate number of shares of our common stock subject to options, restricted stock awards, stock purchase rights, stock appreciation rights, or SARs, and other awards will be no more than 2,000,000 shares, subject to adjustment under specified circumstances. The maximum number of shares which may be subject to options, stock purchase rights, SARs and other awards granted under the 2006 Incentive Award Plan to any individual in any calendar year may not exceed 250,000 shares. In addition, the maximum amount of cash that may be paid as a cash bonus to any individual in any calendar year is $1,000,000.
Our board of directors, or a committee of the board of directors, will be the administrator of the 2006 Incentive Award Plan. The 2006 Incentive Award Plan provides that the administrator may grant or issue stock options, SARs, restricted stock, deferred stock, dividend equivalents, performance awards and stock payments, or any combination thereof. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type, terms and conditions of the award.
Our officers, employees, if any, consultants and non-officer directors, as well as key employees of our advisor and its managing member, are eligible to receive awards under the 2006 Incentive Award Plan. The administrator determines which of our officers, employees, consultants, non-officer directors and key employees of our advisor and its managing member will be granted awards.
On July 19, 2006 and June 12, 2007, we granted an aggregate of 4,000 and 3,000 shares, respectively, of restricted common stock, as defined in the 2006 Incentive Award Plan, to our independent directors under the 2006 Incentive Award Plan, of which 20.0% vested on the grant date and 20.0% will vest on each of the first four anniversaries of the date of the grant. The fair value of each share of restricted common stock was estimated at the date of grant at $10.00 per share, the per share price of shares in our Offering, and is amortized on a straight-line basis over the vesting period. Shares of restricted common stock may not be sold, transferred, exchanged, assigned, pledged, hypothecated or otherwise encumbered. Such restrictions expire upon vesting. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we recognized compensation expense of $15,000 and $11,000, respectively, related to the restricted common stock grants, which is included in general and administrative in
our accompanying consolidated statements of operations. Shares of restricted common stock have full voting rights and rights to dividends.
Amendment and Termination of the 2006 Incentive Award Plan
Our board of directors may not, without stockholder approval within twelve months of the board of director’s action, amend the 2006 Incentive Award Plan to increase the number of shares of our common stock that may be issued under the 2006 Incentive Award Plan.
Our board of directors may terminate the 2006 Incentive Award Plan at any time. The 2006 Incentive Award Plan will be in effect until terminated by our board of directors. However, in no event may any award be granted under the 2006 Incentive Award Plan after ten years following the 2006 Incentive Award Plan’s effective date, July 19, 2006. Except as indicated above, our board of directors may modify the 2006 Incentive Award Plan from time to time.
Code of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics, or the Code of Ethics, which contains general guidelines for conducting our business and is designed to help directors, employees and independent consultants resolve ethical issues in an increasingly complex business environment. The Code of Ethics applies to our principal executive officer, principal financial officer, principal accounting officer, controller and persons performing similar functions and all members of our board of directors. The Code of Ethics covers topics including, but not limited to, conflicts of interest, confidentiality of information, and compliance with laws and regulations. Stockholders may request a copy of the Code of Ethics, which will be provided without charge, by writing to Grubb & Ellis Apartment REIT, Inc. at 1551 N. Tustin Avenue, Suite 300, Santa Ana, California 92705, Attention: Secretary.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires each director, officer, and individual beneficially owning more than 10.0% of a registered security of the company to file with the SEC, within specified time frames, initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of common stock of the company. These specified time frames require the reporting of changes in ownership within two business days of the transaction giving rise to the reporting obligation. Reporting persons are required to furnish us with copies of all Section 16(a) forms filed with the SEC. Based solely on a review of the copies of such forms furnished to us during and with respect to the fiscal year ended December 31, 2007 or written representations that no additional forms were required, to the best of our knowledge, all required Section 16(a) filings were timely and correctly made by reporting persons during 2007.
Item 11.
Item 11.
Executive Compensation.
Executive Compensation
We have no employees. Our day-to-day management functions are performed by employees of our advisor and its affiliates. The individuals who serve as our executive officers do not receive compensation directly from us. Each of our executive officers, including those officers who serve as directors, is employed by our advisor or its affiliates, and is compensated by these entities for their services to us. We pay these entities fees and reimburse expenses pursuant to our Advisory Agreement. We do not currently intend to pay any compensation directly to our executive officers. As a result, we do not have, and our board of directors has not considered, a compensation policy or program for our executive officers and has not included a Compensation Discussion and Analysis in this Form 10-K.
Option/SAR Grants in Last Fiscal Year
No option grants were made to officers and directors for the year ended December 31, 2007.
Compensation Committee Interlocks and Insider Participation
There are no interlocks or insider participation as to compensation decisions required to be disclosed pursuant to SEC regulations.
Director Compensation
Pursuant to the terms of our director compensation program, which are contained in our 2006 Incentive Award Plan, our independent directors receive the following forms of compensation:
•
Annual Retainer. Our independent directors receive an annual retainer of $15,000.
•
Meeting Fees. Our independent directors receive $1,000 for each board meeting attended in person or by telephone, $500 for each committee meeting attended in person or by telephone, and an additional $2,000 to the audit committee chair for each audit committee meeting attended in person or by telephone. If a board meeting is held on the same day as a committee meeting, an additional fee will not be paid for attending the committee meeting, except that the audit committee chair will be paid $2,500 when an audit committee meeting is held on the same day as a board meeting.
•
Equity Compensation. Upon initial election to our board of directors, each independent director receives 1,000 shares of restricted common stock, and an additional 1,000 shares of restricted common stock upon his or her subsequent election each year. The restricted shares vest as to 20.0% of the shares on the date of grant and on each anniversary thereafter over four years from the date of grant.
•
Expense Reimbursement. We reimburse our directors for reasonable out-of-pocket expenses incurred in connection with attendance at meetings, including committee meetings, of our board of directors. Independent directors do not receive other benefits from us.
Our non-independent directors do not receive any compensation from us.
The following table sets forth the compensation earned by our directors from us in 2007:
(1) Consists of the amounts described below.
(2) The amounts in this column represent the proportionate amount of the total fair value of stock awards recognized by the Company in 2007 for financial accounting purposes, disregarding for this purpose the
estimate of forfeitures related to service-based vesting conditions. The amounts included in the table for each award include the amount recorded as expense in our consolidated statement of operations for the year ended December 31, 2007. The fair values of these awards and the amounts expensed in 2007 were determined in accordance with Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment, or SFAS No. 123(R).
The following table shows the shares of restricted common stock awarded to each independent director during 2007, and the aggregate grant date fair value for each award (computed in accordance with SFAS No. 123(R)).
The following table shows the aggregate numbers of nonvested restricted shares of common stock held by each director as of December 31, 2007:
(3) Mr. Olander, Mr. Peters and Mr. Rogers were not independent directors.
(4) Mr. Peters has served as our director since April 2007.
(5) Mr. Rogers served as our director until June 2007.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
PRINCIPAL STOCKHOLDERS
The following table shows, as of March 14, 2008, the amount of shares of our common stock beneficially owned by (1) any person who is known by us to be the beneficial owner of more than 5.0% of the outstanding shares of our common stock, (2) our directors, (3) our executive officers; and (4) all of our directors and executive officers as a group. The percentage of common stock beneficially owned is based on 9,948,488 shares of our common stock outstanding as of March 14, 2008. Beneficial ownership is determined in accordance with the rules of the SEC and generally includes securities over which a person has voting or investment power and securities that a person has the right to acquire within 60 days.
*
Represents less than 1.0% of our outstanding common stock.
(1)
The address of each beneficial owner listed is c/o Grubb & Ellis Apartment REIT, Inc., 1551 N. Tustin Avenue, Suite 300, Santa Ana, California 92705.
(2)
Includes 22,223 shares of our common stock owned by our advisor. Stanley J. Olander, Jr. is the chief executive officer of our advisor. Our advisor also owns 100 units of Grubb & Ellis Apartment REIT Holdings, L.P., or our operating partnership.
(3)
Includes vested and nonvested restricted shares of common stock.
EQUITY COMPENSATION PLAN INFORMATION
Under the terms of our 2006 Incentive Award Plan, the aggregate number of shares of our common stock subject to options, restricted shares of common stock, stock purchase rights, SARs or other awards, will be no more than 2,000,000 shares.
(1) On July 19, 2006 and June 12, 2007, we granted an aggregate of 4,000 and 3,000 shares, respectively, of restricted common stock, as defined in the 2006 Incentive Award Plan, to our independent directors under the 2006 Incentive Award Plan, of which 20.0% vested on the grant date and 20.0% will vest on each of the first four anniversaries of the date of the grant. Such shares are not shown in the chart above as they are deemed outstanding shares of our common stock; however such grants reduce the number of securities
remaining available for future issuance. In addition, 800 shares of restricted common stock were forfeited in November 2006.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Relationships Among Our Affiliates
Some of our executive officers and our non-independent directors are also executive officers and/or holders of direct or indirect interests in our advisor, our sponsor, and NNN Realty Advisors, or other affiliated entities.
Grubb & Ellis Realty Investors owns a 50.0% managing member interest in our advisor. Grubb & Ellis Apartment Management, LLC owns a 25.0% non-managing member interest in our advisor. The members of Grubb & Ellis Apartment Management, LLC include; (1) Scott D. Peters, our executive vice president and our advisor’s executive vice president and chief financial officer; (2) Andrea R. Biller, our secretary and our advisor’s general counsel; and (3) Grubb & Ellis Realty Investors for the benefit of other employees who perform services for us. As of March 28, 2008, each of Mr. Peters and Ms. Biller own 18.0% membership interests in Grubb & Ellis Apartment Management, LLC. Grubb & Ellis Realty Investors owns a 64.0% membership interest in Grubb & Ellis Apartment Management, LLC.
ROC REIT Advisors owns a 25.0% non-managing member interest in our advisor. The members of ROC REIT Advisors are; (1) Stanley J. Olander, Jr., our chief executive officer, president and chairman of our board of directors and our advisor’s chief executive officer; (2) Gus G. Remppies, our executive vice president and chief investment officer and our advisor’s executive vice president and chief investment officer; and (3) David L. Carneal, our executive vice president and chief operating officer and our advisor’s executive vice president and chief operating officer.
Each of Mr. Olander, Mr. Remppies and Mr. Carneal owned 33.3% membership interests in ROC Realty Advisors, LLC, an entity that owned 50.0% of the membership interests in NNN/ROC Apartment Holdings, LLC. NNN/ROC Apartment Holdings, LLC owns several entities that master lease properties sponsored by Grubb & Ellis Realty Investors and earns fees as a result of property acquisitions by programs sponsored by Grubb & Ellis Realty Investors, other than us. On July 20, 2007, NNN Realty Advisors purchased 100% of the membership interests in ROC Realty Advisors, LLC from Mr. Olander, Mr. Remppies and Mr. Carneal for an aggregate purchase price of (1) 400,000 shares of restricted stock of NNN Realty Advisors, which is subject to vesting pursuant to a Restricted Stock Agreement, (2) a $1,700,000 cash payment and (3) an additional cash payment of $1,000,000 that is to be paid out in equal installments on the first business day following January 1 of 2008, 2009 and 2010. The restricted shares of common stock converted into shares of restricted common stock of Grubb & Ellis in connection with the reverse merger of NNN Realty Advisors and Grubb & Ellis.
Fees and Expenses Paid to Affiliates
Upon the effectiveness of our Offering, we entered into the Advisory Agreement and a dealer manager agreement, or the Dealer Manager Agreement, with Grubb & Ellis Securities, Inc., or Grubb & Ellis Securities, or our dealer manager. These agreements entitle our advisor, our dealer manager and their affiliates to specified compensation for certain services with regards to our Offering and the investment of funds in real estate assets, among other services, as well as reimbursement of organizational and offering expenses incurred. In the aggregate, for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred our advisor or its affiliates $14,069,000 and $4,125,000, respectively, as detailed below.
Offering Stage
Selling Commissions
Our dealer manager receives selling commissions of up to 7.0% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. Our dealer manager may re-allow all or a portion of these fees to participating broker-dealers. For the year ended
December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $4,652,000 and $1,141,000, respectively, in selling commissions to our dealer manager. Such commissions are charged to stockholders’ equity as such amounts are reimbursed to our dealer manager from the gross proceeds of our Offering.
Marketing Support Fee and Due Diligence Expense Reimbursements
Our dealer manager may receive non-accountable marketing support fees and due diligence expense reimbursements up to 2.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. Our dealer manager may re-allow up to 1.5% of the gross offering proceeds to participating broker-dealers. In addition, we may reimburse our dealer manager or its affiliates an additional accountable 0.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering, other than shares sold pursuant to the DRIP, as reimbursements for bona fide due diligence expenses. Our dealer manager or its affiliates may re-allow all or a portion of these fees up to 0.5% of the gross offering proceeds to participating broker-dealers. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $1,709,000 and $494,000, respectively, in marketing support fees and due diligence expense reimbursements to our dealer manager or its affiliates. Such fees and reimbursements are charged to stockholders’ equity as such amounts are reimbursed to our dealer manager or its affiliates from the gross proceeds of our Offering.
Other Organizational and Offering Expenses
Our organizational and offering expenses are paid by our advisor or Grubb & Ellis Realty Investors on our behalf. Our advisor or Grubb & Ellis Realty Investors may be reimbursed for actual expenses incurred for up to 1.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $1,006,000 and $249,000, respectively, in offering expenses to our advisor or Grubb & Ellis Realty Investors. Other organizational expenses are expensed as incurred, and offering expenses are charged to stockholders’ equity as such amounts are reimbursed to our advisor or Grubb & Ellis Realty Investors from the gross proceeds of our Offering.
Acquisition and Development Stage
Acquisition Fees
Our advisor or its affiliates receive, as compensation for services rendered in connection with the investigation, selection and acquisition of properties, an acquisition fee of up to 3.0% of the contract purchase price for each property acquired or up to 4.0% of the total development cost of any development property acquired, as applicable. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $4,724,000 and $1,884,000, respectively, in acquisition fees to our advisor or its affiliates. Acquisition fees are capitalized as part of the purchase price allocations.
Reimbursement of Acquisition Expenses
Our advisor or its affiliates will be reimbursed for acquisition expenses related to selecting, evaluating, acquiring and investing in properties. Acquisition expenses, including amounts paid to third parties, will not exceed 0.5% of the purchase price of the properties. The reimbursement of acquisition expenses, acquisition fees and real estate commissions paid to unaffiliated parties will not exceed, in the aggregate, 6.0% of the purchase price or total development costs, unless fees in excess of such limits are approved by a majority of our disinterested independent directors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $3,000 and $0, respectively, in expenses to our advisor or its affiliates, excluding amounts our advisor or its affiliates paid directly to third parties.
Operational Stage
Asset Management Fee
Our advisor or its affiliates are paid a monthly fee for services rendered in connection with the management of our assets in an amount equal to one-twelfth of 1.0% of the average invested assets calculated as of the close of business on the last day of each month, subject to our stockholders receiving annualized distributions in an amount equal to at least 5.0% per annum on average invested capital. The asset management fee is calculated and payable monthly in cash or shares of our common stock, at the option of our advisor, not to exceed one-twelfth of 1.0% of our average invested assets as of the last day of the immediately preceding quarter. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $950,000 and $0, respectively, in asset management fees to our advisor or its affiliates, which is included in general and administrative in our accompanying consolidated statements of operations.
Property Management Fees
Our advisor or its affiliates are paid a property management fee equal to 4.0% of the monthly gross cash receipts from any property managed for us. This fee is paid monthly. Our advisor or its affiliates anticipate that they will subcontract property management services to third parties and will be responsible for paying all fees due to such third party contractors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $489,000 and $24,000, respectively, in property management fees to our advisor or its affiliate, which is included in rental expenses in our accompanying consolidated statements of operations.
On-site Personnel Payroll
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, Grubb & Ellis Realty Investors incurred payroll for on-site personnel on our behalf of $159,000 and $0, respectively, which is included in rental expenses in our accompanying consolidated statements of operations.
Operating Expenses
We reimburse our advisor or its affiliates for expenses incurred in rendering services to us, subject to certain limitations on our operating expenses. However, we cannot reimburse our advisor and its affiliates for fees and costs that exceed the greater of: (1) 2.0% of our average invested assets, as defined in the Advisory Agreement, or (2) 25.0% of our net income, as defined in the Advisory Agreement, unless our board of directors determines that such excess expenses were justified based on unusual and non-recurring factors. For the twelve months ended December 31, 2007, our operating expenses did not exceed this limitation. Our operating expenses as a percentage of average invested assets and as a percentage of net income were 1.8% and 2,972.0%, respectively, for the twelve months ended December 31, 2007.
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, Grubb & Ellis Realty Investors incurred on our behalf $165,000 and $325,000, respectively, in operating expenses which is included in general and administrative in our accompanying consolidated statements of operations or prepaid expenses on our accompanying consolidated balance sheets, as applicable.
Compensation for Additional Services
Our advisor or its affiliates will be paid for services performed on our behalf other than those required to be rendered by our advisor or its affiliates, under the Advisory Agreement. The rate of compensation for these services must be approved by a majority of our board of directors, and cannot exceed an amount that would be paid to unaffiliated third parties for similar services. For the year ended December 31, 2007 and for the
period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $8,000 and $0, respectively, for tax services an affiliate provided to us.
Liquidity Stage
Disposition Fees
Our advisor or its affiliates will be paid for services relating to a sale of one or more properties, a disposition fee up to the lesser of 1.75% of the contract sales price or 50.0% of a customary competitive real estate commission given the circumstances surrounding the sale, which will not exceed market norms. The amount of disposition fees paid, including the real estate commissions paid to unaffiliated parties, will not exceed the lesser of the customary competitive disposition fee or an amount equal to 6.0% of the contract sales price. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such fees.
Incentive Distribution Upon Sales
Upon liquidation, our advisor will be paid an incentive distribution equal to 15.0% of net sales proceeds from any disposition of a property after subtracting (1) the amount of capital we invested in our operating partnership; (2) an amount equal to an 8.0% annual cumulative, non-compounded return on such invested capital; and (3) any shortfall with respect to the overall 8.0% annual cumulative, non-compounded return on the capital invested in our operating partnership. Actual amounts to be received depend on the sale prices of properties upon liquidation. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such distributions.
Incentive Distribution Upon Listing
Upon the listing of shares of our common stock on a national securities exchange, our advisor will be paid an incentive distribution equal to 15.0% of the amount, if any, by which the market value of our outstanding stock plus distributions paid by us prior to listing, exceeds the sum of the amount of capital we invested in our operating partnership plus an 8.0% annual cumulative, non-compounded return on such invested capital. Actual amounts to be received depend upon the market value of our outstanding stock at the time of listing among other factors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such distributions.
Fees Payable upon Termination of Advisory Agreement
Upon termination of the Advisory Agreement due to an internalization of our advisor in connection with our conversion to a self-administered REIT, our advisor will be paid a fee determined by negotiation between our advisor and our independent directors. Upon our advisor’s receipt of such compensation, our advisor’s special limited partnership units will be redeemed and our advisor will not be entitled to receive any further incentive distributions upon sale of our properties. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such fees.
Accounts Payable Due to Affiliates, Net
The following amounts were outstanding to affiliates as of December 31, 2007 and 2006:
Unsecured Note Payables to Affiliate
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we entered into, and subsequently paid down, the following unsecured loans with NNN Realty Advisors, evidenced by unsecured promissory notes:
The unsecured notes bore interest at a fixed rate and required monthly interest-only payments for the terms of the unsecured notes. As of December 31, 2007 and 2006, the balances under the unsecured note payables to affiliate were $7,600,000 and $10,000,000, respectively.
Because these loans were related party loans, the terms of the loans and the unsecured notes were approved by our board of directors, including a majority of our independent directors, and deemed fair, competitive and commercially reasonable by our board of directors.
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred interest expense to NNN Realty Advisor of $204,000 and $8,000, respectively.
Director and Former President’s Financial Arrangement with Legal Counsel
The law firm of Hirschler Fleischer represented Grubb & Ellis Apartment REIT, Inc. in certain legal matters during 2007 and 2006. For the year ended December 31, 2007 and 2006 we, or our affiliates on our behalf, incurred legal fees to Hirschler Fleischer of approximately $42,000 and $312,000, respectively. Louis J. Rogers, our director from July 2006 through June 2007, our president and the chairman of our advisor from inception through April 6, 2007, the president of Triple Net Properties from September 2004 through April 3, 2007 and a director of NNN Realty Advisors, also practiced law with Hirschler Fleischer from 1987 to March 2007. Mr. Rogers was a shareholder of Hirschler Fleischer from 1994 to December 31, 2004, and served as senior counsel in that firm from January 2005 to March 2007. We previously disclosed in the prospectus for our Offering that Mr. Rogers shared in Hirschler Fleischer’s revenues.
On March 19, 2007, we learned that, in connection with his transition from shareholder to senior counsel, Mr. Rogers and Hirschler Fleischer entered into a transition agreement on December 29, 2004. The transition agreement provided, among other things, that Mr. Rogers would receive a base salary from Hirschler Fleischer as follows: $450,000 in 2005, $400,000 in 2006, $300,000 in 2007, and $125,000 in 2008 and subsequent
years. Mr. Rogers’ receipt of the base salary was subject to satisfaction of certain conditions, including that Grubb & Ellis Realty Investors, LLC, the managing member of our advisor, and its affiliated companies, including us, or collectively, the Grubb & Ellis group, remain a client of Hirschler Fleischer and that collections by that firm from the Grubb & Ellis group equaled at least $1,500,000 per year. If the fees collected by Hirschler Fleischer from, the Grubb & Ellis group were less than $1,500,000, Mr. Rogers’ base salary would be proportionately reduced. Under the transition agreement, Mr. Rogers was also entitled to receive a bonus from Hirschler Fleischer on a quarterly basis, equal to a percentage, declining from 5.0% to 1.0% during the term of the agreement, of all collections by that firm from specified pre-2005 clients (including the Grubb & Ellis group) in excess of $3,000,000, as well as a percentage of all collections by that firm from new clients originated by Mr. Rogers, ranging from 6.0% to 3.0% depending on the year originated. For the year ended December 31, 2007 and 2006, the Grubb & Ellis group, incurred legal fees to Hirschler Fleischer of approximately $2,426,000 and $3,696,000, respectively, including legal fees that Grubb & Ellis Apartment REIT, Inc., or our affiliates on our behalf, incurred to Hirschler Fleischer of approximately $42,000 and $312,000, respectively. Under the transition agreement, Hirschler Fleischer paid Mr. Rogers $646,800 in base salary and bonus for 2006. Mr. Rogers’ senior counsel position with Hirschler Fleischer terminated on March 31, 2007, at which point Hirschler Fleischer had paid Mr. Rogers $75,000 for his 2007 services. Mr. Rogers has received from Hirschler Fleischer an additional $450,000 in 2007 pursuant to a separation agreement in satisfaction of all amounts owed to him under the transition agreement.
Process for Resolution of Conflicting Opportunities
The independent directors must, by majority vote, approve all actions by our advisor or its affiliates that present potential conflicts with our company, including, related party transactions.
The Advisory Agreement gives us the first opportunity to buy Class A income-producing apartment properties placed under contract by our advisor or its affiliates that satisfy our investment objectives, so long as our board of directors or appropriate acquisition committee votes to make the purchase within seven days of being offered such property by our advisor. If our board of directors or appropriate acquisition committee does not vote to make such purchase within seven days of being offered such property, our advisor is free to offer such opportunity to any other affiliates or non-affiliates, as it so chooses.
We believe that the above factors, including the obligations of our advisor and its affiliates to present to us any Class A income-producing apartment property opportunities that satisfy our investment objectives, will help to lessen the competition or conflicts with respect to the acquisition of properties and other transactions which affect our interests.
Director Independence
We have a five-member board of directors. Two of our directors, Stanley J. Olander, Jr. and Scott D. Peters, are affiliated with us and we do not consider them to be independent directors. The three remaining directors qualify as “independent directors” as defined in our charter in compliance with the requirements of the North American Securities Administrators Association’s Statement of Policy Regarding Real Estate Investment Trusts. Our charter provides that a majority of the directors must be “independent directors.” As defined in our charter, the term “independent director” means a director who is not on the date of determination, and within the last two years from the date of determination has not been, directly or indirectly associated with the sponsor or the advisor by virtue of (1) ownership of an interest in our sponsor, our advisor or any of their affiliates, other than the Corporation; (2) employment by our sponsor, our advisor or any of their affiliates; (3) service as an officer or director of our sponsor, our advisor or any of their affiliates; (4) performance of services, other than as a director for us; (5) service as a director or trustee of more than three REITs organized by our sponsor or advised by our advisor; or (6) maintenance of a material business or professional relationship with our sponsor, our advisor or any of their affiliates.
Each of our independent directors would also qualify as independent under the rule of the New York Stock Exchange and our Audit Committee members would qualify as independent under the New York Stock
Exchange’s rules applicable to Audit Committee members. However, our stock is not listed on the New York Stock Exchange.
Item 14.
Item 14. Principal Accounting Fees and Services.
Deloitte & Touche, LLP has served as our independent auditors since January 6, 2006 and audited our consolidated financial statements for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006.
The following table lists the fees for services rendered by our independent auditors for 2007 and 2006:
(1) Audit fees billed in 2007 and 2006 consisted of the audit of our annual consolidated financial statements, a review of our quarterly consolidated financial statements, and statutory and regulatory audits, consents and other services related to filings with the SEC, including filings related to our Offering.
(2) Audit-related fees consist of financial accounting and reporting consultations.
(3) Tax services consist of tax compliance and tax planning and advice.
The audit committee preapproves all auditing services and permitted non-audit services (including the fees and terms thereof) to be performed for us by our independent auditor, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(1)(b) of the Exchange Act and the rules and regulations of the SEC.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
(a)(2) Financial Statement Schedules:
The following financial statement schedules for the year ended December 31, 2007 are submitted herewith:
All schedules other than the ones listed above have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
(a)(3) Exhibits:
The exhibits listed on the Exhibit Index (following the signatures section of this report) are included, or incorporated by reference, in this annual report.
(b) Exhibits:
See item 15(a)(3) above.
(c) Financial Statement Schedules:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Grubb & Ellis Apartment REIT, Inc.
We have audited the accompanying consolidated balance sheets of Grubb & Ellis Apartment REIT, Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006 and the related consolidated statements of operations, stockholders’ equity and cash flows for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006. Our audits also included the consolidated financial statement schedules listed in the index at Item 15. These consolidated financial statements and the consolidated financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of their operations and their cash flows for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects, the information set forth therein.
/s/ Deloitte & Touche, LLP
Los Angeles, California
March 28, 2008
Grubb & Ellis Apartment REIT, Inc.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2007 and 2006
The accompanying notes are an integral part of these consolidated financial statements.
Grubb & Ellis Apartment REIT, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year Ended December 31, 2007 and
for the Period from January 10, 2006 (Date of Inception) through December 31, 2006
The accompanying notes are an integral part of these consolidated financial statements.
Grubb & Ellis Apartment REIT, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Year Ended December 31, 2007
and for the Period from January 10, 2006 (Date of Inception)
through December 31, 2006
The accompanying notes are an integral part of these consolidated financial statements.
Grubb & Ellis Apartment REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 2007 and for the Period from
January 10, 2006 (Date of Inception) through December 31, 2006
The accompanying notes are an integral part of these consolidated financial statements.
Grubb & Ellis Apartment REIT, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Year Ended December 31, 2007 and for the Period from January 10, 2006
(Date of Inception) through December 31, 2006
The use of the words “we,” “us” or “our” refers to Grubb & Ellis Apartment REIT, Inc. and its subsidiaries, including Grubb & Ellis Apartment REIT Holdings, L.P., except where the context otherwise requires.
1.
Organization and Description of Business
Grubb & Ellis Apartment REIT, Inc. (formerly known as NNN Apartment REIT, Inc.), a Maryland corporation, was incorporated on December 21, 2005. We were initially capitalized on January 10, 2006 and therefore we consider that our date of inception. We seek to purchase and hold a diverse portfolio of quality apartment communities with strong, stable cash flows and growth potential in select U.S. metropolitan areas. We may also invest in real estate related securities. We focus primarily on investments that produce current income. We qualified to be taxed as a real estate investment trust, or REIT, for federal income tax purposes for our taxable year ended December 31, 2006 and we intend to continue to be taxed as a REIT.
We are conducting a best efforts initial public offering, or our Offering, in which we are offering up to 100,000,000 shares of our common stock for $10.00 per share and 5,000,000 shares of our common stock pursuant to our distribution reinvestment plan, or the DRIP, at $9.50 per share, aggregating up to $1,047,500,000. As of March 14, 2008, we had received and accepted subscriptions in our Offering for 9,710,660 shares of our common stock, or $97,015,000, excluding shares issued under the DRIP.
We conduct substantially all of our operations through Grubb & Ellis Apartment REIT Holdings, L.P. (formerly known as NNN Apartment REIT Holdings, L.P.), or our operating partnership. We are externally advised by Grubb & Ellis Apartment REIT Advisor, LLC (formerly known as NNN Apartment REIT Advisor, LLC), or our advisor, pursuant to an advisory agreement, or the Advisory Agreement, between us and our advisor. Grubb & Ellis Realty Investors, LLC, or Grubb & Ellis Realty Investors (formerly known as Triple Net Properties, LLC), is the managing member of our advisor. The Advisory Agreement had an initial one-year term that expired on July 18, 2007 and is subject to successive one-year renewals upon the mutual consent of the parties. On June 12, 2007, our board of directors and our advisor approved the renewal of the Advisory Agreement for an additional one-year term, which expires on July 18, 2008. Our advisor supervises and manages our day-to-day operations and selects the properties and securities we acquire, subject to the oversight and approval by our board of directors. Our advisor also provides marketing, sales and client services on our behalf. Our advisor is affiliated with us in that we and our advisor have common officers, some of whom also own an indirect equity interest in our advisor. Our advisor engages affiliated entities, including Triple Net Properties Realty, Inc., or Realty, and Grubb & Ellis Residential Management, Inc., or Residential Management, to provide various services to us, including property management services.
On December 7, 2007, NNN Realty Advisors, Inc., or NNN Realty Advisors, which previously served as our sponsor, merged with and into a wholly owned subsidiary of Grubb & Ellis Company, or Grubb & Ellis. The transaction was structured as a reverse merger whereby stockholders of NNN Realty Advisors received shares of common stock of Grubb & Ellis in exchange for their NNN Realty Advisors shares of common stock and, immediately following the merger, former NNN Realty Advisor stockholders held approximately 59.5% of the common stock of Grubb & Ellis. As a result of the merger, we consider Grubb & Ellis to be our sponsor. Following the merger, NNN Apartment REIT, Inc., NNN Apartment REIT Holdings, L.P., NNN Apartment REIT Advisor, LLC, NNN Apartment Management, LLC, Triple Net Properties, LLC, NNN Residential Management, Inc. and NNN Capital Corp. changed their names to Grubb & Ellis Apartment REIT, Inc., Grubb & Ellis Apartment REIT Holdings, L.P., Grubb & Ellis Apartment REIT Advisor, LLC, Grubb & Ellis Apartment Management, LLC, Grubb & Ellis Realty Investors, LLC, Grubb & Ellis Residential Management, Inc. and Grubb & Ellis Securities, Inc., respectively.
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As of December 31, 2007, we owned interests in six properties in Texas consisting of 1,819 apartment units, one property in North Carolina consisting of 160 apartment units, and two properties in Virginia consisting of 394 apartment units for a total of 2,373 apartment units.
2.
Summary of Significant Accounting Policies
The summary of significant accounting policies presented below is designed to assist in understanding our consolidated financial statements. Such consolidated financial statements and accompanying notes are the representations of our management, who are responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America, or GAAP, in all material respects, and have been consistently applied in preparing our accompanying consolidated financial statements.
Basis of Presentation
Our accompanying consolidated financial statements include our accounts and those of our operating partnership, the wholly owned subsidiaries of our operating partnership and any variable interest entities, as defined, in Financial Accounting Standards Board Interpretation, or FIN, No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, as revised, or FIN No. 46(R), that we have concluded should be consolidated. We operate in an umbrella partnership REIT structure in which our operating partnership, or wholly-owned subsidiaries of our operating partnership, own substantially all of the properties we acquire. We are the sole general partner of our operating partnership and as of December 31, 2007 and 2006, we owned a 99.99% general partnership interest therein. Our advisor is also entitled to certain special limited partnership rights under the partnership agreement for our operating partnership. As of December 31, 2007 and 2006, our advisor owned a 0.01% limited partnership interest therein, and is a special limited partner in our operating partnership. Because we are the sole general partner of our operating partnership and have unilateral control over its management and major operating decisions (even if additional limited partners are admitted to our operating partnership), the accounts of our operating partnership are consolidated in our consolidated financial statements. All significant intercompany accounts and transactions are eliminated in consolidation.
Use of Estimates
The preparation of our consolidated financial statements in conformity with GAAP requires 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. These estimates are made and evaluated on an on-going basis using information that is currently available as well as various other assumptions believed to be reasonable under the circumstances. Actual results could differ from those estimates, perhaps in material adverse ways, and those estimates could be different under different assumptions or conditions.
Cash and Cash Equivalents
Cash and cash equivalents consist of all highly liquid investments with a maturity of three months or less when purchased.
Restricted Cash
Restricted cash is comprised of impound reserve accounts for property taxes, insurance, capital replacements and debt service.
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Revenue Recognition, Tenant Receivables and Allowance for Uncollectible Accounts
We lease multifamily residential apartments under operating leases primarily with terms of one year or less. Rent and other property revenue is recorded when due from residents and is recognized monthly as it is earned. Other property revenue consists primarily of utility rebillings, other expense reimbursements, and administrative, application and other fees charged to residents. Expense reimbursements are recognized and presented in accordance with Emerging Issues Task Force, or EITF, Issue 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, or Issue 99-19. Issue 99-19 requires that these reimbursements be recorded on a gross basis, as we are generally the primary obligor with respect to purchasing goods and services from third-party suppliers, have discretion in selecting the supplier and have credit risk.
Receivables are carried net of an allowance for uncollectible receivables. An allowance is maintained for estimated losses resulting from the inability of certain residents to meet their contractual obligations under their lease agreements. We determine the adequacy of this allowance by continually evaluating individual residents’ receivables considering the resident’s financial condition and security deposits and current economic conditions. No allowance for uncollectible accounts as of December 31, 2007 and 2006 was determined to be necessary to reduce receivables to our estimate of the amount recoverable.
Properties Held for Sale
We account for our properties held for sale in accordance with Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, or SFAS No. 144, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires that, in a period in which a component of an entity either has been disposed of or is classified as held for sale, the statements of operations for current and prior periods shall report the results of operations of the component as discontinued operations.
In accordance with SFAS No. 144, at such time as a property is held for sale, such property is carried at the lower of (1) its carrying amount or (2) fair value less costs to sell. In addition, a property being held for sale ceases to be depreciated. We classify operating properties as property held for sale in the period in which all of the following criteria are met:
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management, having the authority to approve the action, commits to a plan to sell the asset;
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the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;
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an active program to locate a buyer and other actions required to complete the plan to sell the asset has been initiated;
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the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within one year;
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the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and
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given the actions required to complete the plan to sell the asset, it is unlikely that significant changes to the plan would be made or that the plan would be withdrawn.
As of December 31, 2007 and 2006, we did not have any properties held for sale.
Purchase Price Allocation
In accordance with SFAS, No. 141, Business Combinations, we, with the assistance from independent valuation specialists, allocate the purchase price of acquired properties to tangible and identified intangible
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assets and liabilities based on their respective fair values. The allocation to tangible assets (building and land) is based upon our determination of the value of the property as if it were vacant. Allocations are made at the fair market value for furniture, fixtures and equipment on premises. Additionally, the purchase price of the applicable property is allocated to the above or below market value of in-place leases, the value of in-place leases, tenant relationships and above or below market debt assumed. Factors considered by us include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.
The value allocable to the above or below market component of the acquired in-place leases is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between: (1) the contractual amounts to be paid pursuant to the lease over its remaining term and (2) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above market leases, if any, would be included in the intangible assets and below market lease values, if any, would be included in intangible liabilities in our consolidated financial statements and would be amortized to rental income over the weighted average remaining term of the acquired leases with each property. As of December 31, 2007 and 2006, we did not have any amounts allocated to above or below market leases.
The total amount of other intangible assets acquired is further allocated to in-place lease costs and the value of tenant relationships based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with that respective tenant. Characteristics considered by management in allocating these values include the nature and extent of the credit quality and expectations of lease renewals, among other factors.
The value allocable to above or below market debt is determined based upon the present value of the difference between the cash flow stream of the assumed fixed rate mortgage and the cash flow stream of a market fixed rate mortgage. The amounts allocated to above or below market debt are included in mortgage loan payables, net on our accompanying consolidated balance sheets and are amortized to interest expense over the remaining term of the assumed mortgage.
These allocations are subject to change based on information received within one year of the purchase related to one or more events identified at the time of purchase which confirm the value of an asset or liability received in an acquisition of property.
Operating Properties
Operating properties are carried at the lower of historical cost less accumulated depreciation or fair value less costs to sell. The cost of operating properties includes the cost of land and completed buildings and related improvements. Expenditures that increase the service life of properties are capitalized; the cost of maintenance and repairs is charged to expense as incurred. The cost of building and improvements is depreciated on a straight-line basis over the estimated useful lives of the buildings and improvements, ranging primarily from 10 to 40 years. Land improvements are depreciated over the estimated useful lives ranging primarily from 10 to 15 years. Furniture, fixtures and equipment is depreciated over the estimated useful lives ranging primarily from five to 15 years. When depreciable property is retired or disposed of, the related costs and accumulated depreciation is removed from the accounts and any gain or loss reflected in operations.
An operating property is evaluated for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Impairment losses are recorded on an operating property when indicators of impairment are present and the carrying amount of the asset is greater than the sum of the future undiscounted cash flows expected to be generated by that asset. We would recognize an impairment loss to the extent the carrying amount exceeded the fair value of the property. For the year ended
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December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, there were no impairment losses recorded.
Other Assets
Other assets consist primarily of deferred financing costs, prepaid expenses and deposits. Deferred financing costs included amounts paid to lenders and others to obtain financing. Such costs are amortized over the term of the related loan. Amortization of deferred financing costs is included in interest expense in our accompanying consolidated statements of operations.
Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, or SFAS No. 107, requires disclosure of the fair value of financial instruments, whether or not recognized on the face of the balance sheet. SFAS No. 107 defines fair value as the quoted market prices for those instruments that are actively traded in financial markets. In cases where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. The fair value estimates are made at the end of each year based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument.
Our consolidated balance sheets include the following financial instruments: cash and cash equivalents, restricted cash, accounts and other receivables, accounts payable and accrued liabilities, accounts payable due to affiliates, net, mortgage loan payables, unsecured note payables to affiliate and borrowings under the line of credit. We consider the carrying values of cash and cash equivalents, restricted cash, accounts and other receivables and accounts payable and accrued liabilities to approximate fair value for these financial instruments because of the short period of time between origination of the instruments and their expected realization. The fair value of accounts payable due to and unsecured note payables to affiliates is not determinable due to the related party nature.
The fair value of the mortgage loan payables is estimated using borrowing rates available to us for mortgage loan payables with similar terms and maturities. As of December 31, 2007 and 2006, the fair value of the mortgage loan payables were $137,958,000 and $19,218,000, respectively, compared to the carrying value of $139,318,000 and $19,218,000, respectively.
The fair value of the secured line of credit with Wachovia Bank, National Association, or Wachovia, and LaSalle Bank National Association, or LaSalle, which we refer to as the line of credit, as of December 31, 2007 and 2006, was $0 and $21,585,000, respectively, compared to a carrying value of $0 and $21,585,000, respectively.
The fair value of the Wachovia Loan (See Note 7, Lines of Credit - Wachovia Loan) as of December 31, 2007 and 2006, was $10,000,000 and $0, respectively, compared to a carrying value of $10,000,000 and $0, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject us to a concentration of credit risk are primarily cash and cash equivalents and accounts receivable from residents. We have cash in financial institutions that is insured by the Federal Deposit Insurance Corporation, or FDIC, up to $100,000 per institution. As of December 31, 2007 and 2006, we had cash and cash equivalent accounts in excess of FDIC insured limits. We believe this
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risk is not significant. Concentration of credit risk with respect to accounts receivable from residents is limited. We perform credit evaluations of prospective residents, and security deposits are obtained upon lease execution.
As of December 31, 2007, we had interests in six properties located in Texas, which accounted for 93.1% of our total revenue.
Organizational, Offering and Related Expenses
Our organizational, offering and related expenses are being paid by our advisor and its affiliates on our behalf. These organizational, offering and related expenses include all expenses (other than selling commissions and the marketing support fee which generally represent 7.0% and 2.5% of our gross offering proceeds, respectively) to be paid by us in connection with our Offering. These expenses will only become our liability to the extent selling commissions, the marketing support fee and due diligence expense reimbursements and other organizational and offering expenses do not exceed 11.5% of the gross proceeds of our Offering. As of December 31, 2007 and, 2006, expenses of $2,672,000 and $1,679,000, respectively, in excess of 11.5% of the gross proceeds of our Offering, have been incurred by our advisor or Grubb & Ellis Realty Investors, and these expenses are not recorded in our accompanying consolidated financial statements as of December 31, 2007 and 2006. See Note 9, Related Party Transactions - Offering Stage for a further discussion of these amounts during our offering stage.
Stock Compensation
We follow SFAS No. 123(R), Share-Based Payment, to account for our stock compensation pursuant to our 2006 Incentive Award Plan. See Note 11, Stockholders’ Equity - 2006 Incentive Award Plan for a further discussion of grants under our 2006 Incentive Award Plan.
Income Taxes
We made an election under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Code, to be taxed as a REIT when we filed our fiscal year 2006 tax return, and qualified to be taxed as such beginning with our taxable year ended December 31, 2006. We intend to continue to qualify as a REIT. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90.0% of our ordinary taxable income to stockholders. As a REIT, we generally will not be subject to federal income tax on taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could materially adversely affect our results of operations and net cash available for distribution to stockholders.
In July 2006, the Financial Accounting Standards Board, or the FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN No. 48. We adopted FIN No. 48 effective January 1, 2007, and as a result did not become aware of any liability for uncertain tax positions that we believe should be recognized in our consolidated financial statements. We follow FIN No. 48 to recognize, measure, present and disclose in our consolidated financial statements uncertain tax positions that we have taken or expect to take on a tax return.
Per Share Data
We report earnings (loss) per share pursuant to SFAS No. 128, Earnings Per Share. Basic earnings (loss) per share attributable for all periods presented are computed by dividing net income (loss) by the weighted
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average number of shares of our common stock outstanding during the period. Diluted earnings (loss) per share are computed based on the weighted average number of shares of our common stock and all potentially dilutive securities, if any. Shares of restricted common stock give rise to potentially dilutive shares of common stock.
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we recorded a net loss of $5,579,000 and $523,000, respectively. As of December 31, 2007 and 2006, 4,200 shares and 2,400 shares, respectively, of restricted common stock were outstanding, but were excluded from the computation of diluted earnings per share because such shares of restricted common stock were anti-dilutive during this period.
Segment Disclosure
The FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, which establishes standards for reporting financial and descriptive information about an enterprise’s reportable segments. We have determined that we have one reportable segment, with activities related to investing in residential properties. Our investments in real estate are geographically diversified and management evaluates operating performance on an individual property level. However, as each of our residential properties has similar economic characteristics, residents, and products and services, our residential properties have been aggregated into one reportable segment for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement, or SFAS No. 157. SFAS No. 157, which will be applied to other accounting pronouncements that require or permit fair value measurements, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and provides for expanded disclosure about fair value measurements. SFAS No. 157 was issued to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position SFAS No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, or FSP FAS 157-1. FSP FAS 157-1 defers the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP FAS 157-1 also excludes from the scope of SFAS No. 157 certain leasing transactions accounted for under SFAS No. 13, Accounting for Leases. We adopted SFAS No. 157 and FSP FAS 157-1 on a prospective basis on January 1, 2008. The adoption of SFAS No. 157 and FSP FAS 157-1 did not have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. We adopted SFAS No. 159 on a prospective basis on January 1, 2008. The adoption of SFAS No. 159 did not have a material impact on our consolidated financial statements since we will not be electing to apply the fair value option for any of our eligible financial instruments or other items on the January 1, 2008 effective date.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or SFAS No. 141(R), and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51, or SFAS No. 160. These two new standards will significantly change the accounting for and reporting
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of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS No. 141(R) requires an acquiring entity to recognize acquired assets and liabilities assumed in a transaction at fair value as of the acquisition date, changes the disclosure requirements for business combination transactions and changes the accounting treatment for certain items, including contingent consideration agreements which will be required to be recorded at acquisition date fair value and acquisition costs which will be required to be expensed as incurred. SFAS No. 160 requires that noncontrolling interests be presented as a component of consolidated stockholders’ equity, eliminates minority interest accounting such that the amount of net income attributable to the noncontrolling interests will be presented as part of consolidated net income in our accompanying consolidated statements of operations and not as a separate component of income and expense, and requires that upon any changes in ownership that result in the loss of control of the subsidiary, the noncontrolling interest be re-measured at fair value with the resultant gain or loss recorded in net income. SFAS No. 141(R) and SFAS No. 160 require simultaneous adoption and are to be applied prospectively for the first annual reporting period beginning on or after December 15, 2008. Early adoption of either standard is prohibited. We will adopt SFAS No. 141(R) and SFAS No. 160 on January 1, 2009. We are evaluating the impact of SFAS No. 141(R) and SFAS No. 160 and have not yet determined the impact the adoption will have on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, or SFAS No. 161. SFAS No. 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 achieves these improvements by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The adoption of SFAS No. 161 is not expected to have a material impact on our consolidated financial statements.
3.
Real Estate Investments
Our investments in our consolidated properties consisted of the following as of December 31, 2007 and 2006:
Depreciation expense for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 was $3,434,000 and $188,000, respectively.
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Acquisitions in 2006
Walker Ranch Apartment Homes - San Antonio, Texas
On October 31, 2006, we purchased Walker Ranch Apartment Homes located in San Antonio, Texas, or the Walker Ranch property, from an unaffiliated third party for a purchase price of $30,750,000 plus closing costs. We financed the purchase price of the property with $22,120,000 in borrowings under the line of credit, and $4,740,000 in borrowings under the mezzanine line of credit with Wachovia. The balance of the purchase price was provided by funds raised through our Offering. We paid an acquisition fee of $923,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Hidden Lake Apartment Homes - San Antonio, Texas
On December 28, 2006, we purchased Hidden Lake Apartment Homes in San Antonio, Texas, or the Hidden Lake property, from an unaffiliated third party for a purchase price of $32,030,000 plus closing costs. We financed the purchase price of the property with $19,218,000 in borrowings under a secured mortgage loan, a $10,000,000 unsecured loan from NNN Realty Advisors and $2,500,000 in borrowings under the line of credit. The balance was provided by funds raised through our Offering. We paid an acquisition fee of $961,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Acquisitions in 2007
Park at Northgate - Spring, Texas
On June 12, 2007, we purchased Park at Northgate, located in Spring, Texas, or the Northgate property, for a purchase price of $16,600,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property from funds raised through our Offering. We paid an acquisition fee of $498,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Residences at Braemar - Charlotte, North Carolina
On June 29, 2007, we purchased Residences at Braemar, located in Charlotte, North Carolina, or the Braemar property, for a purchase price of $15,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of an existing secured loan of $10,000,000, with an unpaid principal balance of $9,722,000, and a $3,300,000 unsecured loan from NNN Realty Advisors, with the balance of the purchase price provided by funds raised through our Offering. We paid an acquisition fee of $450,000, or 3.0% of the purchase price, to our advisor and its affiliate.
Baypoint Resort - Corpus Christi, Texas
On August 2, 2007, we purchased Baypoint Resort, located in Corpus Christi, Texas, or the Baypoint property, for a purchase price of $33,250,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through a loan secured by the property in the principal amount of $21,612,000 and a $13,200,000 unsecured loan from NNN Realty Advisors. An acquisition fee of $998,000, or 3.0% of the purchase price, was paid to our advisor and its affiliate.
Towne Crossing Apartments - Mansfield, Texas
On August 29, 2007, we purchased Towne Crossing Apartments, located in Mansfield, Texas, or the Towne Crossing property, for a purchase price of $21,600,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of an existing secured loan of $15,760,000, with an unpaid principal balance of $15,366,000, and a $5,400,000 unsecured loan from NNN
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Realty Advisors. An acquisition fee of $648,000, or 3.0% of the purchase price, was paid to our advisor and its affiliate.
Villas of El Dorado - McKinney, Texas
On November 2, 2007, we purchased Villas of El Dorado, located in McKinney, Texas, or the El Dorado property, for a purchase price of $18,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through the assumption of a loan secured by the property in the principal amount of $13,600,000, with an unpaid principal balance of $13,600,000, and $3,122,000 in cash proceeds from a $3,195,000 borrowing under the Wachovia Loan, with the balance of the purchase price provided by funds raised through our Offering. We paid an acquisition fee of $540,000, or 3.0% of the purchase price, to our Advisor and its affiliate.
The Heights at Old Towne - Portsmouth, Virginia
On December 21, 2007, we purchased The Heights at Old Towne, located in Portsmouth, Virginia, or the Heights property, for a purchase price of $17,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price through a secured loan of $10,475,000, $3,205,000 in borrowings under the Wachovia Loan, proceeds of $3,208,000 from a $10,000,000 unsecured loan from NNN Realty Advisors, and the remaining balance from funds raised through our Offering. An acquisition fee of $510,000, or 3.0% of the purchase price, was paid to our Advisor and its affiliate.
The Myrtles at Old Towne - Portsmouth, Virginia
On December 21, 2007, we purchased The Myrtles at Old Towne, located in Portsmouth, Virginia, or the Myrtles property, for a purchase price of $36,000,000, plus closing costs, from an unaffiliated third party. We financed the purchase price of the property through a secured loan of $20,100,000, $6,788,000 in borrowings under the Wachovia Loan, proceeds of $6,792,000 from a $10,000,000 unsecured loan from NNN Realty Advisors, and the remaining balance from funds raised through our Offering. An acquisition fee of $1,080,000, or 3.0% of the purchase price, was paid to our Advisor and its affiliate.
Leverage
As a result of the acquisition of the Walker Ranch property October 31, 2006, our leverage exceeded 300.0%. In addition, as a result of the acquisition of the Hidden Lake property on December 28, 2006, our leverage exceeded 300.0%. In connection with each of these acquisitions, a majority of our directors, including a majority of our independent directors, approved our leverage exceeding 300.0%, in accordance with our charter. Our board of directors determined that for each acquisition, the excess leverage was justified because it enabled us to purchase the properties during the initial stages of our Offering, thereby improving our ability to meet our goal of acquiring a diversified portfolio of properties to generate current income for stockholders and preserve stockholder capital. As of December 31, 2007, our leverage did not exceed 300.0%.
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4.
Identified Intangible Assets
Identified intangible assets consisted of the following as of December 31, 2007 and 2006:
Amortization expense recorded on the identified intangible assets for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 was $1,951,000 and $101,000, respectively.
Estimated amortization expense on the identified intangible assets as of December 31, 2007 for each of the next five years ending December 31 and thereafter is as follows:
5.
Other Assets
Other assets consisted of the following as of December 31, 2007 and 2006:
Amortization expense recorded on the deferred financing costs for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 was $232,000 and $30,000, respectively.
Estimated amortization expense on the deferred financing costs as of December 31, 2007 for each of the next five years ending December 31 and thereafter is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6.
Mortgage Loan Payables and Unsecured Note Payables to Affiliate
Mortgage Loan Payables
Mortgage loan payables were $140,251,000 ($139,318,000, net of discount) and $19,218,000 as of December 31, 2007 and 2006, respectively. As of December 31, 2007, we had nine fixed rate mortgage loans with a weighted-average effective interest rate of 5.60% per annum. As of December 31, 2006, we had one fixed rate mortgage loan with an effective interest rate of 5.34% per annum. The mortgage loans secured by the Hidden Lake property, the Walker Ranch property, the Northgate property, the Baypoint property, the El Dorado property, the Heights property, and the Myrtles property have monthly interest-only payments. The mortgage loans secured by the Braemar property and the Towne Crossing property have monthly principal and interest payments. We are required by the terms of the applicable loan documents to meet certain reporting requirements. As of December 31, 2007 and 2006, we were in compliance with all such requirements.
Mortgage loan payables consisted of the following as of December 31, 2007 and 2006:
The principal payments due on our mortgage loan payables as of December 31, 2007 for each of the next five years ending December 31 and thereafter is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Unsecured Note Payables to Affiliate
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we entered into, and subsequently paid down, the following unsecured loans with NNN Realty Advisors, evidenced by unsecured promissory notes:
The unsecured notes bore interest at a fixed rate and required monthly interest-only payments for the terms of the unsecured notes. As of December 31, 2007 and 2006, the balances under the unsecured note payables to affiliate were $7,600,000 and $10,000,000, respectively.
Because these loans were related party loans, the terms of the loans and the unsecured notes, were approved by our board of directors, including a majority of our independent directors, and deemed fair, competitive and commercially reasonable by our board of directors.
7.
Lines of Credit
Line of Credit and Mezzanine Line of Credit
We have a credit agreement, or the Credit Agreement, with Wachovia and LaSalle Bank National Association, or LaSalle, for a secured revolving line of credit with a maximum borrowing amount of $75,000,000 which matures on October 31, 2009 and may be increased to $200,000,000 subject to the terms of the Credit Agreement, or the line of credit. The line of credit has an option to extend for one year in exchange for the payment of an extension fee.
As of December 31, 2007 and 2006, borrowings under the line of credit totaled $0 and $21,585,000, respectively. Borrowings at December 31, 2006 bore interest at a weighted-average interest rate of 6.88% per annum. On April 12, 2007, we repaid the remaining outstanding borrowings and accrued interest under the line of credit.
We have a Mezzanine Credit Agreement, or the Mezzanine Credit Agreement, with Wachovia for a mezzanine secured revolving line of credit with a maximum borrowing amount of $15,000,000 which matures on October 31, 2009, or the mezzanine line of credit. As of December 31, 2007 and 2006, there were no outstanding borrowings under the mezzanine line of credit.
On March 20, 2007, we obtained waivers of certain covenants contained in the Credit Agreement and Mezzanine Credit Agreement from Wachovia and LaSalle, as applicable. The covenants were related to our non-compliance with certain debt to total asset value ratios, fixed charge coverage ratios and the implied debt service coverage ratios, or collectively the financial covenants, arising from our limited operations. As a result of the waivers, Wachovia and LaSalle waived compliance with the financial covenants through the period ending December 31, 2007. Wachovia and LaSalle currently have no obligation to fund additional amounts under either the line of credit or the mezzanine line of credit until we comply with the financial covenants, although they may do so in their sole discretion.
On July 10, 2007, we entered into letter agreements amending the terms of the Credit Agreement and Mezzanine Credit Agreement, or the amendment letters. Pursuant to the amendment letters, we are no longer obligated to pay nonuse fees until such times as Wachovia and LaSalle have agreed in writing to make additional loans under the Credit Agreement or the Mezzanine Credit Agreement, as applicable. Further, until Wachovia and LaSalle have agreed to make additional loans under the Credit Agreement or Mezzanine Credit
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Agreement, as applicable, we will not be obligated to comply with the financial covenants contained in the Credit Agreement or Mezzanine Credit Agreement, nor will we be obligated to comply with the related reporting obligations. Finally, Wachovia and LaSalle, as applicable, have agreed that we will not be obligated to pay any reinstatement fees under the Credit Agreement or Mezzanine Credit Agreement in order for Wachovia or LaSalle to lend us funds in the future.
Wachovia Loan
On November 1, 2007, we entered into a loan agreement with Wachovia for a loan in the principal amount of up to $10,000,000 which matures on November 1, 2008, or the Wachovia Loan. The Wachovia Loan is secured by (1) a pledge of 49.0% of our partnership interests in Apartment REIT Walker Ranch L.P., Apartment REIT Hidden Lakes, L.P. and Apartment REIT Towne Crossing, L.P., (2) 100% of our partnership interests in Apartment REIT Park at North Gate, L.P. and (3) 100% of our ownership interests in entities acquiring properties in the future if financed in part by the Wachovia Loan. The Wachovia Loan may be extended for one year subject to satisfaction of certain conditions. Accrued interest under the Wachovia Loan is payable monthly and at maturity. Advances under the Wachovia Loan bear interest at the applicable LIBOR Rate, as defined in the agreement.
On November 1, 2007, we used $3,195,000 in borrowings under the Wachovia Loan agreement in connection with the acquisition of the El Dorado property. On November 19, 2007, we repaid the outstanding principal and accrued interest on the Wachovia Loan.
On December 21, 2007, we executed a First Amendment to and Waiver of Loan Agreement with Wachovia, and Grubb & Ellis Apartment REIT Holdings, L.P., our operating partnership, entered into a First Amended and Restated Pledge Agreement with Wachovia to pledge its interest in the Myrtles property and the Heights property in connection with $10,000,000 in borrowings under the Wachovia Loan to finance the acquisitions of the Myrtles property and the Heights property. As of December 31, 2007, $10,000,000 was outstanding under the Wachovia Loan at a variable rate of 9.84%.
8.
Commitments and Contingencies
Litigation
We are not presently subject to any material litigation nor, to our knowledge, is any material litigation threatened against us, which if determined unfavorably to us, would have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Environmental Matters
We follow a policy of monitoring our properties for the presence of hazardous or toxic substances. While there can be no assurance that a material environmental liability does not exist at our properties, we are not currently aware of any environmental liability with respect to our properties that would have a material effect on our consolidated financial condition, results of operations or cash flows. Further, we are not aware of any environmental liability or any unasserted claim or assessment with respect to an environmental liability that we believe would require additional disclosure or the recording of a loss contingency.
Repairs and Maintenance Expenses
We are required by the terms of the mortgage loans secured by the Northgate property and the Baypoint property to complete certain repairs to the properties in the amount of $45,000 and $131,000, respectively, by no later than August 1, 2008. Funds of $131,000 for these expenditures are held by the lender and are included in restricted cash on our accompanying consolidated balance sheet as of December 31, 2007.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Organizational, Offering and Related Expenses
Our organizational, offering and related expenses are being paid by our advisor and its affiliates on our behalf. These organizational, offering and related expenses include all expenses (other than selling commissions and the marketing support fee which generally represent 7.0% and 2.5% of our gross offering proceeds, respectively) to be paid by us in connection with our Offering. These expenses will only become our liability to the extent selling commissions, the marketing support fee and due diligence expense reimbursements and other organizational and offering expenses do not exceed 11.5% of the gross proceeds of our Offering. As of December 31, 2007 and 2006, expenses of $2,672,000 and $1,679,000, respectively, in excess of 11.5% of the gross proceeds of our Offering, have been incurred by our advisor or Grubb & Ellis Realty Investors and these expenses are not recorded in our accompanying consolidated financial statements as of December 31, 2007 and 2006. To the extent we raise additional proceeds from our Offering, these amounts may become our liability. See Note 9, Related Party Transactions - Offering Stage, for a further discussion of these amounts during our offering stage.
Other
Our other commitments and contingencies include the usual obligations of real estate owners and operators in the normal course of business. In our opinion, these matters are not expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows.
9.
Related Party Transactions
Fees and Expenses Paid to Affiliates
Some of our executive officers and our non-independent directors are also executive officers and/or holders of a direct or indirect interest in our advisor, our sponsor, Grubb & Ellis Realty Investors, or other affiliated entities. Upon the effectiveness of our Offering, we entered into the Advisory Agreement and a dealer manager agreement, or the Dealer Manager Agreement, with Grubb & Ellis Securities, Inc., or Grubb & Ellis Securities, or our dealer manager. These agreements entitle our advisor, our dealer manager and their affiliates to specified compensation for certain services with regards to our Offering and the investment of funds in real estate assets, among other services, as well as reimbursement of organizational and offering expenses incurred. In the aggregate, for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred to our advisor or its affiliates $14,069,000 and $4,125,000, respectively, as detailed below.
Offering Stage
Selling Commissions
Our dealer manager receives selling commissions of up to 7.0% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. Our dealer manager may re-allow all or a portion of these fees to participating broker-dealers. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $4,652,000 and $1,141,000, respectively, in selling commissions to our dealer manager. Such commissions are charged to stockholders’ equity as such amounts are reimbursed to our dealer manager from the gross proceeds of our Offering.
Marketing Support Fee and Due Diligence Expense Reimbursements
Our dealer manager may receive non-accountable marketing support fees and due diligence expense reimbursements up to 2.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. Our dealer manager may re-allow up to 1.5% of the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
gross offering proceeds to participating broker-dealers. In addition, we may reimburse our dealer manager or its affiliates an additional accountable 0.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering, other than shares sold pursuant to the DRIP, as reimbursements for bona fide due diligence expenses. Our dealer manager or its affiliates may re-allow all or a portion of these fees up to 0.5% of the gross offering proceeds to participating broker-dealers. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $1,709,000 and $494,000, respectively, in marketing support fees and due diligence expense reimbursements to our dealer manager or its affiliates. Such fees and reimbursements are charged to stockholders’ equity as such amounts are reimbursed to our dealer manager or its affiliates from the gross proceeds of our Offering.
Other Organizational and Offering Expenses
Our organizational and offering expenses are paid by our advisor or Grubb & Ellis Realty Investors on our behalf. Our advisor or Grubb & Ellis Realty Investors may be reimbursed for actual expenses incurred for up to 1.5% of the gross offering proceeds from the sale of shares of our common stock in our Offering other than shares sold pursuant to the DRIP. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $1,006,000 and $249,000, respectively, in offering expenses to our advisor or Grubb & Ellis Realty Investors. Other organizational expenses are expensed as incurred, and offering expenses are charged to stockholders’ equity as such amounts are reimbursed to our advisor or Grubb & Ellis Realty Investors from the gross proceeds of our Offering.
Acquisition and Development Stage
Acquisition Fees
Our advisor or its affiliates receive, as compensation for services rendered in connection with the investigation, selection and acquisition of properties, an acquisition fee of up to 3.0% of the contract purchase price for each property acquired or up to 4.0% of the total development cost of any development property acquired, as applicable. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $4,724,000 and $1,884,000, respectively, in acquisition fees to our advisor or its affiliates. Acquisition fees are capitalized as part of the purchase price allocations.
Reimbursement of Acquisition Expenses
Our advisor or its affiliates will be reimbursed for acquisition expenses related to selecting, evaluating, acquiring and investing in properties. Acquisition expenses, including amounts paid to third parties, will not exceed 0.5% of the purchase price of the properties. The reimbursement of acquisition expenses, acquisition fees and real estate commissions paid to unaffiliated parties will not exceed, in the aggregate, 6.0% of the purchase price or total development costs, unless fees in excess of such limits are approved by a majority of our disinterested independent directors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $3,000 and $0, respectively, in expenses to our advisor or its affiliates, excluding amounts our advisor or its affiliates paid directly to third parties.
Operational Stage
Asset Management Fee
Our advisor or its affiliates are paid a monthly fee for services rendered in connection with the management of our assets in an amount equal to one-twelfth of 1.0% of the average invested assets calculated as of the close of business on the last day of each month, subject to our stockholders receiving annualized
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
distributions in an amount equal to at least 5.0% per annum on average invested capital. The asset management fee is calculated and payable monthly in cash or shares of our common stock, at the option of our advisor, not to exceed one-twelfth of 1.0% of our average invested assets as of the last day of the immediately preceding quarter. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $950,000 and $0, respectively, in asset management fees to our advisor or its affiliates, which is included in general and administrative in our accompanying consolidated statements of operations.
Property Management Fees
Our advisor or its affiliates are paid a property management fee equal to 4.0% of the monthly gross cash receipts from any property managed for us. This fee is paid monthly. Our advisor or its affiliates anticipate that they will subcontract property management services to third parties and will be responsible for paying all fees due to such third party contractors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $489,000 and $24,000, respectively, to our advisor or its affiliate, which is included in rental expenses in our accompanying consolidated statements of operations.
On-site Personnel Payroll
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, Grubb & Ellis Realty Investors incurred payroll for on-site personnel on our behalf of $159,000 and $0, respectively, which is included in rental expenses in our accompanying consolidated statements of operations.
Operating Expenses
We reimburse our advisor or its affiliates for expenses incurred in rendering services to us, subject to certain limitations on our operating expenses. However, we cannot reimburse our advisor and its affiliates for fees and costs that exceed the greater of: (1) 2.0% of our average invested assets, as defined in the Advisory Agreement, or (2) 25.0% of our net income, as defined in the Advisory Agreement, unless our board of directors determines that such excess expenses were justified based on unusual and non-recurring factors. For the twelve months ended December 31, 2007, our operating expenses did not exceed this limitation. Our operating expenses as a percentage of average invested assets and as a percentage of net income were 1.8% and 2,972.0%, respectively, for the twelve months ended December 31, 2007.
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, Grubb & Ellis Realty Investors incurred on our behalf $165,000 and $325,000, respectively, in operating expenses which is included in general and administrative in our accompanying consolidated statements of operations or prepaid expenses on our accompanying consolidated balance sheets, as applicable.
Compensation for Additional Services
Our advisor or its affiliates will be paid for services performed for us other than those required to be rendered by our advisor or its affiliates, under the Advisory Agreement. The rate of compensation for these services must be approved by a majority of our board of directors, and cannot exceed an amount that would be paid to unaffiliated third parties for similar services. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred $8,000 and $0, respectively, for tax services an affiliate provided to us.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Liquidity Stage
Disposition Fees
Our advisor or its affiliates will be paid for services relating to a sale of one or more properties, a disposition fee up to the lesser of 1.75% of the contract sales price or 50.0% of a customary competitive real estate commission given the circumstances surrounding the sale, which will not exceed market norms. The amount of disposition fees paid, including the real estate commissions paid to unaffiliated parties, will not exceed the lesser of the customary competitive disposition fee or an amount equal to 6.0% of the contract sales price. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such fees.
Incentive Distribution Upon Sales
Upon liquidation, our advisor will be paid an incentive distribution equal to 15.0% of net sales proceeds from any disposition of a property after subtracting (1) the amount of capital we invested in our operating partnership; (2) an amount equal to an 8.0% annual cumulative, non-compounded return on such invested capital; and (3) any shortfall with respect to the overall 8.0% annual cumulative, non-compounded return on the capital invested in our operating partnership. Actual amounts to be received depend on the sale prices of properties upon liquidation. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such distributions.
Incentive Distribution Upon Listing
Upon the listing of shares of our common stock on a national securities exchange, our advisor will be paid an incentive distribution equal to 15.0% of the amount, if any, by which the market value of our outstanding stock plus distributions paid by us prior to listing, exceeds the sum of the amount of capital we invested in our operating partnership plus an 8.0% annual cumulative, non-compounded return on such invested capital. Actual amounts to be received depend upon the market value of our outstanding stock at the time of listing among other factors. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such distributions.
Fees Payable upon Termination of Advisory Agreement
Upon termination of the Advisory Agreement due to an internalization of our advisor in connection with our conversion to a self-administered REIT, our advisor will be paid a fee determined by negotiation between our advisor and our independent directors. Upon our advisor’s receipt of such compensation, our advisor’s special limited partnership units will be redeemed and our advisor will not be entitled to receive any further incentive distributions upon sale of our properties. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we did not incur such fees.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Accounts Payable Due to Affiliates, Net
The following amounts were outstanding to affiliates as of December 31, 2007 and 2006:
Unsecured Note Payables to Affiliate
For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we incurred interest expense to NNN Realty Advisor of $204,000 and $8,000, respectively. See Note 6, Mortgage Loan Payables and Unsecured Note Payables to Affiliate - Unsecured Note Payables to Affiliate, for a further discussion.
Director and Former President’s Financial Arrangement with Legal Counsel
The law firm of Hirschler Fleischer represented Grubb & Ellis Apartment REIT, Inc. in certain legal matters during 2007 and 2006. For the year ended December 31, 2007 and 2006 we, or our affiliates on our behalf, incurred legal fees to Hirschler Fleischer of approximately $42,000 and $312,000, respectively. Louis J. Rogers, our director from July 2006 through June 2007, our president and the chairman of our advisor from inception through April 6, 2007, the president of Triple Net Properties from September 2004 through April 3, 2007 and a director of NNN Realty Advisors, also practiced law with Hirschler Fleischer from 1987 to March 2007. Mr. Rogers was a shareholder of Hirschler Fleischer from 1994 to December 31, 2004, and served as senior counsel in that firm from January 2005 to March 2007. We previously disclosed in the prospectus for our Offering that Mr. Rogers shared in Hirschler Fleischer’s revenues.
On March 19, 2007, we learned that, in connection with his transition from shareholder to senior counsel, Mr. Rogers and Hirschler Fleischer entered into a transition agreement on December 29, 2004. The transition agreement provided, among other things, that Mr. Rogers would receive a base salary from Hirschler Fleischer as follows: $450,000 in 2005, $400,000 in 2006, $300,000 in 2007, and $125,000 in 2008 and subsequent years. Mr. Rogers’ receipt of the base salary was subject to satisfaction of certain conditions, including that Grubb & Ellis Realty Investors, LLC, the managing member of our advisor, and its affiliated companies, including us, or collectively, the Grubb & Ellis group, remain a client of Hirschler Fleischer and that collections by that firm from the Grubb & Ellis group equaled at least $1,500,000 per year. If the fees collected by Hirschler Fleischer from, the Grubb & Ellis group were less than $1,500,000, Mr. Rogers’ base salary would be proportionately reduced. Under the transition agreement, Mr. Rogers was also entitled to receive a bonus from Hirschler Fleischer on a quarterly basis, equal to a percentage, declining from 5.0% to 1.0% during the term of the agreement, of all collections by that firm from specified pre-2005 clients (including the Grubb & Ellis group) in excess of $3,000,000, as well as a percentage of all collections by that firm from new clients originated by Mr. Rogers, ranging from 6.0% to 3.0% depending on the year originated. For the year ended December 31, 2007 and 2006, the Grubb & Ellis group, incurred legal fees to Hirschler
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Fleischer of approximately $2,426,000 and $3,696,000, respectively, including legal fees that Grubb & Ellis Apartment REIT, Inc., or our affiliates on our behalf, incurred to Hirschler Fleischer of approximately $42,000 and $312,000, respectively. Under the transition agreement, Hirschler Fleischer paid Mr. Rogers $646,800 in base salary and bonus for 2006. Mr. Rogers’ senior counsel position with Hirschler Fleischer terminated on March 31, 2007, at which point Hirschler Fleischer had paid Mr. Rogers $75,000 for his 2007 services. Mr. Rogers has received from Hirschler Fleischer an additional $450,000 in 2007 pursuant to a separation agreement in satisfaction of all amounts owed to him under the transition agreement.
10.
Minority Interest
As of December 31, 2007 and 2006, we owned a 99.99% general partnership interest in our operating partnership and our advisor owned a 0.01% limited partnership interest. As such, 0.01% of the earnings at our operating partnership are allocated to minority interest.
11.
Stockholders’ Equity
Common Stock
On January 10, 2006, our advisor purchased 22,223 shares of our common stock for total cash consideration of $200,000 and was admitted as our initial stockholder. On July 19, 2006, we granted 4,000 shares of restricted common stock in the aggregate to our independent directors, 800 of which were forfeited in November 2006. On June 12, 2007, in connection with their re-election, we granted 3,000 shares of restricted stock in the aggregate to our independent directors. Through December 31, 2007, we issued 8,365,946 shares in connection with our Offering and 134,475 shares under the DRIP. As of December 31, 2007 and, 2006, we had 8,528,844 and 1,686,068 shares, respectively, of common stock outstanding.
We are offering and selling to the public up to 100,000,000 shares of our $0.01 par value common stock for $10.00 per share and up to 5,000,000 shares of our $0.01 par value common stock to be issued pursuant to the DRIP at $9.50 per share. Our charter authorizes us to issue 300,000,000 shares of our common stock.
Preferred Stock
Our charter authorizes us to issue 50,000,000 shares of our $0.01 par value preferred stock. No shares of preferred stock were issued and outstanding as of December 31, 2007 and 2006.
Distribution Reinvestment Plan
We adopted the DRIP that allows stockholders to purchase additional shares of our common stock through reinvestment of distributions, subject to certain conditions. We registered and reserved 5,000,000 shares of our common stock for sale pursuant to the DRIP in our Offering. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, $1,258,000 and $20,000, respectively, in distributions were reinvested and 132,383 and 2,092 shares, respectively, in shares were issued under the DRIP. As of December 31, 2007 and 2006, a total of $1,278,000 and $20,000, respectively, in distributions were reinvested and 134,475 and 2,092 shares, respectively, were issued under the DRIP.
Share Repurchase Plan
Our board of directors has approved a share repurchase plan. On April 21, 2006, we received SEC exemptive relief from rules restricting issuer purchases during distributions. The share repurchase plan allows for share repurchases by us when certain criteria are met by stockholders. Share repurchases will be made at the sole discretion of our board of directors. Funds for the repurchase of shares will come exclusively from the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
proceeds we receive from the sale of shares under the DRIP. As of December 31, 2007, no share repurchases had been made.
Incentive Award Plan
Under the terms of the 2006 Incentive Award Plan, the aggregate number of shares of our common stock subject to options, restricted common stock awards, stock purchase rights, stock appreciation rights or other awards will be no more than 2,000,000 shares.
On July 19, 2006 and June 12, 2007, we granted an aggregate of 4,000 and 3,000 shares, respectively, of restricted common stock, as defined in the 2006 Incentive Award Plan, to our independent directors under the 2006 Incentive Award Plan, of which 20.0% vested on the grant date and 20.0% will vest on each of the first four anniversaries of the date of the grant. The fair value of each share of restricted common stock was estimated at the date of grant at $10.00 per share, the per share price of shares in our Offering, and is amortized on a straight-line basis over the vesting period. Shares of restricted common stock may not be sold, transferred, exchanged, assigned, pledged, hypothecated or otherwise encumbered. Such restrictions expire upon vesting. For the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006, we recognized compensation expense of $15,000 and $11,000, respectively, related to the restricted common stock grants, which is included in general and administrative in our accompanying consolidated statements of operations. Shares of restricted common stock have full voting rights and rights to dividends.
As of December 31, 2007 and 2006, there was $36,000 and $21,000, respectively, of total unrecognized compensation expense, net of estimated forfeitures, related to nonvested shares of restricted common stock. As of December 31, 2007, this expense is expected to be realized over a remaining weighted-average period of 3.1 years.
As of December 31, 2007 and 2006, the fair value of the nonvested shares of restricted common stock was $42,000 and $24,000, respectively. A summary of the status of our shares of restricted common stock as of December 31, 2007 and 2006, and the changes for the period from January 10, 2006 (Date of Inception) through December 31, 2007, is presented below:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12.
Special Limited Partner Interest
Upon termination of the Advisory Agreement in connection with any event other than the listing of our shares of common stock on a national securities exchange or a national market system or the internalization of our advisor in connection with our conversion to a self-administered REIT, our advisor’s special limited partnership interest may be redeemed by us (as the general partner of our operating partnership) for a redemption price equal to the amount of the incentive distribution that our advisor would have received upon property sales if our operating partnership immediately sold all of its properties for their fair market value. Such incentive distribution is payable in cash or in shares of our common stock or in units of limited partnership interest in our operating partnership, if agreed to by us and our advisor, except that our advisor is not permitted to elect to receive shares of our common stock to the extent that doing so would cause us to fail to qualify as a REIT.
13.
Tax Treatment of Distributions
The income tax treatment for distributions reportable for the year ended December 31, 2007 and 2006 was as follows:
14.
Business Combinations
For the year ended December 31, 2007, we completed the acquisition of seven consolidated properties, adding a total of 1,668 apartment units to our property portfolio. We purchased the seven properties on the following dates:
Results of operations for the properties are reflected in our consolidated statements of operations for the years ended December 31, 2007 for the periods subsequent to the acquisition dates. The aggregate purchase price of the seven consolidated properties was $157,450,000 plus closing costs of $5,656,000, of which $135,963,000 was initially financed with mortgage debt, unsecured note payables to an affiliate or borrowings under the Wachovia Loan.
In accordance with SFAS No. 141, we allocated the purchase price to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs and tenant relationships. Certain allocations as of December 31, 2007 are subject to change based on information received within one year of the purchase date
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
related to one or more events at the time of purchase which confirm the value of an asset acquired or a liability assumed in an acquisition of a property. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
For the period from January 10, 2006 (Date of Inception) through December 31, 2006, we completed the acquisition of two wholly-owned properties, adding a total of 705 apartment units to our property portfolio. We purchased the Walker Ranch property on October 31, 2006 and the Hidden Lake property on December 28, 2006. Results of operations for the properties is reflected in our consolidated statement of operations for the periods subsequent to the acquisition dates. The aggregate purchase price of the two consolidated properties was $62,780,000 plus closing costs of $2,094,000, of which $58,578,000 was initially financed with mortgage debt, an unsecured note payable to affiliate or borrowings under the line of credit.
In accordance with SFAS No. 141, we allocated the purchase price to the fair value of the assets acquired and the liabilities assumed, including the allocation of the intangibles associated with the in-place leases considering the following factors: lease origination costs and tenant relationships. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
Assuming all of the acquisitions discussed above had occurred January 1, 2007, pro forma revenue, net income (loss), and net income (loss) per diluted share for the year ended December 31, 2007 would have been $25,251,000, $(10,898,000) and $(2.15), respectively. Assuming all of the acquisitions discussed above had occurred January 10, 2006 (Date of Inception), pro forma revenue, net income (loss) and net income (loss) per diluted share for the period from January 10, 2006 (Date of Inception) through December 31, 2006 would have been $25,218,000, $(8,613,000) and $(1.70), respectively. The pro forma results are not necessarily indicative of the operating results that would have been obtained had the acquisitions occurred at the beginning of the periods presented, nor are they necessarily indicative of future operating results.
Grubb & Ellis Apartment REIT, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15.
Selected Quarterly Financial Data (Unaudited)
Set forth below is the unaudited selected quarterly financial data. We believe that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly, and in accordance with generally accepted accounting principles, the unaudited selected quarterly financial data when read in conjunction with the consolidated financial statements.
16.
Subsequent Events
Status of our Offering
As of March 14, 2008, we had received and accepted subscriptions in our Offering for 9,710,660 shares of our common stock, or $97,015,000, excluding shares issued under the DRIP.
Unsecured Note Payable to Affiliate
On February 20, 2008, we repaid the remaining balance due on the unsecured note payable to affiliate.
Share Repurchases
In February 2008, we repurchased 5,200 shares, or $52,000, under our share repurchase plan.
Grubb & Ellis Apartment REIT, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Related Party Services Agreement
We entered into a services agreement, effective January 1, 2008, with Grubb & Ellis Realty Investors for subscription agreement processing and investor services. The services agreement has an initial one-year term and shall thereafter automatically be renewed for successive one year terms. Since Grubb & Ellis Realty Investors is the managing member of our advisor, the terms of this agreement were approved and determined by a majority of our independent directors as fair and reasonable to us and at fees no greater than the cost to Grubb & Ellis Realty Investors for providing such services to us, which amount shall be no greater than that which would be paid to an unaffiliated third party for similar services. The services agreement requires Grubb & Ellis Realty Investors to provide us with a 180 day advance written notice for any termination, while we have the right to terminate upon 30 days advance written notice.
Proposed Acquisition of Arboleda Luxury Apartments
On January 29, 2008, our board of directors approved the acquisition of Arboleda Luxury Apartments, located in Cedar Park, Texas, a northern suburb of Austin, or the Arboleda property. On March 27, 2008, we entered into an assignment agreement whereby we agreed to assume, and Grubb & Ellis Realty Investors agreed to assign, the rights, title and interest in a purchase and sale agreement, as amended, for the Arboleda property for a purchase price of $29,250,000, plus closing costs, from an unaffiliated third party. We intend to finance the purchase through debt financing and proceeds raised from our offering. In connection with obtaining debt financing for the acquisition, on March 27, 2008, we entered into a commitment agreement with PNC ARCS LLC, the prospective lender, to obtain an $18,030,000 loan with a seven year term which would be secured by the Arboleda property. Pursuant to the commitment agreement, we were required to pay a commitment deposit in the amount of 2.0% of the maximum loan amount. The closing deadline for the loan is March 31, 2008. We expect to pay our advisor and its affiliate an acquisition fee of $878,000, or 3.0% of the purchase price, in connection with the acquisition.
We anticipate that the closing will occur in the first quarter of 2008; however, closing is subject to certain agreed upon conditions and there can be no assurance that we will be able to complete the acquisition of the Arboleda property.
Grubb & Ellis Apartment REIT, Inc.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
December 31, 2007
Grubb & Ellis Apartment REIT, Inc.
SCHEDULE III - REAL ESTATE OPERATING PROPERTIES AND
ACCUMULATED DEPRECIATION
December 31, 2007
(a) The changes in total real estate for the year ended December 31, 2007 and for the period form January 10, 2006 (Date of Inception) through December 31, 2006 are as follows:
Grubb & Ellis Apartment REIT, Inc.
SCHEDULE III - REAL ESTATE OPERATING PROPERTIES AND
ACCUMULATED DEPRECIATION - (Continued)
(b) For federal income tax purposes, the aggregate cost of our nine properties is as follows:
SCHEDULE III - REAL ESTATE OPERATING PROPERTIES AND
ACCUMULATED DEPRECIATION - (Continued)
(c) The changes in accumulated depreciation for the year ended December 31, 2007 and for the period from January 10, 2006 (Date of Inception) through December 31, 2006 are as follows:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
Following the consummation of the merger of NNN Realty Advisors, Inc., which previously served as our sponsor, with and into a wholly owned subsidiary of our current sponsor, Grubb & Ellis Company on December 7, 2007, NNN Apartment REIT, Inc., NNN Apartment REIT Holdings, L.P., NNN Apartment REIT Advisor, LLC, NNN Apartment Management, LLC, Triple Net Properties, LLC and NNN Capital Corp changed their names to Grubb & Ellis Apartment REIT, Inc., Grubb & Ellis Apartment REIT Holdings, L.P., Grubb & Ellis Apartment REIT Advisor, LLC, Grubb & Ellis Apartment Management, LLC, Grubb & Ellis Realty Investors, LLC and Grubb & Ellis Securities, Inc., respectively. The following Exhibit List refers to the entity names used prior to such name changes in order to accurately reflect the names of the parties on the documents listed.
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (and are numbered in accordance with Item 601 of Regulation S-K).

Compensatory plan or arrangement.
*
Filed herewith.