NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2019
(Unaudited)
Note 1 – Organization and Summary of Significant Accounting Policies:
Organization and Nature of Business – National Retail Properties, Inc., a Maryland corporation, is a fully integrated real estate investment trust (“REIT”) formed in 1984. The terms "NNN" or the "Company" refer to National Retail Properties, Inc. and all of its consolidated subsidiaries.
NNN's assets primarily include real estate assets. NNN acquires, owns, invests in and develops properties that are leased primarily to retail tenants under long-term net leases and primarily held for investment ("Properties", "Property Portfolio", or individually a "Property").
|
|
|
|
|
September 30, 2019
|
Property Portfolio:
|
|
Total properties
|
3,057
|
|
Gross leasable area (square feet)
|
32,209,000
|
|
States
|
48
|
|
Weighted average remaining lease term (years)
|
11.2
|
|
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by U.S. generally accepted accounting principles ("GAAP"). The unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Operating results for the quarter and nine months ended September 30, 2019, may not be indicative of the results that may be expected for the year ending December 31, 2019. Amounts as of December 31, 2018 included in the condensed consolidated financial statements have been derived from the audited consolidated financial statements as of that date. The unaudited condensed consolidated financial statements, included herein, should be read in conjunction with the consolidated financial statements and notes thereto as well as Management's Discussion and Analysis of Financial Condition and Results of Operations in NNN's Form 10-K for the year ended December 31, 2018.
Principles of Consolidation – NNN’s condensed consolidated financial statements include the accounts of each of the respective majority owned and controlled affiliates, including transactions whereby NNN has been determined to be the primary beneficiary in accordance with the Financial Accounting Standards Board (“FASB”) guidance included in Consolidation. All significant intercompany account balances and transactions have been eliminated.
Real Estate Portfolio – NNN records the acquisition of real estate at cost, including acquisition and closing costs. The cost of properties developed by NNN includes costs of construction, property taxes, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy. NNN recorded $797,000 and $2,500,000 in capitalized interest during the development period for the nine months ended September 30, 2019 and 2018, respectively, of which $327,000 and $596,000 was recorded during the quarters ended September 30, 2019 and 2018, respectively.
Purchase Accounting for Acquisition of Real Estate Subject to a Lease – In accordance with the FASB guidance on business combinations, the fair value of the real estate acquired with in-place leases is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases and the value of in-place leases, as applicable, based on their respective fair values.
The fair value estimate is sensitive to significant assumptions, such as establishing a range of relevant market assumptions for land, building and rent and where the acquired property falls within that range. These market assumptions for land, building and rent use the most relevant comparable properties for an acquisition. The final range relies upon ranking comparable properties' attributes from most similar to least similar.
The fair value of the tangible assets of an acquired leased property is determined by valuing the property as if it were vacant, and the "as-if-vacant" value is then allocated to land, building and tenant improvements based on the determination of their fair values.
In allocating the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded as other assets or liabilities based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases, and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining term of the lease and the applicable option terms if it is probable that the tenant will exercise options. The capitalized above-market lease values are amortized as a reduction of rental income over the remaining terms of the respective leases. The capitalized below-market lease values are amortized as an increase to rental income over the initial term unless the Company believes that it is likely that the tenant will renew the lease for an option term whereby the Company amortizes the value attributable to the renewal over the renewal period.
The aggregate value of other acquired intangible assets, consisting of in-place leases, is measured by the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to market rental rates over (ii) the estimated fair value of the property as-if-vacant, determined as set forth above. The value of in-place leases exclusive of the value of above-market and below-market in-place leases is amortized to expense over the remaining non-cancelable periods of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be written off in that period. The value of tenant relationships is reviewed on individual transactions to determine if future value was derived from the acquisition.
Intangible assets and liabilities consisted of the following as of (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2019
|
|
December 31, 2018
|
Intangible lease assets (included in other assets):
|
|
|
|
|
Above-market in-place leases
|
|
$
|
15,786
|
|
|
$
|
15,175
|
|
Less: accumulated amortization
|
|
(9,801
|
)
|
|
(9,239
|
)
|
Above-market in-place leases, net
|
|
$
|
5,985
|
|
|
$
|
5,936
|
|
|
|
|
|
|
In-place leases
|
|
$
|
119,713
|
|
|
$
|
104,871
|
|
Less: accumulated amortization
|
|
(63,916
|
)
|
|
(60,797
|
)
|
In-place leases, net
|
|
$
|
55,797
|
|
|
$
|
44,074
|
|
|
|
|
|
|
Intangible lease liabilities (included in other liabilities):
|
|
|
|
|
Below-market in-place leases
|
|
$
|
42,099
|
|
|
$
|
41,554
|
|
Less: accumulated amortization
|
|
(25,922
|
)
|
|
(25,258
|
)
|
Below-market in-place leases, net
|
|
$
|
16,177
|
|
|
$
|
16,296
|
|
The amounts amortized as a net increase to rental income for above-market and below-market in-place leases for the nine months ended September 30, 2019 and 2018, were $579,000 and $2,334,000, respectively, of which $178,000 and $219,000 were recorded for the quarters ended September 30, 2019 and 2018, respectively. The value of in-place leases amortized to expense for the nine months ended September 30, 2019 and 2018, were $5,946,000 and $7,305,000, respectively, of which $1,904,000 and $1,789,000 were recorded for the quarters ended September 30, 2019 and 2018, respectively.
Lease Accounting – Effective January 1, 2019, NNN adopted ASU 2016-02, "Leases (Topic 842)," ("ASC 842") using the modified retrospective approach in which the cumulative effect of applying the new standard was recognized at the date of initial application with a positive adjustment to NNN’s opening balance of accumulated deficit. The modified retrospective approach provides a method for recording existing leases upon adoption which in comparative periods approximates the results of a full retrospective approach. NNN elected the package of practical expedients permitted under the transition guidance (which included: (i) an entity need not reassess whether any expired or existing contracts are or contain leases, (ii) an entity need not reassess the lease classification for any expired or existing leases, and (iii) an entity need not reassess initial direct costs for any existing leases), the land easement practical expedient to carry forward existing accounting treatment on existing land easements, and the lease and non-lease component combined practical expedient.
NNN estimates the collectability of its accounts receivable related to rents, expense reimbursements and other revenues. NNN analyzes accounts receivable and historical bad debt levels, tenant credit-worthiness and current economic trends when evaluating the probable collection. At the point NNN deems the collection of lease payments not probable, a bad debt is recognized for any outstanding receivable and any related accrued rent and, subsequently, any lease revenue is only recognized when cash receipts are received.
Adoption of the new standard resulted in the recording of ROU assets and operating lease liabilities of approximately $7,735,000 and $10,155,000 respectively, as of January 1, 2019. Additional disclosures are included in Note 3 – Right-Of-Use Assets and Operating Lease Liabilities. The condensed consolidated financial statements for the quarter and nine months ended September 30, 2019 are presented under the new standard, while comparative periods presented are not adjusted and continue to be reported in accordance with NNN's historical accounting policy. ASC 842 did not materially impact NNN’s financial position or results of operations and had no impact on cash flows.
Debt Costs – Line of Credit Payable – Debt costs incurred in connection with NNN’s $900,000,000 line of credit have been deferred and are being amortized to interest expense over the term of the loan commitment using the straight-line method, which approximates the effective interest method. NNN has recorded debt costs associated with the line of credit as an asset, in debt costs on the Condensed Consolidated Balance Sheets.
Debt Costs – Mortgages Payable – Debt costs incurred in connection with NNN’s mortgages payable have been deferred and are being amortized over the term of the respective loan commitment using the straight-line method, which approximates the effective interest method. These costs of $147,000 as of September 30, 2019 and December 31, 2018, are included in mortgages payable on the Condensed Consolidated Balance Sheets net of accumulated amortization of $86,000 and $73,000, respectively.
Debt Costs – Notes Payable – Debt costs incurred in connection with the issuance of NNN’s notes payable have been deferred and are being amortized to interest expense over the term of the respective debt obligation using the effective interest method. These costs of $26,932,000, as of September 30, 2019 and December 31, 2018, respectively, are included in notes payable on the Condensed Consolidated Balance Sheets net of accumulated amortization of $8,387,000 and $6,705,000, respectively.
Revenue Recognition – In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606). The core principle of ASU 2014-09, is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Certain contracts are excluded from ASU 2014-09, including lease contracts within the scope of the FASB guidance included in Leases (Topic 842). NNN determined the key revenue stream impacted by ASU 2014-09 is gain on disposition of real estate reported on the Condensed Consolidated Statements of Income and Comprehensive Income. NNN evaluates any separate contracts or performance obligations to determine proper timing and/or amount of revenue recognition, as well as, transaction price allocation.
Earnings Per Share – Earnings per share have been computed pursuant to the FASB guidance included in Earnings Per Share. The guidance requires classification of the Company’s unvested restricted share units, which carry rights to receive nonforfeitable dividends, as participating securities requiring the two-class method of computing earnings per share. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the weighted average shares outstanding during the period.
The following table is a reconciliation of the numerator and denominator used in the computation of basic and diluted earnings per common share using the two-class method (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Basic and Diluted Earnings:
|
|
|
|
|
|
|
|
Net earnings attributable to NNN
|
$
|
66,693
|
|
|
$
|
82,032
|
|
|
$
|
225,394
|
|
|
$
|
255,886
|
|
Less: Series E preferred stock dividends
|
(4,097
|
)
|
|
(4,097
|
)
|
|
(12,291
|
)
|
|
(12,291
|
)
|
Less: Series F preferred stock dividends
|
(4,485
|
)
|
|
(4,485
|
)
|
|
(13,455
|
)
|
|
(13,455
|
)
|
Net earnings available to NNN’s common stockholders
|
58,111
|
|
|
73,450
|
|
|
199,648
|
|
|
230,140
|
|
Less: Earnings allocated to unvested restricted shares
|
(163
|
)
|
|
(147
|
)
|
|
(412
|
)
|
|
(412
|
)
|
Net earnings used in basic and diluted earnings per share
|
$
|
57,948
|
|
|
$
|
73,303
|
|
|
$
|
199,236
|
|
|
$
|
229,728
|
|
|
|
|
|
|
|
|
|
Basic and Diluted Weighted Average Shares Outstanding:
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding
|
165,737,947
|
|
|
157,634,757
|
|
|
163,421,419
|
|
|
155,316,866
|
|
Less: Unvested restricted stock
|
(316,856
|
)
|
|
(294,453
|
)
|
|
(272,185
|
)
|
|
(276,046
|
)
|
Less: Unvested contingent restricted shares
|
(537,582
|
)
|
|
(487,320
|
)
|
|
(507,973
|
)
|
|
(458,371
|
)
|
Weighted average number of shares outstanding used in basic earnings per share
|
164,883,509
|
|
|
156,852,984
|
|
|
162,641,261
|
|
|
154,582,449
|
|
Other dilutive securities
|
478,222
|
|
|
433,181
|
|
|
484,802
|
|
|
425,408
|
|
Weighted average number of shares outstanding used in diluted earnings per share
|
165,361,731
|
|
|
157,286,165
|
|
|
163,126,063
|
|
|
155,007,857
|
|
Fair Value Measurement – NNN’s estimates of fair value of financial and non-financial assets and liabilities are based on the framework established in the fair value accounting guidance. The framework specifies a hierarchy of valuation inputs which was established to increase consistency, clarity and comparability in fair value measurements and related disclosures. The guidance describes a fair value hierarchy based upon three levels of inputs that may be used to measure fair value, two of which are considered observable and one that is considered unobservable. The following describes the three levels:
|
|
•
|
Level 1 – Valuation is based upon quoted prices in active markets for identical assets or liabilities.
|
|
|
•
|
Level 2 – Valuation is based upon inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
|
|
|
•
|
Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include option pricing models, discounted cash flow models and similar techniques.
|
Accumulated Other Comprehensive Income (Loss) – The following table outlines the changes in accumulated other comprehensive income (loss) (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain or Loss on Cash Flow Hedges (1)
|
|
Gains and Losses on Available-for-Sale Securities
|
|
Total
|
Beginning balance, December 31, 2018
|
$
|
(6,911
|
)
|
|
$
|
1,215
|
|
|
$
|
(5,696
|
)
|
|
|
|
|
|
|
Other comprehensive income
|
(11,738
|
)
|
|
116
|
|
|
(11,622
|
)
|
Reclassifications from accumulated other comprehensive income to net earnings
|
975
|
|
(2)
|
(1,331
|
)
|
(3)
|
(356
|
)
|
Net current period other comprehensive income (loss)
|
(10,763
|
)
|
|
(1,215
|
)
|
|
(11,978
|
)
|
Ending balance, September 30, 2019
|
$
|
(17,674
|
)
|
|
$
|
—
|
|
|
$
|
(17,674
|
)
|
(1) Additional disclosure is included in Note 6 – Derivatives.
(2) Recorded in interest expense on the Condensed Consolidated Statements of Income and Comprehensive Income.
(3) Recorded in interest and other income on the Condensed Consolidated Statements of Income and Comprehensive Income.
Use of Estimates – Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these condensed consolidated financial statements in conformity with GAAP. Significant estimates include provisions for impairment and allowances for certain assets, accruals, useful lives of assets and purchase price allocation. Actual results could differ from those estimates.
Reclassification – Certain items in the prior year’s condensed consolidated financial statements and notes to condensed consolidated financial statements have been reclassified to conform to the 2019 presentation.
NNN adopted certain practical expedients in ASC 842 which allows the presentation of all income earned pursuant to tenant leases to be included in rental income reported on the Condensed Consolidated Statements of Income and Comprehensive Income.
Note 2 – Real Estate:
Real Estate – Portfolio
Leases – The following outlines key information for NNN’s leases:
|
|
|
|
|
September 30, 2019
|
Lease classification:
|
|
Operating
|
3,084
|
|
Direct financing
|
7
|
|
Building portion – direct financing/land portion – operating
|
1
|
|
Weighted average remaining lease term (years)
|
11.2
|
|
The following is a summary of the general structure of the leases in the Property Portfolio, although the specific terms of each lease can vary significantly. Generally, the Property leases provide for initial terms of 10 to 20 years. The Properties are generally leased under net leases, pursuant to which the tenant typically bears responsibility for substantially all property costs and expenses associated with ongoing maintenance, repair, replacement and operation of the property, including utilities, property taxes and property and liability insurance. Certain Properties are subject to leases under which NNN retains responsibility for specific costs and expenses of the Property. NNN's leases provide for annual base rental payments (generally payable in monthly installments), and generally provide for limited increases in rent as a result of (i) increases in the Consumer Price Index ("CPI"), (ii) fixed increases, or, to a lesser extent, (iii) increases in the tenant’s sales volume.
Generally, NNN's leases provide the tenant with one or more multi-year renewal options, subject to generally the same terms and conditions provided under the initial lease term, including rent increases. NNN’s lease term is based on the non-cancellable base term unless economic incentives make it reasonably certain that an option period to extend the lease will be exercised, in which event NNN includes the options. Some of the leases also provide that in the event NNN wishes to sell the Property subject to that lease, NNN first must offer the lessee the right to purchase the Property on the same terms and conditions as any offer which NNN intends to accept for the sale of the Property.
Real Estate Portfolio – Accounted for Using the Operating Method – Real estate subject to operating leases consisted of the following as of (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2019
|
|
December 31, 2018
|
Land and improvements(1)
|
$
|
2,463,934
|
|
|
$
|
2,368,891
|
|
Buildings and improvements
|
5,752,916
|
|
|
5,461,888
|
|
Leasehold interests
|
355
|
|
|
3,630
|
|
|
8,217,205
|
|
|
7,834,409
|
|
Less accumulated depreciation and amortization
|
(1,109,285
|
)
|
|
(1,003,519
|
)
|
|
7,107,920
|
|
|
6,830,890
|
|
Work in progress for buildings and improvements
|
13,236
|
|
|
8,017
|
|
|
$
|
7,121,156
|
|
|
$
|
6,838,907
|
|
(1) Includes $11,707 and $5,571 in land for Properties under construction at September 30, 2019 and December 31, 2018,
respectively.
NNN recognized the following revenues in rental income (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Rental income from operating leases
|
$
|
163,674
|
|
|
$
|
150,418
|
|
|
$
|
482,306
|
|
|
$
|
449,216
|
|
Earned income from direct financing leases
|
204
|
|
|
242
|
|
|
624
|
|
|
696
|
|
Percentage rent
|
329
|
|
|
284
|
|
|
1,051
|
|
|
1,018
|
|
Real estate expense reimbursement from tenants
|
4,017
|
|
|
3,712
|
|
|
11,865
|
|
|
11,640
|
|
|
$
|
168,224
|
|
|
$
|
154,656
|
|
|
$
|
495,846
|
|
|
$
|
462,570
|
|
Some leases provide for a free rent term or scheduled rent increases throughout the lease term. Such amounts are recognized on a straight-line basis over the terms of the leases. For the nine months ended September 30, 2019 and 2018, NNN recognized $1,354,000 and $547,000, respectively, of such income, net of reserves, of which $429,000 and ($163,000) of such income, net of reserves, was recorded during the quarters ended September 30, 2019 and 2018, respectively. At September 30, 2019 and December 31, 2018, the balance of accrued rental income was $28,570,000 and $25,387,000, respectively, net of allowance of $1,842,000.
The following is a schedule of undiscounted cash flows to be received on noncancellable operating leases as of September 30, 2019 (dollars in thousands):
|
|
|
|
|
2019
|
$
|
163,060
|
|
2020
|
648,578
|
|
2021
|
630,739
|
|
2022
|
600,904
|
|
2023
|
572,995
|
|
Thereafter
|
4,757,532
|
|
|
$
|
7,373,808
|
|
Since lease renewal periods are exercisable at the option of the tenant, the above table only presents undiscounted cash flows due during the current lease terms. In addition, this table does not include amounts for potential variable rent increases that are based on the CPI or future contingent rents which may be received on the leases based on a percentage of the tenant’s sales volume.
Real Estate Portfolio – Accounted for Using the Direct Financing Method – The following lists the components of net investment in direct financing leases as of (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2019
|
|
December 31, 2018
|
Minimum lease payments to be received
|
$
|
9,860
|
|
|
$
|
10,899
|
|
Estimated unguaranteed residual values
|
3,632
|
|
|
4,395
|
|
Less unearned income
|
(6,610
|
)
|
|
(7,225
|
)
|
Net investment in direct financing leases
|
$
|
6,882
|
|
|
$
|
8,069
|
|
The following is a schedule of undiscounted cash flows to be received on direct financing leases held for investment as of September 30, 2019 (dollars in thousands):
|
|
|
|
|
2019
|
$
|
360
|
|
2020
|
1,045
|
|
2021
|
920
|
|
2022
|
897
|
|
2023
|
895
|
|
Thereafter
|
5,743
|
|
|
$
|
9,860
|
|
The table above does not include future minimum lease payments for renewal periods, potential variable CPI rent increases or contingent rental payments that may become due in future periods (see Real Estate Portfolio – Accounted for Using the Operating Method).
Real Estate – Held For Sale
On a quarterly basis, the Company evaluates its Properties for held for sale classification based on specific criteria as outlined in ASC 360, Property, Plant and Equipment, including management’s intent to commit to a plan to sell the asset. NNN anticipates the disposition of Properties classified as held for sale to occur within 12 months. As of September 30, 2019, NNN had five of its Properties categorized as held for sale. NNN's real estate held for sale at December 31, 2018, included eight Properties, three of which were sold in 2019. Real estate held for sale consisted of the following as of (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2019
|
|
December 31, 2018
|
Land and improvements
|
$
|
5,120
|
|
|
$
|
13,720
|
|
Building and improvements
|
15,591
|
|
|
41,738
|
|
|
20,711
|
|
|
55,458
|
|
Less accumulated depreciation and amortization
|
(6,172
|
)
|
|
(12,752
|
)
|
Less impairment
|
(578
|
)
|
|
(14,250
|
)
|
|
$
|
13,961
|
|
|
$
|
28,456
|
|
Real Estate – Dispositions
The following table summarizes the Properties sold and the corresponding gain recognized on the disposition of Properties (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
# of Sold
Properties
|
|
Gain
|
|
# of Sold
Properties
|
|
Gain
|
|
# of Sold
Properties
|
|
Gain
|
|
# of Sold
Properties
|
|
Gain
|
Gain on disposition of real estate
|
13
|
|
$
|
2,061
|
|
|
18
|
|
$
|
14,348
|
|
|
43
|
|
$
|
25,508
|
|
|
46
|
|
$
|
57,050
|
|
Real Estate – Commitments
NNN has committed to fund construction on 12 Properties. The improvements on such Properties are estimated to be completed within 12 months. These construction commitments, as of September 30, 2019, are outlined in the table below (dollars in thousands):
|
|
|
|
|
Total commitment(1)
|
$
|
53,724
|
|
Less amount funded
|
24,943
|
|
Remaining commitment
|
$
|
28,781
|
|
(1) Includes land, construction costs, tenant improvements, lease costs and
capitalized interest.
|
Real Estate – Impairments
Management periodically assesses its real estate for possible impairment whenever certain events or changes in circumstances indicate that the carrying amount of the asset, including accrued rental income, may not be recoverable through operations. Events or circumstances that may occur include significant changes in real estate market conditions and the ability of NNN to re-lease or sell properties that are vacant or become vacant in a reasonable period of time. Impairments are measured as the amount by which the current book value of the asset exceeds the estimated fair value of the asset. As a result of the Company's review of long-lived assets, including identifiable intangible assets, NNN recognized real estate impairments, net of recoveries of $21,124,000 and $9,718,000 for the nine months ended September 30, 2019 and 2018, respectively, of which $10,692,000 and $3,635,000 was recorded during the quarters ended September 30, 2019 and 2018, respectively.
The valuation of impaired assets is determined using widely accepted valuation techniques including discounted cash flow analysis, income capitalization, analysis of recent comparable sales transactions, actual sales negotiations and bona fide purchase offers received from third parties, which are Level 3 inputs. NNN may consider a single valuation technique or multiple valuation techniques, as appropriate, when estimating the fair value of its real estate.
Note 3 – Right-Of-Use Assets and Operating Lease Liabilities:
NNN is a lessee for three ground lease arrangements and for its headquarters office lease. NNN recognized an ROU asset (recorded in other assets on the Condensed Consolidated Balance Sheets) and an operating lease liability (recorded in other liabilities on the Condensed Consolidated Balance Sheets) for the present value of the minimum lease payments. ROU assets represent NNN’s right to use an underlying asset for the lease term and lease liabilities represent NNN’s obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at the lease commencement date based on the estimated present value of the lease payments over the lease term. NNN’s lease term is based on the non-cancellable base term unless economic incentives make it reasonably certain that an option period to extend the lease will be exercised, in which event NNN includes the options.
NNN estimates an incremental borrowing rate, which is derived from information available at the lease commencement date, in determining the present value of the lease payments. NNN gives consideration to the Company's debt issuances, as well as, publicly available data for secured instruments with similar characteristics when calculating its incremental borrowing rates. A 50 basis point increase or decrease in the estimate of the incremental borrowing rate at January 1, 2019 (the date of adoption of ASC 842) would not have a material impact on NNN’s financial position. NNN will reevaluate its incremental borrowing rate on an annual basis.
NNN's lease agreements do not contain any residual value guarantees.
As of September 30, 2019, NNN has recorded the following (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Ground Leases
|
|
Headquarters Office Lease
|
Operating lease – ROU assets(1)
|
$
|
4,548
|
|
|
$
|
3,117
|
|
Operating lease – lease liabilities
|
(6,247
|
)
|
|
(3,775
|
)
|
|
|
|
|
Weighted average remaining lease term (years)
|
14.5
|
|
|
5.5
|
|
Weighted average discount rate
|
4.1
|
%
|
|
3.5
|
%
|
|
|
(1)
|
ROU assets are shown net of accrued lease payments of $1,699 and $658, respectively.
|
The following is a schedule of the undiscounted cash flows to be paid as of September 30, 2019 (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Ground Leases
|
|
Headquarters Office Lease
|
2019
|
$
|
136
|
|
|
$
|
191
|
|
2020
|
564
|
|
|
773
|
|
2021
|
573
|
|
|
788
|
|
2022
|
582
|
|
|
804
|
|
2023
|
582
|
|
|
821
|
|
Thereafter
|
6,145
|
|
|
1,047
|
|
|
$
|
8,582
|
|
|
$
|
4,424
|
|
Note 4 – Line of Credit Payable:
NNN's $900,000,000 unsecured revolving credit facility (the “Credit Facility”) had a weighted average outstanding balance of $8,443,000 and a weighted average interest rate of 3.2% during the nine months ended September 30, 2019. The Credit Facility matures January 2022, unless the Company exercises its option to extend maturity to January 2023. The Credit Facility bears interest at LIBOR plus 87.5 basis points; however, such interest rate may change pursuant to a tiered interest rate structure based on NNN's debt rating. The Credit Facility also includes an accordion feature which permits NNN to increase the facility size up to $1,600,000,000, subject to lender approval. As of September 30, 2019, there was no outstanding balance and $900,000,000 was available for future borrowings under the Credit Facility.
Note 5 – Stockholders' Equity:
In February 2018, NNN filed a shelf registration statement with the Securities and Exchange Commission (the "Commission") which permits the issuance by NNN of an indeterminate amount of debt and equity securities.
In September 2019, NNN filed a prospectus supplement to the prospectus contained in its February 2018 shelf registration statement and issued 7,000,000 shares of common stock at a price of $56.50 per share and received net proceeds of $379,410,000. In connection with this offering, NNN incurred stock issuance costs totaling approximately $16,090,000, consisting primarily of underwriters' fees and commissions, legal and accounting fees and printing expenses.
Dividend Reinvestment and Stock Purchase Plan – In February 2018, NNN filed a shelf registration statement with the Commission for its Dividend Reinvestment and Stock Purchase Plan ("DRIP") which permits the issuance by NNN of up to 10,000,000 shares of common stock. The following table outlines the common stock issuances pursuant to NNN's DRIP (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
Shares of common stock
|
309,127
|
|
|
225,481
|
|
Net proceeds
|
$
|
16,481
|
|
|
$
|
9,115
|
|
At-The-Market Offerings – NNN has established an at-the-market equity program ("ATM") which allows NNN to sell shares of common stock from time to time. The following outlines NNN's ATM program:
|
|
|
|
|
2018 ATM
|
Established date
|
February 2018
|
|
Termination date
|
February 2021
|
|
Total allowable shares
|
12,000,000
|
|
Total shares issued as of September 30, 2019
|
9,722,185
|
|
The following table outlines the common stock issuances pursuant to NNN's ATM equity programs (dollars in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
Shares of common stock
|
2,344,022
|
|
|
4,896,563
|
|
Average price per share (net)
|
$
|
53.73
|
|
|
$
|
42.60
|
|
Net proceeds
|
$
|
125,946
|
|
|
$
|
208,579
|
|
Stock issuance costs (1)
|
$
|
1,390
|
|
|
$
|
2,792
|
|
(1) Stock issuance costs consist primarily of underwriters' fees and commissions, and legal and accounting fees.
|
Dividends – The following table outlines the dividends declared and paid for each issuance of NNN's stock (dollars in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Series E preferred stock(1):
|
|
|
|
|
|
|
|
Dividends
|
$
|
4,097
|
|
|
$
|
4,097
|
|
|
$
|
12,291
|
|
|
$
|
12,291
|
|
Per depositary share
|
0.356250
|
|
|
0.356250
|
|
|
1.068750
|
|
|
1.068750
|
|
|
|
|
|
|
|
|
|
Series F preferred stock(2):
|
|
|
|
|
|
|
|
Dividends
|
4,485
|
|
|
4,485
|
|
|
13,455
|
|
|
13,455
|
|
Per depositary share
|
0.325000
|
|
|
0.325000
|
|
|
0.975000
|
|
|
0.975000
|
|
|
|
|
|
|
|
|
|
Common stock:
|
|
|
|
|
|
|
|
Dividends
|
83,935
|
|
|
78,253
|
|
|
245,574
|
|
|
223,836
|
|
Per share
|
0.515
|
|
|
0.500
|
|
|
1.515
|
|
|
1.450
|
|
(1) In September 2019, NNN called for redemption of all outstanding shares of its 5.700% Series E Cumulative Redeemable Preferred Stock (the "Series E Preferred Stock"), including all accrued and unpaid dividends through, but not including, the redemption date, on October 5, 2019.
(2) The 5.200% Series F Cumulative Redeemable Preferred Stock (the "Series F Preferred Stock") has no maturity date and will remain outstanding unless redeemed by NNN. The earliest redemption date for the Series F Preferred Stock is October 2021.
In October 2019, NNN declared a dividend of $0.515 per share, which is payable in November 2019 to its common stockholders of record as of October 31, 2019.
Note 6 – Derivatives:
In accordance with the guidance on derivatives and hedging, NNN records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or a firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.
NNN’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, NNN primarily uses treasury locks, forward starting swaps
and interest rate swaps as part of its cash flow hedging strategy. Treasury locks and forward starting swaps are used to hedge forecasted debt issuances. Treasury locks designated as cash flow hedges lock in the yield/price of a treasury security. Forward starting swaps also lock the associated swap spread. Interest rate swaps designated as cash flow hedges are used to hedge the variable cash flows associated with floating rate debt and involve the receipt or payment of variable rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount.
For derivatives designated as cash flow hedges, the change in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings.
NNN discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative expires or is sold, terminated or exercised, the derivative is re-designated as a hedging instrument or management determines that designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued, NNN recognizes any changes in its fair value in earnings and continues to carry the derivative on the balance sheet or may choose to settle the derivative at that time with a cash payment or receipt. NNN records a cash settlement of forward starting swaps in the statement of cash flows as an operating activity.
The following table outlines NNN's terminated derivatives which were hedging the risk of changes in forecasted interest payments on forecasted issuance of long-term debt (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Terminated
|
Description
|
Aggregate Notional Amount
|
Liability (Asset) Fair Value When Terminated
|
Fair Value Deferred In Other Comprehensive Income (1)
|
April 2013
|
Four forward starting swaps
|
$
|
240,000
|
|
$
|
3,156
|
|
$
|
3,141
|
|
May 2014
|
Three forward starting swaps
|
225,000
|
|
6,312
|
|
6,312
|
|
October 2015
|
Four forward starting swaps
|
300,000
|
|
13,369
|
|
13,369
|
|
December 2016
|
Two forward starting swaps
|
180,000
|
|
(13,352
|
)
|
(13,345
|
)
|
September 2017
|
Two forward starting swaps
|
250,000
|
|
7,690
|
|
7,688
|
|
September 2018
|
Two forward starting swaps
|
250,000
|
|
(4,080
|
)
|
(4,080
|
)
|
(1) The amount reported in accumulated other comprehensive income will be reclassified to interest expense as
interest payments are made on the related notes payable.
As of September 30, 2019, $5,936,000 remained in other comprehensive income related to NNN’s previously terminated interest rate hedges. During the nine months ended September 30, 2019 and 2018, NNN reclassified out of other comprehensive income $975,000 and $1,581,000, respectively, as an increase in interest expense. Over the next 12 months, NNN estimates that an additional $1,349,000 will be reclassified as an increase in interest expense from these terminated derivatives. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on NNN’s long-term debt.
During the nine months ended September 30, 2019, NNN entered into three forward starting swaps with a total notional amount of $200,000,000 to hedge the risk of changes in the interest-related cash outflows associated with the potential issuance of long-term debt. The outstanding forward swaps were designated as cash flow hedges, and as of September 30, 2019, had a fair value of $11,738,000 included in other liabilities and accumulated other comprehensive income (loss) on the Condensed Consolidated Balance Sheets. The fair value of the forward starting swaps were based on Level 2 valuation. These derivative financial instruments were still outstanding as of September 30, 2019.
NNN does not use derivatives for trading or speculative purposes or currently have any derivatives that are not designated as hedges.
Note 7 – Fair Value of Financial Instruments:
NNN believes the carrying value of its Credit Facility approximates fair value based upon its nature, terms and variable interest rate. NNN believes that the carrying value of its mortgages payable at September 30, 2019 and December 31, 2018, approximate fair value based upon current market prices of comparable instruments (Level 3). At September 30, 2019 and December 31, 2018, the fair value of NNN’s notes payable net of unamortized discount and excluding debt costs was $3,074,246,000 and $2,813,583,000, respectively, based upon quoted market prices, which is a Level 1 valuation since NNN's notes payable are publicly traded.
Note 8 – Subsequent Events:
NNN reviewed its subsequent events and transactions that have occurred after September 30, 2019, the date of the condensed consolidated balance sheet.
In September 2019, NNN announced the redemption of all outstanding depositary shares representing interests in its 5.700% Series E Preferred Stock. The depositary shares were redeemed on October 5, 2019 at $25.00 per depositary share, plus all accrued and unpaid dividends through, but not including, the redemption date, for an aggregate redemption price of $25.079167 per depositary share. For the quarter ended December 31, 2019, NNN will record a preferred stock redemption charge of $9,856,000, which is the excess carrying amount of the preferred stock redeemed over the cash paid to redeem the Series E Preferred Stock. After the redemption date, dividends on the depositary shares representing interests in the Series E Preferred Stock ceased to accrue.
There were no other reportable subsequent events or transactions.