Risks Relating to Our Business and Our Properties
There are inherent risks associated with real estate investments and with the real estate industry, each of which could have an adverse impact on our
financial performance and the value of our properties.
Real estate investments are subject to various risks and fluctuations and
cycles in value and demand, many of which are beyond our control. Our financial performance and the value of our properties can be affected by many of these factors, including the following:
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adverse changes in financial conditions of buyers, sellers and tenants of our properties, including bankruptcies, financial difficulties or lease defaults by our tenants;
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the national, regional and local economy, which may be negatively impacted by concerns about inflation, government deficits or government budgets, unemployment rates, decreased consumer confidence, industry slowdowns,
reduced corporate profits, liquidity concerns in our markets and other adverse business concerns;
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local real estate conditions, such as an oversupply of, or a reduction in, demand for office space and the availability and creditworthiness of current and prospective tenants;
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vacancies or ability to rent space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or below-market renewal options;
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changes in operating costs and expenses, including, without limitation, increasing labor and material costs, insurance costs, energy prices, environmental restrictions, real estate taxes and costs of compliance with
laws, regulations and government policies, which we may be restricted from passing on to our tenants;
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fluctuations in interest rates, which could adversely affect our ability, or the ability of buyers and tenants of our properties, to obtain financing on favorable terms or at all, or impact the market price of our
properties we own or target for investment;
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competition from other real estate investors with significant capital, including other real estate operating companies, other publicly traded REITs and institutional investment funds;
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inability to refinance our indebtedness, which could result in a default on our obligation and trigger cross default provisions that could result in a default on other indebtedness;
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the convenience and quality of competing office properties;
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inability to collect rent from tenants;
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our ability to secure adequate insurance;
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our ability to secure adequate management services and to maintain our properties;
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changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning, immigration and tax laws, government fiscal, monetary and
trade policies and the Americans with Disabilities Act of 1990 (the ADA); and
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civil unrest, acts of war, cyber attacks, terrorist attacks and natural disasters, including earthquakes, wind damage and floods, which may result in uninsured and underinsured losses.
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In addition, because the yields available from equity investments in real estate depend in large part on the amount of rental income earned,
as well as property operating expenses and other costs incurred, a period of economic slowdown or recession, or declining demand for real estate, or the public perception that any of these
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events may occur, could result in a general decline in rents or an increased incidence of defaults among our existing leases, and, consequently, our properties, including any held by joint
ventures, may fail to generate revenues sufficient to meet operating, debt service and other expenses. As a result, we may have to borrow amounts to cover fixed costs, and our financial condition, results of operations, cash flow, per share market
price of our common stock and ability to satisfy our principal and interest obligations and to make distributions to our stockholders may be adversely affected.
Significant competition may decrease or prevent increases in our properties occupancy and rental rates and may reduce our investment opportunities.
We compete with numerous owners, operators and developers of office properties, many of which own properties similar to ours in the
same submarkets in which our properties are located. Furthermore, undeveloped land in many of the markets in which we operate is generally more readily available and less expensive than in gateway markets, which are commonly defined as New York, Los
Angeles, Washington, D.C., Boston, Chicago and San Francisco. If our competitors offer space from existing or new buildings at rental rates below current market rates, or below the rental rates that we currently charge our tenants, we may lose
existing or potential tenants and we may be pressured to reduce our rental rates below those that we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in
order to retain or attract tenants when our tenants leases expire. Our competitors may have substantially greater financial resources than we do and may be able to accept more risk than we can prudently manage. In the future, competition from
these entities may reduce the number of suitable investment opportunities offered to us or increase the bargaining power of property owners seeking to sell. As a result, our financial condition, results of operations, cash flows and market price of
our common stock could be adversely affected.
We are dependent on our key personnel and the loss of such key personnel could materially adversely
affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
We are
dependent on the efforts of our key officers and employees, including James Farrar, our Chief Executive Officer, Gregory Tylee, our President and Chief Operating Officer, and Anthony Maretic, our Chief Financial Officer, Secretary and Treasurer. The
loss of Mr. Farrars, Mr. Tylees and/or Mr. Maretics services could have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to our
stockholders. Although we have employment agreements with them, we cannot assure you they will remain employed with us.
A decrease in demand for
office space may have a material adverse effect on our financial condition and results of operations.
Our portfolio of properties
consists entirely of office properties and because we seek to acquire similar properties, a decrease in the demand for office space may have a greater adverse effect on our business and financial condition than if we owned a more diversified real
estate portfolio. If parts of our properties are leased within a particular sector, a significant downturn in that sector in which the tenants businesses operate would adversely affect our results of operations. In addition, where a government
agency is a tenant, which is the case for a number of our properties, austerity measures, the inability of the federal, state or local government to approve a budget, and governmental deficit reduction programs may lead government agencies to stop
paying rent, consolidate and reduce their office space, terminate their lease or decrease their workforce, which may reduce demand for office space in the government sector.
Failure by any major tenant to make rental payments to us, because of a deterioration of its financial condition, a termination of its lease, a
non-renewal
of its lease or otherwise, could seriously harm our results of operations.
As of
December 31, 2017, approximately 32.4% of the base rental revenue of our properties was derived from our ten largest tenants. Our largest tenant is the Colorado Department of Public Health and Environment, which accounted for approximately
5.8% of base rental revenue of our properties for the year ended December 31, 2017.
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At any time, our tenants may experience a downturn in their businesses that may significantly weaken their financial condition, whether as a result of general economic conditions or otherwise. As
a result, our tenants may fail to make rental payments when due, delay lease commencements, decline to extend or renew leases upon expiration or declare bankruptcy. Any of these actions could result in the termination of the tenants leases or
the failure to renew a lease and the loss of rental income attributable to the terminated leases. The occurrence of any of the situations described above could seriously harm our results of operations.
We may be unable to secure funds for future tenant or other capital improvements or payment of leasing commissions, which could limit our ability to
attract or replace tenants and adversely impact our ability to make cash distributions to our stockholders.
When tenants do not renew
their leases or otherwise vacate their space, it is common that, in order to attract replacement tenants, we will be required to expend funds for tenant improvements, payment of leasing commissions and other concessions related to the vacated space.
Such tenant improvements may require us to incur substantial capital expenditures. We may not be able to fund capital expenditures solely from cash provided from our operating activities because we must distribute at least 90% of our REIT taxable
income, determined without regard to the deduction for dividends paid and excluding net capital gains, each year to qualify as a REIT. As a result, our ability to fund tenant and other capital improvements or payment of leasing commissions
through retained earnings may be limited. If we have insufficient capital reserves, we will have to obtain financing from other sources. We may also have future financing needs for other capital improvements to refurbish or renovate our properties.
If we are unable to secure financing on terms that we believe are acceptable or at all, we may be unable to make tenant and other capital improvements or payment of leasing commissions or we may be required to defer such improvements. If this
happens, it may cause one or more of our properties to suffer from a greater risk of obsolescence or a decline in value, as a result of fewer potential tenants being attracted to the property or existing tenants not renewing their leases. If we
do not have access to sufficient funding in the future, we may not be able to make necessary capital improvements to our properties, pay leasing commissions or other expenses or pay distributions to our stockholders.
We may be required to make rent or other concessions and significant capital expenditures to improve our properties in order to retain and attract tenants,
which could adversely affect our financial condition, results of operations and cash flow.
In order to retain existing tenants and
attract new clients, we may be required to offer more substantial rent abatements, tenant improvements and early termination rights or accommodate requests for renovations,
build-to-suit
remodeling and other improvements or provide additional services to our tenants. As a result, we may have to make significant capital or other expenditures
in order to retain tenants whose leases expire and to attract new tenants in sufficient numbers, which could adversely affect our results of operations and cash flow. Additionally, if we need to raise capital to make such expenditures and are unable
to do so, or such capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in
non-renewals
by tenants upon expiration of their leases, which could adversely
affect our financial condition, results of operations and cash flow.
We depend on external sources of capital that are outside of our control, which
may affect our ability to seize strategic opportunities, satisfy our debt obligations and make distributions to our stockholders.
In
order to maintain our qualification as a REIT, we are generally required under the U.S. Internal Revenue Code of 1986, as amended (the Code) to annually distribute at least 90% of our REIT taxable income, determined without regard to the
deduction for dividends paid and excluding any net capital gain. In addition, as a REIT, we will be subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our REIT taxable income, including any net
capital gains. Because of these distribution requirements, we may not be able to fund future capital needs (including redevelopment, acquisition, expansion and renovation activities, payments of principal and interest on and the refinancing of our
existing debt, tenant improvements
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and leasing costs), from operating cash flow. Consequently, we may rely on third-party sources to fund our capital needs. We may not be able to obtain the necessary financing on favorable terms,
in the time period that we desire or at all. Any additional debt we incur will increase our leverage, expose us to the risk of default and may impose operating restrictions on us, and any additional equity we raise could be dilutive to existing
stockholders. Our access to third-party sources of capital depends, in part, on:
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general market conditions;
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the markets view of the quality of our assets;
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the markets perception of our growth potential;
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our current debt levels;
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our current and expected future earnings;
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our cash flow and cash distributions; and
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the market price of securities we may issue from time to time.
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If we cannot obtain capital
from third-party sources, we may not be able to acquire or develop properties when strategic opportunities exist, satisfy our principal and interest obligations or make the cash distributions to our stockholders necessary to maintain our
qualification as a REIT.
Covenants in our Amended and Restated Credit Agreement may cause us to fail to qualify as a REIT.
In order to maintain our qualification as a REIT, we are generally required under the Code to distribute annually at least 90% of our net
taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain. In addition, we will be subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our net
taxable income, including any net capital gains. Under our Amended and Restated Credit Agreement, we are generally prohibited from making distributions in excess of 100% of Core Funds From Operations, as defined in the Amended and Restated Credit
Agreement. If Core Funds From Operations is less than 90% of our net taxable income, we will not be able to make sufficient distributions to maintain our REIT status. In addition, if Core Funds From Operations is greater than 90% of our net taxable
income but less than 100% of our net taxable income, we will be required to pay income tax at regular corporate rates on any net taxable income we are prohibited from distributing as a result of this covenant. Furthermore, if we fail to distribute
at least the sum of 85% of our REIT ordinary income for the year, 95% of our REIT capital gain for the year and any undistributed taxable income from prior years, we will incur a 4% nondeductible excise tax on the excess of such required
distribution over the amount we actually distribute.
We have a substantial amount of indebtedness outstanding which may affect our ability to pay
distributions, may expose us to interest rate fluctuation risk and may expose us to the risk of default under our debt obligations.
Our total consolidated principal indebtedness, as of December 31, 2017, was approximately $494.5 million. We do not anticipate that
our internally generated cash flows will be adequate to repay our existing indebtedness upon maturity, and, therefore, we expect to repay our indebtedness through refinancings and future offerings of equity and debt securities, either of which we
may be unable to secure on favorable terms or at all. Our substantial outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have other significant adverse consequences, including the following:
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our cash flow may be insufficient to meet our required principal and interest payments;
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we may be unable to borrow additional funds as needed or on favorable terms, which could, among other things, adversely affect our ability to capitalize upon emerging acquisition opportunities or meet operational needs;
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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
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we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;
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we may be forced to enter into financing arrangements with particularly burdensome collateral requirements or restrictive covenants;
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we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations or require us to retain cash for reserves;
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we may be unable to hedge floating rate debt, counterparties may fail to honor their obligations under our hedge agreements and these agreements may not effectively hedge interest rate fluctuation risk;
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we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans;
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our default under any of our indebtedness with cross default provisions could result in a default on other indebtedness; and
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cross default provisions on properties with minority parties could trigger indemnity obligations.
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If any one of these events were to occur, our financial condition, results of operations, cash flows, market price of our common stock or
preferred stock and ability to satisfy our debt service obligations and to pay distributions to you could be adversely affected. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which
could adversely affect our ability to meet the distribution requirements necessary to maintain our qualification as a REIT.
We could become highly
leveraged in the future because our organizational documents contain no limitations on the amount of debt that we may incur.
As of
December 31, 2017, our principal indebtedness represented approximately 55.2% of our total assets. However, our organizational documents contain no limitations on the amount of indebtedness that we or City Office REIT Operating Partnership,
L.P. (our Operating Partnership) may incur. We could alter the balance between our total outstanding indebtedness and the value of our properties at any time. If we become more highly leveraged, the resulting increase in outstanding debt
could adversely affect our ability to make debt service payments, to pay our anticipated distributions and to make the distributions required to maintain our qualification as a REIT. The occurrence of any of the foregoing risks could adversely
affect our business, financial condition and results of operations, our ability to make distributions to our stockholders and the trading price of our securities.
Lenders may require us to enter into restrictive covenants relating to our operations, which could limit our ability to make distributions to our
stockholders.
In providing financing to us, a lender may impose restrictions on us that would affect our ability to incur additional
debt, make certain investments, reduce liquidity below certain levels, make distributions to our stockholders and otherwise affect our distribution and operating policies. In general, we expect that our loan agreements will restrict our ability to
encumber or otherwise transfer our interest in the respective property without the prior consent of the lender. Such loan documents may contain other negative covenants that may limit our ability to discontinue insurance coverage or impose other
limitations. Any such restriction or limitation may limit our ability to make distributions to you. Further, such restrictions could make it difficult for us to satisfy the requirements necessary to maintain our qualification as a REIT.
We may engage in hedging transactions, which can limit our gains and increase exposure to losses.
Subject to maintaining our qualification as a REIT, we may enter into hedging transactions to protect us from the effects of interest rate
fluctuations on floating rate debt. Our hedging transactions may include entering into interest rate swap agreements or interest rate cap or floor agreements, or other interest rate exchange contracts. Hedging activities may not have the desired
beneficial impact on our results of operations or financial
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condition. No hedging activity can completely insulate us from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect us or adversely affect us
because, among other things:
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available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;
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the duration of the hedge may not match the duration of the related liability;
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the party owing money in the hedging transaction may default on its obligation to pay;
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the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
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the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value, such as downward adjustments, or
mark-to-market
losses, which would reduce our stockholders equity.
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Hedging involves risk and typically involves costs, including transaction costs, that may reduce our overall returns on our investments. These
costs increase as the period covered by the hedging increases and during periods of rising and volatile interest rates. These costs will also limit the amount of cash available for distribution to stockholders. We generally intend to hedge as much
of the interest rate risk as we determine is in our best interests given the cost of such hedging transactions. The REIT tax rules may limit our ability to enter into hedging transactions by requiring us to limit our income from
non-qualifying
hedges. If we are unable to hedge effectively because of the REIT tax rules, we will face greater interest rate exposure than may be commercially prudent.
Changes in the method pursuant to which the LIBOR rates are determined and potential phasing out of LIBOR after 2021 may affect our financial results.
The chief executive of the United Kingdom Financial Conduct Authority (FCA), which regulates LIBOR, has recently announced
that the FCA intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. It is not possible to predict the effect of these changes, other reforms or the establishment of alternative reference rates in the United Kingdom
or elsewhere. Furthermore, in the United States, efforts to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee of the Federal Reserve Board and the Federal Reserve Bank
of New York. On August 24, 2017, the Federal Reserve Board requested public comment on a proposal by the Federal Reserve Bank of New York, in cooperation with the Office of Financial Research, to produce three new reference rates intended to
serve as alternatives to LIBOR. These alternative rates are based on overnight repurchase agreement transactions secured by U.S. Treasury Securities. The Federal Reserve Bank said that the publication of these alternative rates is targeted to
commence by
mid-2018.
Any changes announced by the FCA, including the FCA Announcement, other
regulators or any other successor governance or oversight body, or future changes adopted by such body, in the method pursuant to which the LIBOR rates are determined may result in a sudden or prolonged increase or decrease in the reported LIBOR
rates. If that were to occur, the level of interest payments we incur may change. In addition, although certain of our LIBOR based obligations provide for alternative methods of calculating the interest rate payable on certain of our obligations if
LIBOR is not reported, which include requesting certain rates from major reference banks in London or New York, or alternatively using LIBOR for the immediately preceding interest period or using the initial interest rate, as applicable, uncertainty
as to the extent and manner of future changes may result in interest rates and/or payments that are higher than, lower than or that do not otherwise correlate over time with the interest rates and/or payments that would have been made on our
obligations if LIBOR rate was available in its current form.
Economic conditions may adversely affect the real estate market and our income.
Uncertainty over whether the U.S. economy will be adversely affected by inflation or stagflation, volatile energy costs, geopolitical issues,
the availability and cost of credit, future policy and fiscal decisions of the federal
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government, the mortgage market in the United States and the late-cycle real estate market may contribute to increased market volatility or threaten business and consumer confidence. This
uncertain operating environment could adversely affect our ability to generate revenues, thereby reducing our operating income and earnings.
In addition, local real estate conditions such as an oversupply of properties or a reduction in demand for properties, competition from other
similar properties, our ability to provide or arrange for adequate maintenance, insurance and management and advisory services, increased operating costs (including real estate taxes), the attractiveness, location of the property, changes in market
rental rates and region-specific legislation or political initiatives may adversely affect a propertys income and value. A rise in energy costs could result in higher operating costs, which may affect our results of operations. In addition,
local conditions in the markets in which we own or intend to own properties may significantly affect occupancy or rental rates at such properties. Events that could prevent us from raising or maintaining rents or cause us to reduce rents include
layoffs, plant closings, relocations of significant local employers and other events reducing local employment rates, an oversupply ofor a lack of demand foroffice space, a decline in household formation, the inability or unwillingness
of tenants to pay rent increases, and geopolitical developments having a disproportionate effect on the markets in which we operate.
Our joint venture
investments could be adversely affected by the capital markets, our lack of sole decision-making authority, our reliance on joint venture partners financial condition and any disputes that may arise between us and our joint venture partners.
We have in the past
co-invested,
and may in the future
co-invest,
with third parties through partnerships, joint ventures or other structures, acquiring
non-controlling
interests in, or sharing responsibility for managing
the affairs of, a property, partnership,
co-tenancy
or other entity. Investments in joint ventures may, under certain circumstances, involve risks not present when a third party is not involved, including
potential deadlocks in making major decisions, restrictions on our ability to exit the joint venture, reliance on our joint venture partners and the possibility that joint venture partners might become bankrupt or fail to fund their share of
required capital contributions, thus exposing us to liabilities in excess of our share of the investment or take action that could jeopardize our REIT status. The funding of our capital contributions may be dependent on proceeds from asset sales,
credit facility advances and/or sales of equity securities. Joint venture partners may have business interests or goals that are inconsistent with our business interests or goals and may be in a position to take actions contrary to our policies or
objectives. We may in specific circumstances be liable for the actions of our joint venture partners. In addition, any disputes that may arise between us and joint venture partners may result in litigation or arbitration that would increase our
expenses.
We may incur significant costs complying with various federal, state and local laws, regulations and covenants that are applicable to our
properties, which could have an adverse impact on our financial condition, results of operations, cash flows and market price of our common stock.
The properties in our portfolio are subject to various covenants and federal, state and local laws and regulatory requirements, including
permitting and licensing requirements. Local regulations, including municipal or local ordinances, zoning restrictions and restrictive covenants imposed by community developers may restrict our use of our properties and may require us to obtain
approval or waivers from local officials or restrict our use of our properties and may require us to obtain approval from local officials of community standards organizations at any time with respect to our properties, including prior to acquiring a
property or when undertaking renovations of any of our existing properties. Among other things, these restrictions may relate to fire and safety, seismic or hazardous material abatement requirements. There can be no assurance that existing or future
laws and regulatory policies, including federal laws or executive actions affecting the markets in which we operate, will not adversely affect us or the timing or cost of any future acquisitions or renovations, or that additional regulations will
not be adopted that could increase such delays or result in additional costs. Our growth strategy may be affected by our ability to obtain permits, licenses and zoning relief. Our failure to obtain such permits, licenses and zoning relief or to
comply with applicable laws could have an adverse effect on our financial condition, results of operations, cash flow and per share market price of our common stock or preferred stock.
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We could incur significant costs related to government regulation and private litigation over environmental
matters involving the presence, discharge or threat of discharge of hazardous or toxic substances, which could adversely affect our operations, the value of our properties and our ability to make distributions to our stockholders.
Our properties may be subject to environmental liabilities. Under various federal, state and local laws, a current or previous owner,
operator or tenant of real estate can face liability for environmental contamination created by the presence, discharge or threat of discharge of hazardous or toxic substances. Liabilities can include the cost to investigate, clean up and monitor
the actual or threatened contamination and damages caused by the contamination or threatened contamination.
The liability under such laws
may be strict, joint and several, meaning that we may be liable regardless of whether we knew of, or were responsible for, the presence of the contaminants, and the government entity or private party may seek recovery of the entire amount from us
even if there are other responsible parties. Liabilities associated with environmental conditions may be significant and can sometimes exceed the value of the affected property. The presence of hazardous substances on a property may adversely affect
our ability to sell or rent that property or to borrow using that property as collateral.
Environmental laws also:
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may require the removal or upgrade of underground storage tanks;
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regulate the discharge of storm water, wastewater and other pollutants;
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regulate air pollutant emissions;
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regulate hazardous materials generation, management and disposal; and
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regulate workplace health and safety.
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Existing conditions at some of our properties may expose us to
liability related to environmental matters.
Independent environmental consultants have conducted Phase I or similar environmental
site assessments on all of our properties. Site assessments are intended to discover and evaluate information regarding the environmental condition of the surveyed property and surrounding properties. These assessments do not generally include
subsurface investigations or mold or asbestos surveys. None of the recent site assessments revealed any past or present environmental liability that we believe would have a material adverse effect on our business, financial condition, cash flows or
results of operations. However, the assessments may have failed to reveal all environmental conditions, liabilities or compliance concerns. Material environmental conditions, liabilities or compliance concerns may have arisen after the review was
completed or may arise in the future; and future laws, ordinances or regulations may impose material additional environmental liability.
Costs of future environmental compliance could negatively affect our ability to make distributions to our stockholders, and remedial measures
required to address such conditions could have a material adverse effect on our business, financial condition, cash flows or results of operations.
Our properties may contain asbestos or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem,
which could adversely affect the value of the affected property and our ability to make distributions to our stockholders.
We are
required by federal regulations with respect to our properties to identify and warn, via signs and labels, of potential hazards posed by workplace exposure to installed asbestos-containing materials (ACMs) and potential ACMs. We may
be subject to an increased risk of personal injury lawsuits by workers and others exposed to ACMs and potential ACMs at our properties as a result of these regulations. The regulations may affect the value of any of our properties containing ACMs
and potential ACMs. Federal, state and local laws and
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regulations also govern the removal, encapsulation, disturbance, handling and disposal of ACMs and potential ACMs when such materials are in poor condition or in the event of construction,
remodeling, renovation or demolition of a property.
When excessive moisture accumulates in buildings or on building materials, mold
growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing because exposure to
mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions.
The presence of ACMs or
significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the ACMs or mold from the affected property. In addition, the presence of ACMs or significant mold could expose us to claims of
liability to our tenants, their or our employees, and others if property damage or health concerns arise.
Potential losses, including from adverse
weather conditions, natural disasters and title claims, may not be covered by insurance.
Certain of our properties are located in
states where natural disasters such as tornadoes, hurricanes and earthquakes are more common than in other states. Given recent extreme weather events across parts of the United States, including devastating hurricanes in Florida and wildfires in
California, it is also possible that our other properties could incur significant damage due to other natural disasters. While we carry insurance to cover a substantial portion of the cost of such events, such as droughts or flooding, our insurance
includes deductible amounts and certain items may not be covered by insurance. Future natural disasters may significantly affect our operations and properties and, more specifically, may cause us to experience reduced rental revenue (including from
increased vacancy), incur
clean-up
costs or otherwise incur costs in connection with such events. Any of these events may have a material adverse effect on our business, cash flows, financial condition,
results of operations and ability to make distributions to our stockholders.
Furthermore, we do not carry insurance for certain losses,
including, but not limited to, losses caused by certain environmental conditions, such as mold or asbestos, riots, civil unrest or war. In addition, our title insurance policies may not insure for the current aggregate market value of our portfolio,
and we do not intend to increase our title insurance coverage as the market value of our portfolio increases. As a result, we may not have sufficient coverage against all losses that we may experience, including from adverse title claims.
If we experience a loss that is uninsured or exceeds policy limits, we could incur significant costs and lose the capital invested in the
damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were
irreparably damaged.
Moreover, we carry several different lines of insurance, placed with several large insurance carriers. If any
one of these large insurance carriers were to become insolvent, we would be forced to replace the existing insurance coverage with another suitable carrier and any outstanding claims would be at risk for collection. In such an event, we cannot
be certain that we would be able to replace the coverage at similar or otherwise favorable terms. Replacing insurance coverage at unfavorable rates and the potential of uncollectible claims due to carrier insolvency could adversely affect our
results of operations and cash flows.
Climate change may adversely affect our business.
To the extent that climate change does occur, we may experience extreme weather and changes in precipitation and temperature, all of which may
result in physical damage or a decrease in demand for our properties located in the areas affected by these conditions. Should the impact of climate change be material in nature or occur for lengthy periods of time, our financial condition or
results of operations would be adversely affected. In addition,
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changes in federal and state legislation and regulation on climate change could result in increased capital expenditures to improve the energy efficiency of our existing properties in order to
comply with such regulations.
We may be limited in our ability to diversify our investments making us more vulnerable economically than if our
investments were diversified.
Our ability to diversify our portfolio may be limited both as to the number of investments owned and the
geographic regions in which our investments are located. While we seek to diversify our portfolio by geographic location, we focus on our specified target markets that we believe offer the opportunity for attractive returns and, accordingly, our
actual investments may result in concentrations in a limited number of geographic regions. As a result, there is an increased likelihood that the performance of any single property, or the economic performance of a particular region in which our
properties are located, could materially affect our operating results.
We may acquire properties with
lock-out
provisions, or agree to such provisions in connection with obtaining financing, which may prohibit us from selling or refinancing a property during the
lock-out
period.
We may acquire properties in exchange for common units and agree to restrictions on sales or refinancing, called
lock-out
provisions, which are intended to preserve favorable tax treatment for the owners of such properties who sell them to us. In addition, we may agree to
lock-out
provisions in connection with obtaining financing for the acquisition of properties.
Lock-out
provisions could materially restrict us from selling, otherwise
disposing of or refinancing properties. These restrictions could affect our ability to turn our investments into cash and thus affect cash available for distributions to our stockholders.
Lock-out
provisions
could impair our ability to take actions during the
lock-out
period that would otherwise be in the best interests of our stockholders and, therefore, could adversely impact the market value of our common
stock. In particular,
lock-out
provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or
change in control might be in the best interests of our stockholders.
Illiquidity of real estate investments could significantly impede our ability to
respond to adverse changes in the performance of our properties and harm our financial condition.
The real estate investments made,
and to be made, by us are relatively difficult to sell quickly. As a result, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited. Return of
capital and realization of gains, if any, from an investment generally will occur upon disposition or refinancing of the underlying property. We may be unable to realize our investment objectives by sale, other disposition or refinancing at
attractive prices within any given period of time or may otherwise be unable to complete any exit strategy. In particular, our ability to dispose of one or more properties is subject to weakness in or even the lack of an established market for
a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions and changes in laws, regulations or fiscal policies of jurisdictions in which the property is located.
In addition, the Code imposes restrictions on a REITs ability to dispose of properties that are not applicable to other types of
real estate companies. In particular, the tax laws applicable to REITs effectively require that we hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forego or defer sales of
properties that otherwise would be in our best interest. Therefore, we may not be able to adjust our portfolio in response to economic or other conditions promptly or on favorable terms, which may adversely affect our financial condition, results of
operations, cash flow and per share market price of our common stock or preferred stock.
If we sell properties by providing financing to purchasers,
we will bear the risk of default by the purchaser.
If we decide to sell any of our properties, we intend to use commercially
reasonable efforts to sell them for cash. However, in some instances we may sell our properties by providing financing to purchasers. If we provide
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financing to purchasers, we will bear the risk of default by the purchasers which would reduce the value of our assets, impair our ability to make distributions to our stockholders and reduce the
price of our common stock.
We may be unable to collect balances due on our leases from any tenants in bankruptcy, which could adversely affect our
cash flow and the amount of cash available for distribution to our stockholders.
The bankruptcy or insolvency of one or more of
our tenants may adversely affect the income produced by our properties. We cannot assure you that any tenant that files for bankruptcy protection will continue to pay us rent. If a tenant files for bankruptcy, any or all of the tenants or a
guarantor of a tenants lease obligations could be subject to a bankruptcy proceeding pursuant to Chapter 11 or Chapter 7 of the U.S. Bankruptcy Code. Such a bankruptcy filing would impose an automatic stay barring all efforts by us to collect
pre-bankruptcy
rents from these entities or their properties, unless we receive an order from the bankruptcy court lifting the automatic stay to permit us to pursue collections. A tenant or lease guarantor
bankruptcy could delay our efforts to collect past due balances under the relevant leases and could ultimately preclude collection of these sums. If a lease is rejected by a tenant in bankruptcy, we would only have a general unsecured claim for
damages. This claim could be paid only in the event funds were available and then only in the same percentage as that realized on other unsecured claims. Our claim would be capped at the rent reserved under the lease, without acceleration, for the
greater of one year or 15% of the remaining term of the lease, but not greater than three years, plus rent already due but unpaid. Therefore, if a lease is rejected, it is possible that we would not receive payment from the tenant or that
we would receive substantially less than the full value of any unsecured claims we hold, which would result in a reduction in our rental income, cash flow and the amount of cash available for distribution to our stockholders.
We may face additional risks and costs associated with owning properties occupied by government tenants, which could negatively impact our cash flows and
results of operations.
As of December 31, 2017, we owned eight properties in which some or all of the tenants are federal
government agencies. We may continue to pursue the acquisition of office properties in which substantial space is leased to governmental agencies. As such, lease agreements with these federal government agencies contain certain provisions required
by federal law, which require, among other things, that the contractor (which is the lessor or the owner of the property), agree to comply with certain rules and regulations, including, but not limited to, rules and regulations related to
anti-kickback procedures, examination of records, audits and records, equal opportunity provisions, prohibition against segregated facilities, certain executive orders, subcontractor cost or pricing data, certain provisions intending to assist small
businesses and contractual rights of termination by the tenants. We may be subject to requirements of the Employment Standards Administrations Office of Federal Contract Compliance Programs and requirements to prepare affirmative action plans
pursuant to the applicable executive order may be determined to be applicable to us.
In addition, some of our leases with government
tenants may be subject to statutory or contractual rights of termination by the tenants, which will allow them to vacate the leased premises before the stated terms of the leases expire with little or no liability. For fiscal policy reasons,
security concerns or other reasons, some or all of our government tenants may decide to vacate our properties. If a significant number of such vacancies occur, our rental income may materially decline, our cash flow and results of operations could
be adversely affected and our ability to pay regular distributions to you may be jeopardized.
Our government tenants are also subject to
discretionary funding from the federal government. Federal government programs are subject to annual congressional budget authorization and appropriation processes. For many programs, Congress appropriates funds on a fiscal year basis even though
the program performance period may extend over several years. Laws and plans adopted by the federal government relating to, along with pressures on and uncertainty surrounding the federal budget, potential changes in priorities and spending levels,
sequestration, the appropriations process, use of continuing resolutions (with restrictions, e.g., on new starts) and the permissible federal debt limit, could adversely affect the funding for our government tenants. The budget environment and
uncertainty surrounding the appropriations processes remain significant long-term risks as budget cuts could adversely affect the viability of our government tenants.
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Some of the leases at our properties contain early termination provisions which, if triggered, may
allow tenants to terminate their leases without further payment to us, which could adversely affect our financial condition and results of operations and the value of the applicable property.
Certain tenants have a right to terminate their leases upon payment of a penalty, but others are not required to pay any penalty associated
with an early termination. Most of our tenants that are federal or state governmental agencies, which account for approximately 18.8% of the base rental revenue from our properties as of December 31, 2017, may, under certain circumstances,
vacate the leased premises before the stated terms of the leases expire with little or no liability to us. There can be no assurance that tenants will continue their activities and continue occupancy of the premises. Any cessation of occupancy by
tenants may have an adverse effect on our operations.
The federal governments green lease policies may adversely affect us.
In recent years, the federal government has instituted green lease policies which allow a government tenant to require
leadership in energy and environmental design for commercial interiors, or LEED
®
-CI, certification in selecting new premises or renewing leases at existing premises. In addition, the Energy
Independence and Security Act of 2007 allows the General Services Administration to prefer buildings for lease that have received an Energy Star label. Obtaining such certifications and labels may be costly and time consuming, but our
failure to do so may result in our competitive disadvantage in acquiring new or retaining existing government tenants.
We may be unable to complete
acquisitions and, even if acquisitions are completed, we may fail to successfully operate acquired properties.
Our business plan
includes, among other things, growth through identifying suitable acquisition opportunities, consummating acquisitions and leasing such properties. We will evaluate the market of available properties and may acquire properties when we believe
strategic opportunities exist. Our ability to acquire properties on favorable terms and successfully develop or operate them is subject to, among others, the following risks:
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we may be unable to acquire a desired property because of competition from other real estate investors with substantial capital, including from other REITs and institutional investment funds;
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even if we are able to acquire a desired property, competition from other potential acquirers may significantly increase the purchase price;
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even if we enter into agreements for the acquisition of properties, these agreements are subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction;
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we may incur significant costs in connection with evaluation and negotiation of potential acquisitions, including acquisitions that we are subsequently unable to complete;
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we may acquire properties that are not initially accretive to our results upon acquisition, and we may not successfully lease those properties to meet our expectations;
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we may be unable to finance the acquisition on favorable terms in the time period we desire, or at all;
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even if we are able to finance the acquisition, our cash flows may be insufficient to meet our required principal and interest payments;
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we may spend more than budgeted to make necessary improvements or renovations to acquired properties;
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we may be unable to quickly and efficiently integrate new acquisitions, particularly the acquisition of portfolios of properties, into our existing operations;
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market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and
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we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities for
clean-up
of undisclosed
environmental contamination, claims by tenants or other persons dealing with former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
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Acquired properties may be located in new markets where we may face risks associated with investing in an unfamiliar market.
We may acquire properties in markets that are new to us. When we acquire properties located in new markets, we may face risks associated with a
lack of market knowledge or understanding of the local economy, forging new business relationships in the area and unfamiliarity with local government and permitting procedures. We work to mitigate such risks through extensive diligence and research
and associations with experienced service providers. However, there can be no guarantee that all such risks will be eliminated.
Adverse market and
economic conditions could cause us to recognize impairment charges or otherwise impact our performance.
We intend to review the
carrying value of our properties when circumstances, such as adverse market conditions, indicate a potential impairment may exist. We intend to base our review on an estimate of the future cash flows (excluding interest charges) expected to result
from the propertys use and eventual disposition on an undiscounted basis. We intend to consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our
evaluation indicates that we may be unable to recover the carrying value of a real estate investment, an impairment loss will be recorded to the extent that the carrying value exceeds the estimated fair value of the property.
Impairment losses would have a direct impact on our operating results because recording an impairment loss results in an immediate negative
adjustment to our operating results. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results
in future periods. If the real estate market deteriorates, we may reevaluate the assumptions used in our impairment analysis. Impairment charges could materially adversely affect our financial condition, results of operations, cash flows and ability
to pay distributions on, and the per share market price of, our common stock or preferred stock.
Litigation may result in unfavorable outcomes.
Like many real estate operators, we may be involved in lawsuits involving premises liability claims and alleged violations of
landlord-tenant laws, which may give rise to class action litigation or governmental investigations. Any material litigation not covered by insurance, such as a class action, could result in us incurring substantial costs and harm our financial
condition, results of operations, cash flows and ability to pay distributions to you.
We may invest in properties with other entities, and our lack of
sole decision-making authority or reliance on a joint-venturers financial condition could make these joint venture investments risky and expose us to losses or impact our ability to maintain our qualification as a REIT.
We may
co-invest
in the future with third parties through partnerships, joint ventures or other
entities. We may acquire
non-controlling
interests or share responsibility for managing the affairs of a property, partnership, joint venture or other entity. In such events, we would not be in a position to
exercise sole decision-making authority regarding the property or entity. Investments in entities may, under certain circumstances, involve risks not present were a third party not involved. These risks include the possibility that partners or
joint-venturers:
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might become bankrupt or fail to fund their share of required capital contributions;
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may have economic or other business interests or goals that are inconsistent with our business interests or goals; and
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may be in a position to take actions contrary to our policies or objectives or exercise rights to buy or sell at an inopportune time for us.
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Such investments may also have the potential risk of impasses on decisions, such as a sale or refinancing of the property, because neither we
nor the partner or joint-venturer would have full control over the partnership or joint venture. Disputes between us and partners or joint-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers
and directors from focusing their time and effort on our business or result in costs to terminate the relationship. Actions of partners or joint-venturers may cause losses to our investments and adversely affect our ability to maintain our
qualification as a REIT. In addition, we may in certain circumstances be liable for the actions of our third-party partners or joint-venturers if:
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we structure a joint venture or conduct business in a manner that is deemed to be a general partnership with a third party;
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third-party managers incur debt or other liabilities on behalf of a joint venture which the joint venture is unable to pay, and the joint venture agreement provides for capital calls, in which case we could be liable to
make contributions as set forth in any such joint venture agreement or suffer adverse consequences for a failure to contribute; or
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we agree to cross default provisions or to cross-collateralize our properties with the properties in a joint venture, in which case we could face liability if there is a default relating to those properties in the joint
venture or the obligations relating to those properties.
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Compliance with the Americans with Disabilities Act and similar laws may
require us to make significant unanticipated expenditures.
All of our properties and any future properties that we acquire are and
will be required to comply with the ADA. The ADA requires that all public accommodations must meet federal requirements related to access and use by disabled persons. For those projects receiving federal funds, the Rehabilitation Act of 1973 (the
RA) also has requirements regarding disabled access. Although we believe that our properties are substantially in compliance with the present requirements, we may incur unanticipated expenses to comply with the ADA, the RA and other
applicable legislation in connection with the ongoing operation or redevelopment of our properties. These and other federal, state and local laws may require modifications to our properties, or affect renovations of our properties.
Non-compliance
with these laws could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any
non-complying
feature, which could result in substantial capital expenditures.
Our property taxes could
increase due to property tax rate changes or reassessment, which may adversely impact our cash flows.
Even as a REIT, we will be
required to pay some state and local taxes on our properties. The real property taxes on our properties may increase as property tax rates change or as our properties are assessed or reassessed by taxing authorities. Therefore, the amount of
property taxes that we pay in the future may increase substantially. In addition, the real property taxes on Cherry Creek are reduced due to having a government user as its largest tenant and loss of such tenant would increase the amount of property
taxes. If the property taxes that we pay increase, our cash flow could be impacted, and our ability to pay expected distributions to our stockholders may be adversely affected.
It may be difficult to enforce civil liabilities against members of our board of directors or our executive officers.
Most of the members of our board of directors and our executive officers reside in Canada and substantially all of the assets of such persons
are located in Canada. As a result, it may be difficult for you to effect service of
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process within the United States or in any other jurisdiction outside of Canada upon these persons or to enforce against them in any jurisdiction outside of Canada judgments predicated upon the
laws of any such jurisdiction, including any judgment predicated upon the federal and state securities laws of the United States.
Our commitment to
Second City Real Estate II Corporation and its affiliates (Second City) following our internalization transactions may give rise to various conflicts of interest.
We are subject to conflicts of interest arising out of our relationship with Second City. As a result of the internalization of our former
external advisor on February 1, 2016, we agreed to allow our management to continue to provide services to Second City under the terms of an administrative services agreement. In addition, the terms of the administrative services agreement and
the employment agreements we have entered into with each of our executive officers permit, under certain circumstances and subject to the oversight of our Board of Directors, our executive officers to advise or oversee new or additional funds in the
future. These arrangements may create potential conflicts of interests, including competition for the time and services of personnel that work for us and our affiliates.
Our business could be adversely impacted if there are deficiencies in our disclosure controls and procedures or internal control over financial reporting.
The design and effectiveness of our disclosure controls and procedures and internal control over financial reporting may not prevent
all errors, misstatements or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, there can be no guarantee that our internal control
over financial reporting will be effective in accomplishing all control objectives all of the time. Deficiencies, including any material weakness, in our internal control over financial reporting that may occur in the future could result in
misstatements of our results of operations, restatements of our financial statements, or otherwise adversely impact our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy
our debt service obligations and to pay dividends and distributions to our security holders.
Risks Related to Our Status as a REIT
Our failure to maintain our qualification as a REIT would result in significant adverse tax consequences to us and would adversely affect our
business and the value of our stock.
We have elected and intend to continue to operate in a manner that will allow us to qualify to be
taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2014. Qualification as a REIT involves the application of highly technical and complex tax rules, for which there are only limited
judicial and administrative interpretations. The fact that we hold substantially all of our assets through our Operating Partnership further complicates the application of the REIT requirements. Even a seemingly minor technical or inadvertent
mistake could jeopardize our REIT status. Our REIT status depends upon various factual matters and circumstances that may not be entirely within our control. For example, in order to qualify as a REIT, at least 95% of our gross income in
any year must be derived from qualifying sources, such as rents from real property, and we must satisfy a number of requirements regarding the composition of our assets. Also, we must make distributions to stockholders aggregating annually at
least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains. In addition, new legislation, regulations, administrative interpretations or court decisions, each of which could
have retroactive effect, may make it more difficult or impossible for us to maintain our qualification
as a REIT, or could reduce the desirability of an investment in a REIT relative to other investments. We have not requested and do not plan
to request a ruling from the Internal Revenue Service (the IRS) that we qualify as a REIT, and the statements in this annual report are not binding on the IRS or any court. Accordingly, we cannot be certain that we will be successful in
maintaining our qualification as a REIT.
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If we fail to maintain our qualification as a REIT in any taxable year, we will face serious
adverse U.S. federal income tax consequences that would substantially reduce the funds available to distribute to you. If we fail to maintain our qualification as a REIT:
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we would not be allowed to deduct distributions to stockholders in computing our taxable income and would be subject to U.S. federal income tax at regular corporate rates (a maximum rate of 35% applies through 2017 and
a 21% rate applies for subsequent years);
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we could also be subject to the U.S. federal alternative minimum tax for taxable years prior to 2018 and possibly increased state and local taxes; and
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unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year in which we were disqualified.
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In addition, if we fail to maintain our qualification as a REIT, we will not be required to make distributions to stockholders. As a result of
all these factors, our failure to maintain our qualification as a REIT could impair our ability to expand our business and raise capital and would adversely affect the value of our capital stock.
Even if we qualify as a REIT, we may be subject to some U.S. federal, state and local income, property and excise taxes on our income or
property and, in certain cases, a 100% penalty tax, in the event we sell property that we hold primarily for sale to customers in the ordinary course of business. In addition, our taxable REIT subsidiaries (TRSs) are subject to tax as
regular corporations in the jurisdictions in which they operate.
To maintain our qualification as a REIT, we may be forced to borrow funds during
unfavorable market conditions to make distributions to our stockholders.
To maintain our qualification as a REIT, we generally must
distribute to our stockholders at least 90% of our REIT taxable income each year, determined without regard to the deduction for dividends paid and excluding any net capital gain, and we will be subject to regular corporate income taxes to the
extent that we distribute less than 100% of our REIT taxable income each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the
sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. To maintain our qualification as a REIT and avoid the payment of income and excise taxes, we may need to borrow funds
to meet the REIT distribution requirements. These borrowing needs could result from:
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differences in timing between the actual receipt of cash and inclusion of income for U.S. federal income tax purposes;
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the effect of nondeductible capital expenditures;
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the creation of reserves; or
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required debt or amortization payments.
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We may need to borrow funds at times when the
then-prevailing market conditions are not favorable for borrowing. These borrowings could increase our costs or reduce our equity and adversely affect the value of our common stock.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum U.S. federal income tax rate applicable to qualified dividend income payable to certain
non-corporate
U.S. stockholders, including individuals, trusts and estates, is 20%. Dividends payable by REITs, however, generally are not eligible for the reduced qualified dividend rates. For taxable years
beginning after December 31, 2017 and before January 1, 2026, under the recently enacted law informally known as the Tax Cuts and Jobs Act (TCJA),
non-corporate
taxpayers may deduct up to
20% of certain pass-through business
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income, including qualified REIT dividends (generally, dividends received by a REIT shareholder that are not designated as capital gain dividends or qualified dividend income),
subject to certain limitations, resulting in an effective maximum U.S. federal income tax rate of 29.6% on such income. Although the reduced U.S. federal income tax rate applicable to qualified dividend income does not adversely affect the taxation
of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends and the reduced corporate tax rate (currently 21%) could cause investors who are individuals, trusts and estates to perceive
investments in REITs to be relatively less attractive than investments in the stocks of
non-REIT
corporations that pay dividends, which could adversely affect the value of the shares of REITs, including
the market price of our capital stock.
The tax imposed on REITs engaging in prohibited transactions may limit our ability to engage in
transactions which would be treated as sales for U.S. federal income tax purposes.
A REITs net income from prohibited
transactions is subject to a 100% penalty tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held in inventory primarily for sale to customers in the ordinary course of business.
Although we do not intend to hold any properties that would be characterized as inventory held for sale to customers in the ordinary course of our business, such characterization is a factual determination and no guarantee can be given that the IRS
would agree with our characterization of our properties or that we will always be able to make use of the available safe harbors.
To maintain our
qualification as a REIT, we may be forced to forego otherwise attractive opportunities.
To maintain our qualification as a REIT, we
must satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our stockholders and the ownership of our stock. We may be required to make distributions
to stockholders at times when it would be more advantageous to reinvest cash in our business or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the
basis of maximizing profits.
In particular, we must ensure that at the end of each calendar quarter, at least 75% of the value of our
assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities, securities of any qualified REIT subsidiary or TRS of ours and securities
that are qualified real estate assets) generally may not include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in
general, no more than 5% of the value of our assets (other than government securities, securities of any qualified REIT subsidiary or TRS of ours and securities that are qualified real estate assets) may consist of the securities of any
one issuer. No more than 20% (25% for taxable years beginning prior to January 1, 2018) of the value of our total assets can be represented by securities of one or more TRSs, and no more than 25% of our assets can be represented by debt of
publicly offered REITs (i.e., REITs that are required to file annual and periodic reports with the SEC under the Exchange Act) that is not secured by real property or interests in real property. If we fail to comply with these
requirements at the end of any calendar quarter, we must remedy the failure within 30 days or qualify for certain limited statutory relief provisions to avoid losing status as a REIT. As a result, we may be required to liquidate otherwise
attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
We may
be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the market price of our shares of capital stock.
At any time, the U.S. federal income tax laws governing REITs may be amended or the administrative and judicial interpretations of those laws
may be changed. We cannot predict when or if any new U.S. federal income tax law, regulation, or administrative and judicial interpretation, or any amendment to any existing U.S. federal
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income tax law, regulation or administrative or judicial interpretation, will be adopted, promulgated or become effective, and any such law, regulation, or interpretation may be effective
retroactively. The TCJA significantly changed the U.S. federal income tax laws applicable to businesses and their owners, including REITs and their stockholders. Technical corrections or other amendments to the TCJA or administrative guidance
interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the TCJA or any future changes on REITs and their stockholders. We and our stockholders could be adversely affected by any change in, or any new, U.S.
federal income tax law, regulation or administrative and judicial interpretation.
Risks Related to Our Organizational Structure
Conflicts of interest exist or could arise in the future between the interests of our stockholders and the interests of holders of units in our
Operating Partnership, which may impede business decisions that could benefit our stockholders.
Conflicts of interest exist or could
arise in the future as a result of the relationships between us, on the one hand, and our Operating Partnership or any partner thereof, on the other. Our directors and officers have duties to our Company under applicable Maryland law in
connection with their management of our Company. At the same time, we, as the general partner of our Operating Partnership, have fiduciary duties and obligations to our Operating Partnership and its limited partners under Maryland law and the
partnership agreement of our Operating Partnership in connection with the management of our Operating Partnership. Our fiduciary duties and obligations as general partner to our Operating Partnership and its partners may come into conflict with the
duties of our directors and officers to our Company.
Additionally, the partnership agreement provides that we and our officers, directors
and employees, will not be liable or accountable to our Operating Partnership for losses sustained, liabilities incurred or benefits not derived if we, or such officer, director or employee acted in good faith. The partnership agreement also
provides that we will not be liable to our Operating Partnership or any partner for monetary damages for losses sustained, liabilities incurred or benefits not derived by our Operating Partnership or any limited partner, except for liability for our
intentional harm or gross negligence. Moreover, the partnership agreement provides that our Operating Partnership is required to indemnify us and our officers, directors, employees, agents and designees from and against any and all claims that
relate to the operations of our Operating Partnership, except (1) if the act or omission of the person was material to the matter giving rise to the action and either was committed in bad faith or was the result of active and deliberate
dishonesty, (2) for any transaction for which the indemnified party received an improper personal benefit, in money, property or services or otherwise in violation or breach of any provision of the partnership agreement or (3) in the case
of a criminal proceeding, if the indemnified person had reasonable cause to believe that the act or omission was unlawful. We are not aware of any reported decision of a Maryland appellate court that has interpreted provisions similar to the
provisions of the partnership agreement of our Operating Partnership that modify and reduce our fiduciary duties or obligations as the general partner or reduce or eliminate our liability for money damages to our Operating Partnership and its
partners, and we have not obtained an opinion of counsel as to the enforceability of the provisions set forth in the partnership agreement that purport to modify or reduce the fiduciary duties that would be in effect were it not for the partnership
agreement.
The consideration that we pay for the properties and assets we own may exceed their aggregate fair market value.
The amount of consideration that we pay for properties is based on managements estimate of fair market value, including an analysis of
market sales comparables, market capitalization rates for other properties and assets and general market conditions for such properties and assets. In certain instances, managements estimate of fair market value may exceed the fair market
value of these properties and assets.
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We are a holding company with no direct operations and, as such, we rely on funds received from our Operating
Partnership to pay liabilities, and the interests of our stockholders are structurally subordinated to all liabilities and obligations of our Operating Partnership and its subsidiaries.
We are a holding company and conduct substantially all of our operations through our Operating Partnership. We do not have, apart from an
interest in our Operating Partnership, any independent operations. As a result, we rely on distributions from our Operating Partnership to pay any dividends that we may declare on shares of our capital stock. We also rely on distributions from
our Operating Partnership to meet any of our obligations, including any tax liability on taxable income allocated to us from our Operating Partnership. In addition, because we are a holding company, your claims as stockholders are structurally
subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those
of our Operating Partnership and its subsidiaries will be available to satisfy the claims of our stockholders only after all of our Operating Partnerships and its subsidiaries liabilities and obligations have been paid in full.
We may have assumed unknown liabilities in connection with our acquisition of properties and any properties we may acquire in the future may expose us to
unknown liabilities.
We may have acquired entities and assets that may be subject to existing liabilities, some of which may be
unknown or unquantifiable. These assumed liabilities might include liabilities for cleanup or remediation of undisclosed environmental conditions, claims by tenants, vendors, tax liabilities and accrued but unpaid liabilities incurred in the
ordinary course of business or other potential claims or liabilities. While in some instances we may have the right to seek reimbursement against an insurer, any recourse against third parties, including the contributors of our assets, for these
liabilities are limited. There can be no assurance that we are entitled to any such reimbursements or that ultimately we will be able to recover in respect of such rights for any of these historical liabilities.
In addition, there can be no assurance that our current title insurance policies will adequately protect us against any losses resulting from
such title defects or adverse developments.
We may acquire properties subject to liabilities and without any recourse, or with only
limited recourse, against the prior owners or other third parties with respect to unknown liabilities. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or
contest it, which could adversely affect our results of operations and cash flow. Unknown liabilities with respect to acquired properties might include:
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liabilities for
clean-up
of undisclosed or undiscovered environmental contamination
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claims by tenants, vendors or other persons against the former owners of the properties;
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liabilities incurred in the ordinary course of business; and
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claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
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We may be unable to renew expiring leases or
re-lease
vacant space on a timely basis or on attractive terms, which
could have a material adverse effect on our results of operations and cash flow.
At December 31, 2017, approximately 12.6%, 10.0%
and 8.9% of our annualized base rent is scheduled to expire in 2018, 2019 and 2020, respectively, excluding
month-to-month
leases. Current tenants may not renew their
leases upon the expiration of their terms and may attempt to terminate their leases prior to the expiration of their current terms. If
non-renewals
or terminations occur, we may not be able to locate qualified
replacement tenants and, as a result, we could lose a significant source of revenue while remaining responsible for the payment of our financial obligations. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less
favorable to us
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than the current lease terms, or we may be forced to provide tenant improvements at our expense or provide other concessions or additional services to maintain or attract tenants. Any of these
factors could cause a decline in lease revenue or an increase in operating expenses, which would have a material adverse effect on our results of operations and cash flow.
Our business and operations would suffer in the event of system failures.
Despite system redundancy and the implementation of security measures for our IT networks and related systems, our systems are vulnerable to
damages from any number of sources, including computer viruses, energy blackouts, natural disasters, terrorism, war, and telecommunication failures. We rely on our IT networks and related systems, including the Internet, to process, transmit and
store electronic information and to manage or support a variety of our business processes, including financial transactions and keeping of records, which may include personal identifying information of tenants and lease data. We rely on commercially
available systems, software, tools and monitoring to provide security for processing, transmitting and storing confidential tenant information, such as individually identifiable information relating to financial accounts. Any failure to maintain
proper function, security and availability of our IT networks and related systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a material adverse effect on our
operations. As such, any of the foregoing events could have a material adverse effect on our results of operations.
We face risks associated with
security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems.
We face risks associated with security breaches, whether through cyber attacks or cyber intrusions over the Internet, malware, computer
viruses, attachments to
e-mails,
persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of
a security breach or disruption, particularly through cyber attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks
and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform
day-to-day
operations (including managing our building systems), and, in some cases, may be critical to the operations of certain of our tenants. There can be no
assurance that our efforts to maintain the security and integrity of these types of IT networks and related systems will be effective or that attempted security breaches or disruptions would not be successful or damaging. A security breach or other
significant disruption involving our IT networks and related systems could, among other things:
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result in unauthorized access to, destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, including personally identifiable and
account information that could be used to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes;
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result in unauthorized access to or changes to our financial accounting and reporting systems and related data;
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result in our inability to maintain building systems relied on by our tenants;
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require significant management attention and resources to remedy any damage that results;
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subject us to regulatory penalties or claims for breach of contract, damages, credits, penalties or terminations of leases or other agreements; or
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damage our reputation among our tenants and investors.
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These events could have an adverse
impact on our financial condition, results of operations, cash flows, the quoted trading price of our securities, and our ability to satisfy our debt service obligations and to pay dividends and distributions to our security holders.
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We face risks associated with our tenants being designated Prohibited Persons by the Office of
Foreign Assets Control.
Pursuant to Executive Order 13224 and other laws, the Office of Foreign Assets Control of the U.S. Department
of the Treasury, or OFAC, maintains a list of persons designated as terrorists or who are otherwise blocked or banned, or Prohibited Persons. OFAC regulations and other laws prohibit conducting business or engaging in transactions with Prohibited
Persons. Certain of our loan and other agreements may require us to comply with these OFAC requirements. If a tenant or other party with whom we contract is placed on the OFAC list, we may be required by the OFAC requirements to terminate the lease
or other agreement. Any such termination could result in a loss of revenue or a damage claim by the other party that the termination was wrongful.
Tax
protection agreements may limit our ability to sell or otherwise dispose of certain properties and may require our Operating Partnership to maintain certain debt levels that otherwise would not be required to operate our business.
In connection with contributions of properties to our Operating Partnership, our Operating Partnership has entered and may in the future enter
into tax protection agreements under which it agrees to minimize the tax consequences to the contributing partners resulting from the sale or other disposition of the contributed properties. Tax protection agreements may make it economically
prohibitive to sell any properties that are subject to such agreements even though it may otherwise be in our stockholders best interests to do so. In addition, we may be required to maintain a minimum level of indebtedness throughout the term
of any tax protection agreement regardless of whether such debt levels are otherwise required to operate our business. Nevertheless, we have entered and may in the future enter into tax protection agreements to assist contributors of properties to
our Operating Partnership in deferring the recognition of taxable gain as a result of and after any such contribution.
Our charter, our amended and
restated bylaws and Maryland law contain provisions that may delay, defer or prevent a change of control transaction and may prevent our stockholders from receiving a premium for their shares.
Our charter contains ownership limits that may delay, defer or prevent a change of control transaction.
Our charter, with certain
exceptions, authorizes our directors to take such actions as are necessary and desirable to qualify as a REIT. Unless exempted by our board of directors, our charter provides that no person may own more than 9.8% of the value of our
outstanding shares of capital stock or more than 9.8% in value or number (whichever is more restrictive) of the outstanding shares of our common stock. Our board of directors may not grant such an exemption to any proposed transferee whose
ownership in excess of 9.8% of the foregoing ownership limits would result in the termination of our status as a REIT. These restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in
our best interests to attempt to qualify as a REIT. The ownership limit may delay or impede a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
We could authorize and issue stock without stockholder approval that may delay, defer or prevent a change of control
transaction.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock. In addition, our board of directors may classify or reclassify any unissued shares of our common
stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. Our board of directors may also, without stockholder approval, amend our charter to increase the authorized number
of shares of our common stock or our preferred stock that we may issue. Our board of directors could establish a class or series of common stock or preferred stock that could, depending on the terms of such class or series, delay, defer or
prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
Certain provisions of Maryland law could delay, defer or prevent a change of control transaction.
Certain provisions of the
Maryland General Corporation Law (MGCL) may have the effect of inhibiting a third party
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from making a proposal to acquire us or of impeding a change of control. In some cases, such an acquisition or change of control could provide you with the opportunity to realize a premium over
the then-prevailing market price of your shares. These MGCL provisions include:
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business combination provisions that, subject to limitations, prohibit certain business combinations between us and an interested stockholder for certain periods. An interested
stockholder is generally any person who beneficially owns 10% or more of the voting power of our shares or an affiliate or associate of ours who, at any time within the
two-year
period prior to the
date in question, was the beneficial owner of 10% or more of the voting power of our then-outstanding voting stock. A person is not an interested stockholder under the statute if our board of directors approved in advance the transaction by
which he otherwise would have become an interested stockholder. Business combinations with an interested stockholder are prohibited for five years after the most recent date on which the stockholder becomes an interested stockholder. After that
period, the MGCL imposes two super-majority voting requirements on such combinations; and
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control share provisions that provide that holders of control shares of our Company acquired in a control share acquisition have no voting rights with respect to the
control shares unless holders of
two-thirds
of our voting stock (excluding interested shares) consent. Control shares are shares that, when aggregated with other shares
controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors. A control share acquisition is the direct or indirect acquisition of ownership or control
of control shares from a party other than the issuer.
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In the case of the business combination provisions
of the MGCL, we opted out by resolution of our board of directors. In the case of the control share provisions of the MGCL, we opted out pursuant to a provision in our amended and restated bylaws. However, our board of directors may by resolution
elect to opt in to the business combination provisions of the MGCL. Further, we may opt in to the control share provisions of the MGCL in the future by amending our bylaws, which our board of directors can do without stockholder approval.
Maryland law, and our charter and amended and restated bylaws, also contain other provisions that may delay, defer or prevent a transaction or
a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
The ability of
our board of directors to revoke our REIT status without stockholder approval may cause adverse consequences to our stockholders.
Our
charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to
be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our
stockholders.
Our board of directors may amend our investing and financing guidelines without stockholder approval, and, accordingly, you would have
limited control over changes in our policies that could increase the risk that we default under our debt obligations or that could harm our business, results of operations and share price.
Although we are not required to maintain any particular leverage ratio, we intend, when appropriate, to employ prudent amounts of leverage and
to use debt as a means of providing additional funds for the acquisition of our target assets and the diversification of our portfolio. Our organizational documents do not limit the amount or percentage of debt that we may incur, nor do they limit
the types of properties that we may acquire or develop. The amount of leverage we will deploy for particular investments in our target assets will depend upon our management teams assessment of a variety of factors, which may include the
anticipated liquidity and price volatility of the target assets in our investment portfolio, the potential for losses, the availability and cost of
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financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial mortgage markets, our outlook for the level, slope and
volatility of interest rates, the credit quality of our target assets and the collateral underlying our target assets. Our board of directors may alter or eliminate our current guidelines on investing and financing at any time without stockholder
approval. Changes in our strategy or in our investing and financing guidelines could expose us to greater credit risk and interest rate risk and could also result in a more leveraged balance sheet. These factors could result in an increase in our
debt service and could adversely affect our cash flow and our ability to make expected distributions to you. Higher leverage also increases the risk that we would default on our debt.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director or officer generally has no liability in that capacity if he or she performs his or her duties in good
faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. As permitted by the MGCL, our charter limits the liability of
our directors and officers to us and our stockholders for money damages, except for liability resulting from:
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actual receipt of an improper benefit or profit in money, property or services; or
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active and deliberate dishonesty established by a final judgment and which is material to the cause of action.
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In addition, our charter authorizes us to obligate our Company, and our amended and restated bylaws require us, to indemnify and pay or
reimburse our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and
officers than might otherwise exist under common law. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our Company, your ability to recover damages from such director or officer
will be limited.