TPTS 10-K
Terra Property Trust, Inc. (TPTS)
10-K
2024-03-15
For: 2023-12-31
View Original
Added on
April 09, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Fiscal Year Ended December 31 , 2023
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the Transition Period from to
Commission File Number: 001-40496
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
(Address of principal executive offices)
(212 ) 753-5100
(Registrant’s telephone number, including area code)
Securities registered pursuant to section 12(b) of the Securities Exchange Act of 1934:
| Title of each class | Trading Symbol(s) | Name of exchange on which registered | ||||||||||||
Securities registered pursuant to section 12(g) of the Securities Exchange Act of 1934:
Class B Common Stock, $0.01 par value per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | Accelerated filer | ¨ | ||||||||
| þ | Smaller reporting company | ||||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☑
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
As of March 15, 2024, the registrant had 24,336,284 shares of Class B Common Stock, $0.01 par value, outstanding. No market value has been computed based upon the fact that no active trading market had been established as of the date of this document.
Documents Incorporated by Reference
TABLE OF CONTENTS
| Page | ||||||||
| PART I | ||||||||
| PART II | ||||||||
| PART III | ||||||||
| PART IV | ||||||||
i
CERTAIN DEFINITIONS
Except as otherwise specified herein, the terms: “we,” “us,” “our,” “our company” and the “company” refer to Terra Property Trust, Inc., a Maryland corporation, together with its subsidiaries. Additionally, the following defined terms are used in this Annual Report on Form 10-K.
•“Terra Capital Advisors” refers to Terra Capital Advisors, LLC, a subsidiary of Terra Capital Partners, LLC;
•“Terra Capital Advisors 2” refers to Terra Capital Advisors 2, LLC, a subsidiary of Terra Capital Advisors;
•“Terra Capital Partners” refers to Terra Capital Partners, LLC, our sponsor;
•“Terra Fund 1” refers to Terra Secured Income Fund, LLC; “Terra Fund 2” refers to Terra Secured Income Fund 2, LLC; “Terra Fund 3” refers to Terra Secured Income Fund 3, LLC; “Terra JV” refers to Terra JV, LLC (formerly known as Terra Secured Income Fund 4, LLC or Terra Fund 4); “Terra Fund 5” refers to Terra Secured Income Fund 5, LLC; “Fund 5 International” refers to Terra Secured Income Fund 5 International; “TIFI” refers to Terra Income Fund International; “Terra BDC” refers to Terra Income Fund 6, Inc.; “Terra Offshore REIT” refers to Terra Offshore Funds REIT, LLC; “Terra Fund 7” refers to Terra Secured Income Fund 7, LLC; “Terra Property Trust 2” refers to Terra Property Trust 2, Inc., formerly a subsidiary of Terra Fund 7; “RESOF” refers to Mavik Real Estate Special Opportunities Fund, L.P.; “RESOF REIT” refers to Mavik Real Estate Special Opportunities Fund REIT, LLC, a subsidiary of RESOF; and “Terra LLC” refers to Terra Income Fund 6, LLC, our wholly owned subsidiary;
•“Terra Fund Advisors” refers to Terra Fund Advisors, LLC, an affiliate of Terra Capital Partners, and the manager of Terra Fund 5;
•“Terra Funds” refer to Terra Fund 1, Terra Fund 2, Terra Fund 3, Terra Fund 4 and Terra Fund 5, collectively;
•“Terra Income Advisors” refers to Terra Income Advisors, LLC, an affiliate of Terra Capital Partners;
•“Terra Income Advisors 2” refers to Terra Income Advisors 2, LLC, an affiliate of Terra Capital Partners; and
•“Terra REIT Advisors” or our “Manager” refers to Terra REIT Advisors, LLC, a subsidiary of Terra Capital Partners and our external manager.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this Annual Report on Form 10-K within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such Sections. The forward-looking statements contained in this Annual Report on Form 10-K may include, but are not limited to, statements as to:
•our expected financial performance, operating results and our ability to make distributions to our stockholders in the future;
•our ability to achieve the expected synergies, cost savings and other benefits from the BDC Merger (as defined below);
•risks associated with achieving expected synergies, cost savings and other benefits from our increased scale;
•the availability of attractive risk-adjusted investment opportunities in our target asset class and other real estate-related investments that satisfy our objectives and strategies;
•the origination or acquisition of our targeted assets, including the timing of originations or acquisitions;
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•volatility in our industry, interest rates and spreads, the debt or equity markets, the general economy or the real estate market specifically, whether the results of market events or otherwise;
•changes in our investment objectives and business strategy;
•the availability of strategic non-real estate investment opportunities;
•the availability of financing on acceptable terms or at all;
•the performance and financial condition of our borrowers;
•changes in interest rates and the market value of our assets;
•borrower defaults or decreased recovery rates from our borrowers;
•changes in prepayment rates on our loans;
•our use of financial leverage;
•actual and potential conflicts of interest with any of the following affiliated entities: our Manager, Terra Capital Partners, Terra Fund 7, Terra 5 International, TIFI, Terra Offshore REIT, RESOF, Mavik Capital Management, LP, Mavik Real Estate Special Opportunities Fund, LP, or any of their affiliates;
•our dependence on our Manager or its affiliates and the availability of its senior management team and other personnel;
•liquidity transactions that may be available to us in the future, including a liquidation of our assets, a sale of our company, a listing of our shares of common stock on a national securities exchange, or an adoption of a share repurchase plan or a strategic business combination, in each case, which may include the further distribution of our common stock indirectly owned by certain of our affiliate funds to the ultimate investors in such affiliate funds, and the timing of any such transactions;
•actions and initiatives of the U.S., federal, state and local government and changes to the U.S. federal, state and local government policies and the execution and impact of these actions, initiatives and policies;
•limitations imposed on our business and our ability to satisfy complex rules in order for us to maintain our exclusion or exemption from registration under the Investment Company Act of 1940, as amended (the “1940 Act”), and to maintain our qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes; and
•the degree and nature of our competition.
In addition, words such as “anticipate,” “believe,” “expect” and “intend” indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this Annual Report on Form 10-K involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in “Part I — Item 1A. Risk Factors” in this Annual Report on Form 10-K. Other factors that could cause actual results to differ materially include:
•changes in the economy;
•risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters; and
•future changes in laws or regulations and conditions in our operating areas.
We have based the forward-looking statements included in this Annual Report on Form 10-K on information available to us on the date of this Annual Report on Form 10-K. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise.
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Stockholders are advised to consult any additional disclosures that we may make directly to stockholders or through reports that we may file in the future with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
RISK FACTOR SUMMARY
We are subject to numerous risks and uncertainties that could cause our actual results and future events to differ materially from those set forth or contemplated in our forward-looking statements, including those summarized below. The following list of risks and uncertainties is only a summary of some of the most important factors and is not intended to be exhaustive. This risk factor summary should be read together with the more detailed discussion of risks and uncertainties set forth under “Risk Factors.”
Risks Related to Owning Our Common Stock
•There is no public market for our common stock and a market may never develop, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.
•Common stock and preferred stock eligible for future sale may have adverse effects on our share price.
•Our principal stockholders, which are currently controlled by affiliates of our Manager, own a significant amount of our outstanding shares of common stock.
Risks Related to Our Business
•Changes in national, regional or local economic, demographic or real estate market conditions may adversely affect our results of operations, our financial position, the value of our assets and our cash flows.
•Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to medium-term, which may have an adverse impact on the valuation of our investments.
•The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.
•Our investments are selected by our Manager and our investors will not have input into investment decisions.
•If our Manager underestimates the borrower’s credit analysis or originates loans by using an exception to its loan underwriting guidelines, we may experience losses.
•Changes in interest rates could adversely affect the demand for our target loans, the value of our loans, commercial mortgage-backed securities (“CMBS”) and other real-estate debt or equity assets and the availability and yield on our targeted assets.
•New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to originate and acquire real estate-related loans at attractive risk-adjusted returns.
•Our loan portfolio may at times be concentrated in certain property types or secured by properties concentrated in a limited number of geographic areas, which increases our exposure to economic downturn with respect to those property types or geographic locations.
•The mezzanine loans, preferred equity and other subordinated loans in which we invest involve greater risks of loss than senior loans secured by income-producing commercial properties.
•Our acquisitions and the integration of acquired businesses subject us to various risks and may not result in all of the cost savings and benefits anticipated, which could adversely affect our financial condition or results of operations.
•The Current Expected Credit Loss (“CECL”) accounting standard requires us to make certain estimates and judgments, which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
Risks Related to Regulation
•Maintenance of our 1940 Act exclusion imposes limits on our operations.
Risks Related to Our Management and Our Relationship With Our Manager
•We rely entirely on the management team and employees of our Manager for our day-to-day operations.
•We face certain conflicts of interest with respect to our operations and our relationship with our Manager and its affiliates.
•The compensation that our Manager receives was not determined on an arm’s-length basis and therefore may not be on the same terms as we could achieve from a third-party.
•Our Manager and its affiliates have limited prior experience operating a REIT and therefore may have difficulty in successfully and profitably operating our business or complying with regulatory requirements, including REIT
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provisions of the Internal Revenue Code of 1986, as amended (the “Code”), which may hinder their ability to achieve our objectives or result in loss of our qualification as a REIT.
Risks Related to Financing and Hedging
•Covenants in our debt agreements may restrict our operating activities and adversely affect our financial condition, operating results and cash flows.
•Our inability to access funding could have a material adverse effect on our results of operations, financial condition and business. We may rely on short-term financing and thus are especially exposed to changes in the availability of financing.
•We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Risks Related to Our Organization and Structure
•Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exclusion from the 1940 Act.
Risks Related to Our Qualification as a REIT
•Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for principal and interest payments on the notes.
•REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or sell assets to make such distributions.
•Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flow.
•Complying with the REIT requirements may force us to liquidate or forego otherwise attractive investments.
General Risk Factors
•COVID-19, or the future outbreak of other highly infectious or contagious diseases, could materially and adversely impact or disrupt our investments, business, financial condition and results of operations.
•Future recessions, downturns, disruptions or instability could have a materially adverse effect on our business.
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PART I
Item 1. Business.
Overview
We are a real estate investment trust that originates, invests in and manages a diverse portfolio of real estate and real estate-related assets. We focus primarily on commercial real estate credit investments, including first mortgage loans, subordinated loans (including B-notes, mezzanine and preferred equity) and credit facilities throughout the United States, which we collectively refer to as our targeted assets. Our loans finance the acquisition, development or recapitalization of high-quality commercial real estate in the United States. We focus on middle market loans in the approximately $10 million to $50 million range, which we believe are subject to less competition, offer higher risk-adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. Our investment objective is to provide attractive risk-adjusted returns to our stockholders, primarily by earning high current income that allows for regular distributions, and, in certain instances, benefiting from potential capital appreciation. There can be no assurances that we will be successful in meeting our investment objective. We may also make strategic real estate equity and non-real estate-related investments that align with our investment objectives and criteria.
Each of our investments was originated by Terra Capital Partners or its affiliates. Our portfolio is diversified based on location of the underlying properties, loan structure and property type. As of December 31, 2023, our portfolio included underlying properties located in 21 markets, across nine states and includes property types such as multifamily housing, hotels, student housing, commercial offices, medical offices, mixed-use, industrial and infrastructure properties. The profile of these properties ranges from stabilized and value-added properties to pre-development and construction. Our loans are structured across mezzanine debt, first mortgages, preferred equity investments and credit facilities.
We were incorporated under the general corporation laws of the State of Maryland on December 31, 2015. Through December 31, 2015, our business was conducted through a series of predecessor private partnerships. At the beginning of 2016, we completed the merger of these private partnerships into a single entity as part of our plan to reorganize our business as a REIT for federal income tax purposes (the “REIT Formation Transaction”). Following the REIT Formation Transaction, Terra Fund 5 contributed the consolidated portfolio of net assets of the Terra Funds to us in exchange for all of the shares of common stock of our company.
On March 1, 2020, Terra Property Trust 2 merged with and into our company, and we continued as the surviving corporation (the “Merger”). In connection with the Merger, we issued 2,116,785.76 shares of our common stock to Terra Fund 7, the sole stockholder of Terra Property Trust 2, in exchange for the settlement of $17.7 million of participation interests in loans held by us, cash of $16.9 million and other working capital. Subsequent to the Merger, Terra Fund 5 and Terra Fund 7 contributed their shares of our common stock to Terra JV in exchange for ownership interest in Terra JV. In addition, on March 2, 2020, we issued 2,457,684.59 shares of our common stock to Terra Offshore REIT in exchange for the settlement of $32.1 million of participation interests in loans also held by us, $8.6 million in cash and other net working capital.
BDC Merger
On October 1, 2022 (the “Closing Date”), pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 (the “Merger Agreement”), Terra BDC merged with and into Terra LLC, our wholly owned subsidiary, with Terra LLC continuing as the surviving entity of the merger (the “BDC Merger”) and as our wholly owned subsidiary. The Certificate of Merger and Articles of Merger with respect to the BDC Merger were filed with the Secretary of State of the State of Delaware and State Department of Assessments and Taxation of Maryland (the “SDAT”), respectively, with an effective time and date of 12:02 a.m., Eastern Time, on the Closing Date (the “Effective Time”).
At the Effective Time, except for any shares of common stock, par value $0.001 per share, of Terra BDC (“Terra BDC Common Stock”) held by us or any of our wholly owned subsidiaries or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of our newly designated Class B Common Stock, par value $0.01 per share (“Class B Common Stock”), and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38.
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Pursuant to the terms of the transactions described in the Merger Agreement, approximately 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as of the Closing Date.
On the Closing Date, we filed with the SDAT our Articles of Amendment to the Articles of Amendment and Restatement (the “Charter Amendment”). Pursuant to the Charter Amendment, (i) the authorized shares of our stock which we have authority to issue were increased from 500,000,000 to 950,000,000, consisting of 450,000,000 shares of Class A Common Stock, $0.01 par value per share (“Class A Common Stock”), 450,000,000 shares of Class B Common Stock, and 50,000,000 shares of Preferred Stock, $0.01 par value per share (“Preferred Stock”), and (ii) each share of our common stock issued and outstanding immediately prior to the Effective Time was automatically changed into one issued and outstanding share of Class B Common Stock.
The Class B Common Stock rank equally with and have identical preferences, rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms and conditions of redemption as each other share of our common stock, except with respect to conversion. For additional information on our Class A Common Stock, please see the “Potential Liquidity Transactions” section below.
Distribution of Class B Common Stock by Terra Fund 5
Prior to undertaking the REIT Formation Transaction, the Terra Funds distributed a consent solicitation memorandum disclosing the details of the proposed transactions and received the requisite consent of investors in each of the Terra Funds to engage in the REIT Formation Transaction. The consent solicitation memorandum disclosed that Terra Fund 5 could in the future make a distribution-in-kind to its members of shares of our company, rather than a cash distribution. The limited liability company agreement of Terra Fund 5 provides that the term of Terra Fund 5 expired on December 31, 2023.
On December 20, 2023, Terra Fund 5 announced that effective December 29, 2023 (the “Distribution Date”), Terra Fund 5 would distribute all of its shares of Class B Common Stock to its members as part of the winding up of Terra Fund 5. On the Distribution Date, each member of Terra Fund 5 received 2,252.02 shares of Class B Common Stock for each unit of membership interest in Terra Fund 5 held by such member. Because Terra Fund 5 previously owned its interests in the shares of Class B Common Stock indirectly through its ownership of interests in Terra JV, prior to the Distribution Date, Terra JV first distributed the shares of Class B Common Stock to Terra Fund 5, and Terra Fund 5 then distributed those shares to its members on the Distribution Date. On February 8, 2024, each of Terra Fund 5 and Terra JV were dissolved.
As of December 31, 2023, Terra Fund 7 and Terra Offshore REIT held approximately 8.7% and 10.1%, respectively, of our issued and outstanding Class B Common Stock.
Potential Liquidity Transactions
As previously disclosed, we continue to explore alternative liquidity transactions on an opportunistic basis to maximize stockholder value. Examples of the alternative liquidity transactions that, depending on market conditions, may be available to us include a listing of our shares of common stock on a national securities exchange, adoption of a share repurchase plan, a liquidation of our assets, a sale of our company or a strategic business combination, in each case, which may include the further in-kind distribution of our shares of common stock indirectly owned by certain of our affiliate funds to the ultimate investors in such affiliate funds. We cannot provide any assurance that any alternative liquidity transaction will be available to us or, if available, that we will pursue or be successful in completing any such alternative liquidity transaction.
One of the potential future liquidity transactions that we continue to evaluate is a “direct listing” of the Class A Common Stock on a national securities exchange (i.e., a listing not involving a concurrent public offering of newly issued shares). If market conditions are not supportive of a direct listing that would in our view lead to a constructive trading environment for the Class A Common Stock, we will explore alternative paths to pursue our investment strategy and provide liquidity to our investors, including converting our company into a traditional “non-traded REIT.” As part of a potential conversion to a non-traded REIT, we would adopt a customary share repurchase plan pursuant to which our investors could request to have their shares of our common stock redeemed for cash.
To this end, as previously disclosed, we amended our articles of amendment and restatement on December 1, 2023 (the “A&R Articles”), to provide our board of directors (our “Board”) with greater flexibility to pursue a direct listing. In connection with a listing of shares of Class A Common Stock on a national securities exchange, the outstanding shares of Class B Common Stock will be convertible on a one-for-one basis into listed shares of Class A Common Stock, subject to certain conversion terms and holding periods. Currently, there are no outstanding shares of Class A Common Stock.
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The A&R Articles also incorporate the provisions generally required by state regulators in order to become a non-traded REIT and publicly sell shares of our stock not listed on an exchange. These non-traded REIT provisions will spring into effect and become operative if we ultimately decide to register and sell shares in a non-traded REIT format.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2016. So long as we qualify as a REIT, we generally are not subject to U.S. federal income tax on our net taxable income to the extent that we annually distribute all of our net taxable income to our stockholders.
Our Manager, Mavik Capital Management, LP and Terra Capital Partners
We are externally managed by our Manager, which is registered as an investment adviser under the Investment Advisers Act of 1940 Act, and is a subsidiary of Terra Capital Partners.
Mavik Capital Management, LP (“Mavik”), an entity controlled by Vikram S. Uppal, our Chief Executive Officer and Chief Investment Officer, is the sole member of Terra Capital Partners. Terra Capital Partners is led by Mr. Uppal (Chief Executive Officer), Sarah Schwarzschild (Chief Operating Officer), Gregory M. Pinkus (Chief Financial Officer) and Daniel Cooperman (Chief Originations Officer). Mr. Uppal was a Partner of Axar Capital Management L.P. (“Axar Capital Management”) and its Head of Real Estate. Prior to Axar Capital Management, Mr. Uppal was a Managing Director on the Investment Team at Fortress Investment Group’s Credit and Real Estate Funds and Co-Head of North American Real Estate Investments at Mount Kellett Capital Management. Members of the Terra Capital Partners management team have broad based, long-term relationships with major financial institutions, property owners and commercial real estate service providers. The entire senior management team has held leadership roles at many top international real estate and investment banking firms, including Mount Kellett Capital Management, Fortress Investment Group and BGO Strategic Capital Partners.
Terra Capital Partners is a real estate credit focused investment manager based in New York City with a 20-year track record focused primarily on the origination and management of mezzanine loans, as well as first mortgage loans, bridge loans, and preferred equity investments in all major property types through multiple pooled investment vehicles. Since its formation in 2001 and its commencement of operations in 2002, Terra Capital Partners has been engaged in providing financing on commercial properties of all major property types throughout the United States. In the lead up to the global financial crisis in 2007, believing that the risks associated with commercial real estate markets had grown out of proportion to the potential returns from such markets, Terra Capital Partners sold 100% of its investment management interests prior to the global financial crisis. It was not until mid-2009, after its assessment that commercial mortgage markets would begin a period of stabilization and growth, that Terra Capital Partners began to sponsor new investment vehicles, which included the predecessor private partnerships, to again provide debt capital to commercial real estate markets. The financings provided by all vehicles managed by Terra Capital Partners from January 2004 through December 31, 2023 have been secured by approximately 13.9 million square feet of office properties, 3.7 million square feet of retail properties, 7.1 million square feet of industrial properties, 5,058 hotel rooms and 30,080 apartment units. The value of the properties underlying this capital was approximately $11.9 billion based on appraised values as of the closing dates of each financing. In addition to its extensive experience originating and managing debt financings, Terra Capital Partners and its affiliates owned and operated over six million square feet of office and industrial space between 2005 and 2007, and this operational experience further informs its robust origination and underwriting standards and enables our Manager to effectively operate property underlying a financing upon a foreclosure.
Our Investment Strategy
We focus on providing real estate (primarily commercial real estate) loans to creditworthy borrowers and seek to generate an attractive and consistent low volatility cash income stream. Our focus on originating debt and debt-like instruments emphasizes the payment of current returns to investors and the preservation of invested capital. From time to time, we may acquire real estate encumbering the senior loans through foreclosure, may invest in real estate related joint ventures and may directly acquire real estate properties. We may also elect to make strategic non-real estate-related investments that align with our investment objectives and criteria.
As part of our investment strategy, we:
•target middle market loans of approximately $10 million to $50 million;
•focus on the origination of new loans;
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•focus on loans backed by properties in the United States;
•invest primarily in floating rate rather than fixed rate loans, but our Manager reserves the right to make debt investments that bear interest at a fixed rate;
•originate loans expected to be repaid within one to five years;
•maximize current income;
•lend to creditworthy borrowers;
•construct a portfolio that is diversified by property type, geographic location, tenancy and borrower;
•source off-market transactions;
•hold loans until maturity unless, in our Manager’s judgment, market conditions warrant earlier disposition; and
•invest in strategic non-real estate-related investments that align with our investment objectives and criteria.
Our Financing Strategy
We have historically utilized only limited amounts of borrowings as part of our financing strategy. One of the reasons we completed the REIT Formation Transaction, as described under “—Overview,” is to expand our financing options, access to capital and capital flexibility in order to position us for future growth. We deploy moderate amounts of leverage as part of our operating strategy, which currently consists of unsecured notes payable, borrowings under first mortgage financings, a revolving line of credit, repurchase agreements and a term loan. We may in the future also deploy leverage through other credit facilities and senior notes and we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business. In addition, we intend to match our use of floating rate leverage with floating rate investments.
As of December 31, 2023, we had outstanding indebtedness, consisting of unsecured notes payable of $123.5 million and secured financing of $293.4 million. As of December 31, 2023, the amount remaining available under our credit facilities was $378.6 million.
Additionally, from time to time, we may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties. The purpose of the participation agreements is to allow us and an affiliate to originate a specified loan when, individually, we do not have the liquidity to do so. We do not have direct liability to a participant under the participation agreements with respect to the underlying loan and the participants’ share of the investments is repayable only from the proceeds received from the related borrower/issuer of the investments and, therefore, the participants also are subject to credit risk (i.e., risk of default by the underlying borrower/ issuer). With our larger size and enhanced access to capital and capital flexibility, our company expects to de-emphasize our use of participation arrangements. As of December 31, 2023, we did not have any obligations under participation agreements outstanding.
For additional information concerning our indebtedness, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10‑K.
Targeted Assets
Real Estate-Related Investments
We originate, structure, fund and manage commercial real estate loans, including mezzanine loans, first mortgage loans, subordinated mortgage loans and preferred equity investments related to high-quality commercial real estate in the United States. We may, to the extent consistent with our qualification as a REIT, invest in our targeted assets directly or through joint ventures and acquire equity participations in the underlying collateral of some of such loans. Certain of our real estate-related loans require the borrower to make payments of interest on the fully committed principal amount of the loan regardless of whether the full loan amount is outstanding. We may also acquire real estate properties encumbering the first mortgage loans through foreclosure or deed-in-lieu of foreclosure, may invest in joint ventures that own real estate properties and may directly acquire real estate properties.
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We originate, structure and underwrite most, if not all, of our loans. We, in reliance on our Manager, use what we consider to be conservative underwriting criteria, and our underwriting process involves comprehensive financial, structural, operational and legal due diligence to assess the risks of financings so that we can optimize pricing and structuring. By originating, not purchasing, loans, we are able to structure and underwrite financings that satisfy our standards, utilize our proprietary documentation and establish a direct relationship with our borrower. Described below are some of the types of loans we own and seek to originate with respect to high-quality properties in the United States. We continue to see attractive lending opportunities, and we expect market conditions to remain favorable for our strategy for the foreseeable future.
First Mortgage Loans. These loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. First mortgage loans may be either short-term (one to five years) or long-term (up to 10 years), may be fixed or floating rate and are predominantly current-pay loans. Our Manager originates first mortgage loans backed by high-quality properties in the United States that fit our investment strategy. Certain of our first mortgage loans finance the acquisition, rehabilitation and construction of infill land property and for these loans we target a weighted average last dollar loan-to-value of 70%. We may selectively syndicate portions of our first mortgage loans, including senior or junior participations to provide third-party financing for a portion of the loan or optimize returns which may include retained origination fees.
First mortgage loans are expected to provide for a higher recovery rate and lower defaults than other debt positions due to the lender’s senior position. However, such loans typically generate lower returns than subordinate debt such as mezzanine loans, B-notes, or preferred equity investments. As of December 31, 2023, we owned 13 first mortgage loans with a total net principal amount of $365.5 million, which constituted 71.7% of our net loan investment portfolio. As of December 31, 2023, we used $342.9 million of senior mortgage loans as collateral for $204.9 million of borrowings under secured financing agreements.
Subordinated Mortgage Loans (B-notes). B-notes include structurally subordinated mortgage loans and junior participations in first mortgage loans or participations in these types of assets. Like first mortgage loans, these loans generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. B-notes may be either short-term (one to five years) or long-term (up to 10 years), may be fixed or floating rate and are predominantly current-pay loans. We may create B-notes by tranching our directly originated first mortgage loans generally through syndications of senior first mortgages or buy these loans directly from third-party originators. We believe that the opportunities to both directly originate and to buy these types of loans from third parties on favorable terms will continue to be attractive.
Investors in B-notes are compensated for the increased risk of such assets from a pricing perspective but still benefit from a mortgage lien on the related property. Investors typically receive principal and interest payments at the same time as senior debt unless a default occurs, in which case any such payments are made only after any senior debt is made whole. Rights of holders of B-notes are usually governed by participation and other agreements that, subject to certain limitations, typically provide the holders of subordinated positions of the mortgage loan with the ability to cure certain defaults and control certain decisions of holders of senior debt secured by the same properties (or otherwise exercise the right to purchase the senior debt), which provides for additional downside protection and higher recoveries. As of December 31, 2023, we did not own any B-notes.
Mezzanine Loans. These are loans secured by ownership interests in an entity that owns commercial real estate and that generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. Mezzanine loans may be either short-term (one to five years) or long-term (up to 10 years) and may be fixed or floating rate. We may own mezzanine loans directly or we may hold a participation in a mezzanine loan or a sub-participation in a mezzanine loan. These loans generally pay interest on a specified due date (although there may be a portion of the interest that is deferred) and may, to the extent consistent with our qualification as a REIT, provide for participation in the value or cash flow appreciation of the underlying property as described below. Generally, we invest in mezzanine loans with last dollar loan-to-value ratios ranging from 60% to 85%. As of December 31, 2023, we owned three mezzanine loans with a total net principal amount of $17.4 million, which constituted 3.4% of our net loan investment portfolio.
Preferred Equity Investments. These are investments in preferred membership interests in an entity that owns commercial real estate and generally finance the acquisition, refinancing, rehabilitation or construction of commercial real estate. These investments are expected to have characteristics and returns similar to mezzanine loans. As of December 31, 2023, we owned five preferred equity investments with a total net principal amount of $126.6 million, which constituted 24.8% of our net loan investment portfolio.
Equity Participations. In connection with our loan investments, we may pursue equity participation opportunities, or interests in the projects being financed, in instances when we believe that the risk-reward characteristics of the loan merit
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additional upside participation because of the possibility of appreciation in value of the underlying properties securing the loan. Equity participations can be paid in the form of additional interest, exit fees or warrants in the borrower. Equity participation can also take the form of a conversion feature, permitting the lender to convert a loan or preferred equity investment into equity in the borrower at a negotiated premium to the current net asset value of the borrower. We expect to obtain equity participations in certain instances where the loan collateral consists of a property that is being repositioned, expanded or improved in some fashion which is anticipated to improve future cash flow. In such case, the borrower may wish to defer some portion of the debt service or obtain higher leverage than might be merited by the pricing and leverage level based on historical performance of the underlying property. We can generate additional revenues from these equity participations as a result of excess cash flows being distributed or as appreciated properties are sold or refinanced. As of December 31, 2023, we did not own any equity participations.
Operating Real Estate and Real Estate Owned. From time to time, we may acquire operating real estate properties that meet our investment criteria. As well, we may assume control of properties acquired in connection with foreclosures or deed in lieu of foreclosure. As of December 31, 2023, we owned eight industrial buildings purchased in 2023. The real estate and related lease intangible assets and liabilities had a net carrying value of $129.8 million, and the mortgage loans payable encumbering the industrial buildings had an outstanding principal amount of $73.5 million.
Equity Investment in Unconsolidated Investments and Joint Ventures. We may, to the extent consistent with our qualification as a REIT, invest in our targeted assets directly or through joint ventures. As of December 31, 2023, we owned equity interest in a limited partnership that invests in performing and non-performing mortgages, loans, mezzanines, B-notes and other credit instruments supported by underlying commercial real estate assets. We also owned beneficial equity interests in four joint ventures that invest in real estate properties. The equity interests had a total carrying value of $37.2 million as of December 31, 2023.
Other Real Estate-Related Securities. We may invest in other real estate-related securities, which may include marketable securities and securitizations, so long as such securities do not constitute more than 15% of our assets. As of December 31, 2023, we owned $5.0 million in other real estate-related securities.
Non-Real Estate-Related Investments
From time to time, to the extent consistent with our qualification as a REIT for so long as we elect to be taxed as a REIT, we may invest in strategic non-real estate-related investments that align with our investment objectives and criteria.
Investment Guidelines
Our Board has adopted investment guidelines, which may be amended from time to time, that set forth certain criteria for the Manger to use when evaluating specific investment opportunities as well as our overall portfolio composition. Our Board will review the Manager’s compliance with the investment guidelines periodically and receive an investment report at each quarter-end in conjunction with the review of our quarterly results by our Board.
Our Board adopted the following investment guidelines:
•no origination or acquisition shall be made that would cause us to fail to qualify as a REIT;
•no origination or acquisition shall be made that would cause us or any of our subsidiaries to be required to register as an investment company under the 1940 Act; and
•until appropriate investments can be identified, we may invest the proceeds of our equity or debt offerings in interest-bearing, short-term investments, including money market accounts and/or funds, that are consistent with our intention to qualify as a REIT.
These investment guidelines may be changed from time to time by a majority of our Board without the approval of our stockholders.
Disposition Policies
The period we hold our investments in real estate-related loans varies depending on the type of asset, interest rates and other factors. Our Manager has developed a well-defined exit strategy for each of our investments. Our Manager continually performs a hold-sell analysis on each asset in order to determine the optimal time to hold the asset and generate optimal returns
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to our stockholders. Economic and market conditions may influence us to hold investments for longer or shorter periods of time. We may dispose of an asset before the end of the expected holding period if we believe that market conditions have maximized its value to us or the sale of the asset would otherwise be in our best interests. We intend to make any such dispositions in a manner consistent with our qualification as a REIT and our desire to avoid being subject to the “prohibited transaction” penalty tax.
Operating and Regulatory Structure
REIT Qualification
We elected to be taxed as a REIT under the Code commencing with our taxable year ended December 31, 2016. We believe that we have been organized and have operated in conformity with the requirements for qualification and taxation as a REIT under the Code, and that our manner of operation will enable us to continue to meet the requirements for qualification and taxation as a REIT. To qualify as a REIT, we must meet on a continuing basis, through our organization and actual investment and operating results, various requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of shares of our stock. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we failed to qualify as a REIT. Even if we qualify for taxation as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. In addition, subject to maintaining our qualification as a REIT, a portion of our business may be conducted through, and a portion of our income may be earned with respect to, our taxable REIT subsidiaries (“TRSs”), should we decide to utilize TRSs in the future, which are subject to corporate income tax. Any distributions paid by us generally will not be eligible for taxation at the preferential U.S. federal income tax rates that currently apply to certain distributions received by individuals from taxable corporations, unless such distributions are attributable to dividends received by us from our TRSs, should we form a TRS in the future. As of December 31, 2023, we had one TRS, but the TRS had no activity and no current or deferred taxes. We will continue to file a return for the TRS until it is dissolved.
1940 Act Exclusion
We are not registered as an investment company under the 1940 Act. If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the 1940 Act that impose, among other things:
•limitations on our capital structure and the use of leverage;
•restrictions on specified investments;
•prohibitions on transactions with affiliates; and
•compliance with reporting, record keeping, and other rules and regulations that would significantly change our operations.
We conduct our operations so that neither we nor our subsidiaries are required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. The value of the “investment securities” held by an issuer must be less than 40% of the value of such issuer’s total assets on an unconsolidated basis (exclusive of U.S. government securities and cash items). In addition, we conduct our operations so that neither we nor our subsidiaries will be considered an investment company under Section 3(a)(1)(A) of the 1940 Act, as neither we nor our subsidiaries are engaged primarily nor do we hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, we and our subsidiaries are primarily engaged in the non-investment company businesses.
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We and certain of our subsidiaries may at times rely primarily on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the 1940 Act, or any other exclusions that may be available to us (other than the exclusions under Section 3(c)(1) or Section 3(c)(7)). Section 3(c)(5)(C) of the 1940 Act is available for entities primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. This exclusion generally requires that at least 55% of our portfolio must be comprised of “qualifying real estate” assets and at least 80% of our portfolio must be comprised of “qualifying real estate” assets and “real estate-related” assets (and no more than 20% comprised of miscellaneous assets). For purposes of the Section 3(c)(5)(C) exclusion, we classify our investments based in large measure on no-action letters issued by the staff of the SEC and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a “qualifying real estate” asset and a “real estate-related” asset. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action letters were issued more than twenty years ago. Pursuant to this guidance, and depending on the characteristics of the specific investments, certain mortgage loans, participations in mortgage loans, mortgage-backed securities, mezzanine loans, joint venture investments, preferred equity and the equity securities of other entities may not constitute qualifying real estate assets and therefore our investments in these types of assets may be limited. No assurance can be given that the SEC or its staff will concur with our classification of the assets we hold for purposes of the 3(c)(5)(C) exclusion or any other exclusion or exemption under the 1940 Act. Future revisions to the 1940 Act or further guidance from the SEC or its staff may cause us to lose our exclusion from registration or force us to re-evaluate our portfolio and investment strategy. Such changes may prevent us from operating our business successfully.
In order to maintain an exclusion from registration under the 1940 Act, we may be unable to sell assets that we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire assets that we would otherwise want to acquire and would be important to our strategy.
Although we monitor our portfolio periodically and prior to each acquisition and disposition, we may not be able to maintain an exclusion from registration as an investment company. If we were required to register as an investment company, but failed to do so, we would be prohibited from engaging in our business, and legal proceedings could be instituted against us. In addition, our contracts may be unenforceable, and a court could appoint a receiver to take control of us and liquidate our business, all of which would have an adverse effect on our business.
Emerging Growth Company Status
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”), and as such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. A number of these exemptions are not relevant to us, but we intend to take advantage of the exemption from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
In addition, Section 107 of the JOBS Act provides that an emerging growth company can use the extended transition period provided in Section 13(a) of the Exchange Act for complying with new or revised accounting standards. This permits an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to take advantage of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.
We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (ii) the date on which we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period, and (iv) the end of the year in which the five year anniversary of our initial public offering of our common stock occurs.
Competition
We compete with other REITs, numerous regional and community banks, specialty finance companies, savings and loan associations and other entities, and we expect that others may be organized in the future. The effect of the existence of
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additional REITs and other institutions may be increased competition for the available supply of our targeted assets suitable for purchase, which may cause the price for such assets to rise.
In the face of this competition, we expect to have access to our Manager’s professionals and their industry expertise, which may provide us with a competitive advantage in sourcing transactions and help us assess origination and acquisition risks and determine appropriate pricing for potential assets. The more conservative underwriting standards used by many large commercial banks and traditional providers of commercial real estate capital following the 2008 downturn has and we believe will continue to constrain the lending capacity of these institutions. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. For additional information concerning these competitive risks, see “Item 1A. Risk Factors — New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to originate and acquire real estate-related loans at attractive risk-adjusted returns” in this Annual Report on Form 10-K.
Governmental Regulations
As an owner of real estate, our operations are subject, in certain instances, to supervision and regulation by U.S. and other governmental authorities, and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, which, include among other things: (i) federal and state securities laws and regulations; (ii) federal, state and local tax laws and regulations, (ii) state and local laws relating to real property; (iv) federal, state and local environmental laws, ordinances, and regulations, and (v) various laws relating to housing, including permanent and temporary rent control and stabilization laws, the Americans with Disabilities Act of 1990 and the Fair Housing Amendment Act of 1988, among others.
Compliance with the federal, state and local laws described above has not had a material, adverse effect on our business, assets, results of operations, financial condition and ability to pay distributions, and we do not believe that our existing portfolio will require us to incur material expenditures to comply with these laws and regulations.
Employees; Staffing; Human Capital
We are supervised by our Board consisting of six directors. We have entered into a management agreement (“Management Agreement”) with our Manager pursuant to which certain services are provided by our Manager and paid for by us. Our Manager is not obligated under the Management Agreement to dedicate any of its personnel exclusively to us, nor is it or its personnel obligated to dedicate any specific portion of its or their time to our business. We are responsible for the costs of our own employees; however, we do not currently have any employees and do not currently expect to have any employees.
Information About our Executive Officers
The names, ages, positions and biographies of our officers are as follows:
| Name | Age | Position(s) Held with the Company | ||||||||||||
| Vikram S. Uppal | 40 | Chairman of the Board of Directors, Chief Executive Officer and Chief Investment Officer | ||||||||||||
| Sarah Schwarzschild | 43 | Chief Operating Officer | ||||||||||||
| Gregory M. Pinkus | 59 | Chief Financial Officer, Treasurer and Secretary | ||||||||||||
| Daniel J. Cooperman | 49 | Chief Originations Officer | ||||||||||||
Vikram S. Uppal has served as the Chairman of the Board of Directors since November 2021, one of our directors from February 2018 to November 2021 and as Chief Executive Officer for our company, our Manager, Terra Fund Advisors and Terra Capital Partners since December 2018 and as a director of RESOF since October 2020. Mr. Uppal has also served as Chief Investment Officer for our company, Terra Capital Partners and our Manager since February 2018. Mr. Uppal served as the Chief Executive Officer of Terra Income Advisors and Terra BDC from April 2019 to October 2022 and as the Chairman of the board of directors and President of Terra BDC from November 2019 to October 2022. Prior to joining Terra Capital Partners, Mr. Uppal was a Partner and Head of Real Estate at Axar Capital Management since 2016. Prior to Axar Capital Management, Mr. Uppal was a Managing Director on the Investment Team at Fortress Investment Group’s Credit and Real Estate Funds from 2015 to 2016. From 2012 to 2015, Mr. Uppal worked at Mount Kellett Capital Management, a private
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investment organization, and served as Co-Head of North American Real Estate Investments. Mr. Uppal holds a B.S. from the University of St. Thomas and a M.S. from Columbia University.
Sarah Schwarzschild has served as the Chief Operating Officer of our company since February 2024 and Terra Capital Partners since July 2023. Prior to joining our company, Ms. Schwarzschild served as Managing Director and Co-Head of BGO Strategic Capital Partners, a $3 billion global integrated multi-manager platform. Ms. Schwarzschild also managed BGO Strategic Capital Partners’ secondaries funds and separately managed accounts with oversight for the business’ and co-managed the business’ platform. Prior to merging with BentallGreenOak in April 2021, Ms. Schwarzschild held the same responsibilities at Metropolitan Real Estate Equity Management (“Metropolitan”), a firm wholly owned by The Carlyle Group. Prior to joining Metropolitan in 2014, Ms. Schwarzschild led Partners Group’s real estate Secondary team in the U.S., where she was responsible for acquisitions as well as the portfolio management of Partners Group’s dedicated real estate Secondary capital totaling over $2 billion. Prior to joining Partners Group, Ms. Schwarzschild was an Assistant Vice President in the acquisitions team in the Global Opportunity Funds group at RREEF. She began her career at Rothschild as an investment banking analyst in the Mergers & Acquisitions and Private Placement groups. Ms. Schwarzschild received a B.A. (summa cum laude) from the University of Pennsylvania and an M.B.A. with honors from the Tuck School of Business at Dartmouth. Ms. Schwarzschild sits on the MBA Council for the Tuck School of Business and is Secretary of the board of The Mianus River Gorge Preserve and sits on the Advisory Board for INCEPTIV.
Gregory M. Pinkus has served as the Chief Financial Officer, Treasurer and Secretary of our company and the Chief Financial Officer and Chief Operating Officer of our Manager, and Terra Fund Advisors since January 2016, October 2017, and October 2017, respectively. Mr. Pinkus also served as the Chief Operating Officer of our company from January 2016 to February 2024. He also served as (i) the Chief Financial Officer of Terra Capital Advisors, Terra Capital Advisors 2 and Terra Income Advisors 2 since May 2012, September 2012 and October 2016; (ii) the Chief Operating Officer of Terra Capital Advisors, Terra Capital Advisors 2 and Terra Capital Partners since July 2014; (iii) the Chief Operating Officer of Terra Income Advisors 2 since October 2016; (iv) the Chief Financial Officer of Fund 5 International, Terra International and Terra Fund 7 since June 2014, October 2016 and October 2016, respectively; (v) a director of RESOF since October 2020; and (vi) the Chief Financial Officer and Chief Operating Officer of Terra Income Advisors and the Chief Financial Officer, Treasurer and Secretary of Terra BDC from May 2013 to October 2022 and the Chief Operating Officer of Terra BDC from July 2014 to October 2022. Prior to joining Terra Capital Partners in May 2012, he served as Assistant Controller for W.P. Carey & Co. from 2006 to August 2010 and as Controller from August 2010 to May 2012. Mr. Pinkus also served as Controller and Vice President of Finance for several early-stage technology companies during the period of 1999 to 2005. Additionally, he managed large-scale information technology budgets at New York Life Insurance Company from 2003 to 2004 and oversaw an international reporting group at Bank of America from 1992 to 1996. Mr. Pinkus is a Certified Public Accountant and member of the American Institute of Certified Public Accountants. He holds a B.S. in Accounting from the Leonard N. Stern School of Business at New York University.
Daniel J. Cooperman has served as Chief Originations Officer of our company, our Manager, and Terra Fund Advisors since January 2016, September 2017 and September 201, respectively. Mr. Cooperman has served as Chief Originations Officer of (i) each of Terra Capital Advisors and Terra Capital Advisors 2 since January 2015, having previously served as Managing Director of Originations until January 2015 of Terra Capital Advisors and Terra Capital Advisors 2 since April 2009 and September 2012, respectively; (ii) Fund 5 International since January 2015, having previously served as Managing Director of Originations of Terra BDC from June 2014 to June 2014; (iii) Terra Income Advisors and Terra BDC from February 2015 to October 2022, having previously served as Managing Director of Originations from May 2013 until February 2015; and (iv) each of Terra Income Advisors 2, Terra International, and Terra Fund 7 since October 2016. Mr. Cooperman has 18 years’ experience in the acquisition, financing, leasing and asset management of commercial real estate with an aggregate value of over $5 billion. Prior to the formation of Terra Capital Partners in 2001 and its commencement of operations in 2002, Mr. Cooperman handled mortgage and mezzanine placement activities for The Greenwich Group International, LLC. Prior to joining The Greenwich Group, Mr. Cooperman worked in Chase Manhattan Bank’s Global Properties Group, where he was responsible for financial analysis and due diligence for the bank’s strategic real estate acquisitions and divestitures. Prior to that time, he was responsible for acquisitions and asset management for JGS, a Japanese conglomerate with global real estate holdings. Mr. Cooperman holds a B.S. in Finance from the University of Colorado at Boulder.
Available Information
We are subject to the information requirements of the Exchange Act. Therefore, we file periodic reports and other information with the SEC. Stockholders may obtain copies of our filings with the SEC, free of charge from the website maintained by the SEC at www.sec.gov or from our website at www.terrapropertytrust.com. We will provide without charge a copy of this Annual Report on Form 10-K, including financial statements and schedules, upon written request delivered to our principal executive offices.
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We are providing the address to our website solely for the information of investors. The information on our website is not a part of, nor is it incorporated by reference into, this Annual Report on Form 10-K.
Item 1A. Risk Factors.
Before making an investment decision, you should carefully consider the following risk factors together with all of the other information contained in this Annual Report on Form 10-K. The risks set forth below are not the only risks we face, and we may face other risks that we have not yet identified, which we do not currently deem material or which are not yet predictable. If any of the following risks occur, our results of operations, financial condition and cash flows could be materially adversely affected. Some statements in this section constitute forward-looking statements. See “Forward-Looking Statements.”
Risks Related to Owning Our Common Stock
There is no public market for our common stock and a market may never develop, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.
There is no established trading market for our common stock, and there can be no assurance that an active trading market for our common stock will develop, or if one develops, be maintained. Accordingly, no assurance can be given as to the ability of our stockholders to sell their common stock or the price that our stockholders may obtain for their common stock.
Some of the factors that could negatively affect the fair value of our common stock include:
•our expected operating results and our ability to make distributions to our stockholders in the future;
•volatility in our industry, the performance of the real estate-related loans we target, interest rates and spreads, the debt or equity markets, the general economy or the real estate market specifically, whether the result of market events or otherwise;
•the availability of financing on acceptable terms or at all;
•events or circumstances which undermine confidence in the financial markets or otherwise have a broad impact on financial markets, such as the sudden instability or collapse of large depository institutions or other significant corporations, terrorist attacks, natural or man-made disasters or threatened or actual armed conflicts;
•the availability of attractive risk-adjusted investment opportunities in real estate-related loans that satisfy our objectives and strategies;
•the degree and nature of our competition;
•changes in personnel of our Manager and lack of availability of qualified personnel;
•unanticipated costs, delays and other difficulties in executing our long-term growth strategy;
•the timing of cash flows, if any, from our investments due to the lack of liquidity of loans relative to more commonly traded securities;
•an increase in interest rates;
•the performance, financial condition and liquidity of our borrowers; and
•legislative and regulatory changes (including changes to laws governing the taxation of REITs or the exclusion or exemption from registration as an investment company under the 1940 Act).
Market factors unrelated to our performance could also negatively impact the market price of our common stock. One of the factors that investors may consider in deciding whether to buy or sell our common stock is our distribution rate as a percentage of our stock price relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in capital markets can affect the fair market value of our common stock. For instance, if interest
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rates rise, it is likely that the market price of our common stock will decrease as market rates on interest-bearing securities increase.
If we complete an alternative liquidity transaction by pursuing an initial public offering or listing of our shares of common stock in the future, you will be subject to additional risks.
As previously disclosed, we continue to explore alternative liquidity transactions on an opportunistic basis to maximize stockholder value. Examples of the alternative liquidity transactions that, depending on market conditions, may be available to us include a listing of our shares of common stock on a national securities exchange, adoption of a share repurchase plan, a liquidation of our assets, a sale of our company or a strategic business combination, in each case, which may include the further in-kind distribution of our shares of common stock indirectly owned by certain of our affiliate funds to the ultimate investors in such affiliate funds. We cannot provide any assurance that any alternative liquidity transaction will be available to us or, if available, that we will pursue or be successful in completing any such alternative liquidity transaction. If we complete an alternative liquidity transaction that involves us becoming a publicly traded company through an initial public offering or listing of our shares of common stock on a national securities exchange, you will subject to the following additional risks:
Trading Value of our Shares: Our shares will be publicly traded and investors will be able to assess the value of their shares by reference to the public trading price of our shares.
Distributions: We do not expect that the distributions investors receive following any such liquidity event would be adversely impacted. Following any such transaction, we would be expected to pay regular monthly distributions to our stockholders and would continue to be required to distribute dividends equal to at least 90% of our taxable income (calculated without regard to our net capital gain and the dividends paid deduction) to our investors each year in order to maintain our qualification as a REIT.
Manager Compensation: We expect we will enter into a new management agreement with our Manager or an affiliate of our Manager. The base management fees, incentive distributions or other amounts that would be payable to our Manager in the case of any such transaction are expected to be market-based fees determined in the case of any initial public offering by discussions between our Manager and the underwriters involved in the initial public offering. Any such fees are expected to be paid in lieu of the fees currently payable to our Manager.
Transfer Restrictions: We expect that shares currently held by our stockholders will constitute restricted securities under the Securities Act and will be subject to restrictions on transfer under applicable U.S. securities laws
Common stock and preferred stock eligible for future sale may have adverse effects on our share price.
Our Board has the power, without further stockholder approval, to authorize us to issue additional authorized shares of common stock and preferred stock on the terms and for the consideration it deems appropriate subject, if applicable, to the rules of any stock exchange on which our securities may be listed or traded and the terms of any class or series of our stock. We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales, on the market price of our common stock. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock. As of December 31, 2023, Terra Fund 7 and Terra Offshore REIT held approximately 8.7% and 10.1% of our issued and outstanding Class B Common Stock, respectively.
Our principal stockholders, which are currently controlled by affiliates of our Manager, own a significant amount of our outstanding shares of common stock.
Terra Fund 7 and Terra Offshore REIT hold approximately 8.7% and 10.1% of our issued and outstanding Class B Common Stock, respectively. Our Manager also serves as manager to Terra Offshore REIT. As a result, our Manager and its affiliates (for the period that such shares continue to be held by Terra Fund 7 and Terra Offshore REIT and not distributed to their respective equity owners), subject to a voting agreement as described below, hold significant voting power over matters submitted to our stockholders for approval, including:
•the election and removal of directors; and
•the approval of any merger, consolidation or sale of all or substantially all of our assets.
Our Manager is a subsidiary of Terra Capital Partners. Mavik, an entity controlled by our Chief Executive Officer and Chief Investment Officer, is the sole member of Terra Capital Partners. Terra Fund 7 is managed by Terra Fund Advisors,
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which is 51% owned by the estate of Bruce Batkin, Dan Cooperman and Simon Mildé and 49% owned by Terra Capital Partners. On March 2, 2020, we, Terra Fund 5, Terra JV and our Manager also entered into the Amended and Restated Voting Agreement (the “2020 Voting Agreement”). Consistent with the original voting agreement dated February 8, 2018, for the period that Terra REIT Advisors remains our external manager, it will have the right to nominate two individuals to serve as our directors.
Except as otherwise required by law or the provisions of other agreements to which our Manager is or may in the future become bound, our Manager has agreed to vote all shares of our common stock directly or indirectly owned in favor (or against removal) of the directors properly nominated in accordance with the 2020 Voting Agreement.
Our Manager’s voting power may discourage transactions involving a change of control of our company, including transactions in which a holder of our common stock might otherwise receive a premium for his or her shares over the then-current market price.
Holders of our common stock may receive distributions on a delayed basis or distributions may decrease over time. Changes in the amount and timing of distributions we pay or in the tax characterization of distributions we pay may adversely affect the fair value of our common stock or may result in holders of our common stock being taxed on distributions at a higher rate than initially expected.
Our distributions are driven by a variety of factors, including our minimum distribution requirements under the REIT tax laws and our REIT taxable income (including certain items of non-cash income) as calculated pursuant to the Internal Revenue Code. We are generally required to distribute to our stockholders dividends equal to at least 90% of our REIT taxable income (calculated without regard to our net capital gain and the dividends paid deduction), although our reported financial results for United States generally accepted accounting principles (“U.S. GAAP”) purposes may differ materially from our REIT taxable income.
For the years ended December 31, 2023 and 2022, our Board declared total cash distributions of $0.76 and $0.78 per share, respectively, which were paid monthly.
We continue to prudently evaluate our liquidity and review the rate of future distributions in light of our financial condition and the applicable minimum distribution requirements under applicable REIT tax laws and regulations. We may determine to pay distributions on a delayed basis or decrease distributions for a number of factors, including the risk factors described in this Annual Report on Form 10-K.
To the extent we determine that future distributions would represent a return of capital to investors or would not be required under applicable REIT tax laws and regulations rather than the distribution of income, we may determine to discontinue distribution payments until such time that distributions would again represent a distribution of income or be required under applicable REIT tax laws and regulations. Any reduction or elimination of our payment of distributions would not only reduce the amount of distributions you would receive as a holder of our common stock, but could also have the effect of reducing the fair value of our common stock and our ability to raise capital in future securities offerings.
In addition, the rate at which holders of our common stock are taxed on distributions we pay and the characterization of our distribution, whether through ordinary income, capital gains, or a return of capital, could have an impact on the fair value of our common stock. After we announce the expected characterization of distributions we have paid, the actual characterization (and, therefore, the rate at which holders of our common stock are taxed on the distributions they have received) could vary from our expectations, including due to errors, changes made in the course of preparing our corporate tax returns, or changes made in response to an audit by the Internal Revenue Service (the “IRS”), with the result that holders of our common stock could incur greater income tax liabilities than expected.
Investing in our common stock may involve a high degree of risk and may result in loss of capital invested in us.
Our investment strategy and our originations may result in a high amount of risk when compared to alternative strategies and volatility or loss of principal. Our originations or acquisitions may be highly speculative and aggressive, and therefore an investment in our shares of common stock may not be suitable for someone with lower risk tolerance.
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Risks Related to Our Business
Changes in national, regional or local economic, demographic or real estate market conditions may adversely affect our results of operations, our financial position, the value of our assets and our cash flows.
We are subject to risks incident to the ownership of real estate-related assets including: changes in national, regional or local economic, demographic or real estate market conditions; changes in supply of, or demand for, similar properties in an area; increased competition for real estate assets targeted by our investment strategy; bankruptcies, financial difficulties or lease defaults by property owners and tenants; inflation; changes in interest rates and availability of financing; and changes in government rules, regulations and fiscal policies, including changes in tax, real estate, environmental and zoning laws. Our assets are also subject to the risk of significant adverse changes in financial market conditions that can result in a deleveraging of the global financial system and the forced sale of large quantities of mortgage-related and other financial assets. Concerns over economic recession, inflation, geopolitical issues, including events such as the Russia’s invasion of Ukraine, United Kingdom’s exit from the European Union, unemployment, the availability and cost of finance, or a prolonged government shutdown may contribute to increased volatility and diminished expectations for the economy and markets, which could result in an increase in mortgage defaults or a decline in the value of our assets. In addition, any increase in mortgage defaults in the residential market may have a negative impact on the credit markets generally as well as on economic conditions generally. We do not know whether the values of the property securing our real estate-related loans will remain at the levels existing on the dates of origination of such loans, and we are unable to predict future changes in national, regional or local economic, demographic or real estate market conditions. These conditions, or others we cannot predict, may adversely affect our results of operations, our financial position, the value of our assets and our cash flows.
Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to medium-term, which may have an adverse impact on the valuation of our investments.
Inflation in the U.S. has accelerated in recent years and is currently expected to continue at an elevated level in the near-to medium-term. While inflation in the U.S. appears to be easing gradually, there can be no assurance that further deterioration in financial market and economic conditions will not occur. Further, heightened competition for workers, the relocation of foreign production and manufacturing businesses to the U.S., and rising energy and commodity prices have contributed to increasing wages and other economic inputs. Elevated inflation and input costs may have adverse effects on our commercial real estate-related loans, commercial real estate-related debt securities and select commercial real estate equity investments, which are subject to the risks typically associated with real estate. Inflation can negatively impact the profitability of real estate assets with long-term leases that do not provide for short-term rent increases or that provide for rent increases with a lower annual percentage increase than inflation. Continued inflation, particularly at elevated levels, may have an adverse impact on the valuation of our investments.
The lack of liquidity of our assets may adversely affect our business, including our ability to value and sell our assets.
A portion of the real estate-related loans and other assets we originate or acquire may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less value than the value at which we have previously recorded our assets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations, financial condition and cash flows.
Our investments are selected by our Manager and our investors will not have input into investment decisions.
Pursuant to the terms of the Management Agreement, our Manager is responsible for, among other services, managing the investment and reinvestment of our assets, subject to the oversight and supervision of our Board. We may also make strategic non-real estate-related investments that align with our investment objectives and criteria. Our investors will not have input into investment decisions. This will increase the uncertainty, and thus the risk, of investing in us, as we may make investments with which you may not agree. Our Manager intends to conduct due diligence with respect to each investment and suitable investment opportunities may not be immediately available. The failure of our Manager to find investments that meet our investment criteria in sufficient time or on acceptable terms could result in unfavorable returns and could cause a material adverse effect on our results of operations, financial condition and cash flows. Even if investment opportunities are available, there can be no assurance that the due diligence processes of our Manager will uncover all relevant facts or that any particular investment will be successful.
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From time to time, before appropriate real estate-related investments can be identified, our Manager may choose to have us invest in interest-bearing, short-term investments, including money market accounts and/or funds, among others, that align with our investment objectives and criteria and are consistent with our intention to maintain our qualification as a REIT. These short-term, non-real estate-related investments, if any, may provide a lower net return than we seek to achieve from investments in real estate-related loans and other commercial real estate assets. Furthermore, when our Manager does identify suitable real estate-related loans and other commercial real estate assets that are the types of assets which we target, you will be unable to influence the decision of our Manager ultimately to invest in, or refrain from investing in, such assets.
Our Manager’s due diligence of potential real estate-related loans and other commercial real estate assets may not reveal all of the liabilities associated with such assets and may not reveal other weaknesses in our assets, which could lead to investment losses.
Before originating or acquiring a financing, our Manager calculates the level of risk associated with the real estate-related loans and other commercial real estate assets to be originated or acquired based on several factors which include the following: top-down reviews of both the current macroeconomic environment generally and the real estate and commercial real estate loan market specifically; detailed evaluation of the real estate industry and its sectors; bottom-up reviews of each individual investment’s attributes and risk/reward profile relative to the macroeconomic environment; and quantitative cash flow analysis and impact of the potential investment on our portfolio. In making the assessment and otherwise conducting customary due diligence, we employ standard documentation requirements and require appraisals prepared by local independent third-party appraisers selected by us. Additionally, we seek to have borrowers or sellers provide representations and warranties on loans we originate or acquire, and if we are unable to obtain representations and warranties, we factor the increased risk into the price we pay for such loans. Despite our review process, there can be no assurance that our Manager’s due diligence process will uncover all relevant facts or that any investment will be successful.
If our Manager underestimates the borrower’s credit analysis or originates loans by using an exception to its loan underwriting guidelines, we may experience losses.
Our Manager values our real estate-related loans based on an initial credit analysis and the investment’s expected risk-adjusted return relative to other comparable investment opportunities available to us, taking into account estimated future losses on the loans, and the estimated impact of these losses on expected future cash flows. Our Manager’s loss estimates may not prove accurate, as actual results may vary from estimates. In the event that our Manager underestimates the losses relative to the price we pay for a particular investment, we may experience losses with respect to such investment, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
Further, from time to time and in the ordinary course of business, our Manager may make exceptions to our predetermined loan underwriting guidelines. Loans originated with exceptions may result in a higher number of delinquencies and defaults, which could have a material and adverse effect on our results of operations, financial condition and cash flows.
Deficiencies in appraisal quality in the mortgage loan origination process may result in increased principal loss severity.
During the loan underwriting process, appraisals are generally obtained on the collateral underlying each prospective loan. The quality of these appraisals may vary widely in accuracy and consistency. The appraiser may feel pressure from the broker or lender to provide an appraisal in the amount necessary to enable the originator to make the loan, whether or not the value of the property justifies such an appraised value. Inaccurate or inflated appraisals may result in an increase in the severity of losses on the loans, which could have a material and adverse effect on our results of operations, financial condition and cash flows.
Our Manager utilizes analytical models and data in connection with the valuation of our real estate-related loans and other commercial real estate assets, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks.
As part of the risk management process our Manager uses detailed proprietary models, including loan level non-performing loan models, to evaluate collateral liquidation timelines and price changes by region, along with the impact of different loss mitigation plans. Additionally, our Manager uses information, models and data supplied by third parties. Models and data are used to value potential targeted assets. In the event models and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. For example, by relying on incorrect models and data, especially valuation models, our Manager may be induced to buy certain targeted assets at prices that are too high, to sell certain other assets at prices that are too low or to miss favorable opportunities altogether. Similarly, any hedging based on faulty models and data may prove to be unsuccessful. If any of the aforementioned occur, such event could have a material adverse effect on our results of operations, financial condition and cash flows.
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Changes in interest rates could adversely affect the demand for our target loans, the value of our loans, CMBS and other real-estate debt or equity assets and the availability and yield on our targeted assets.
We invest in real estate-related loans and other commercial real estate assets, which are subject to changes in interest rates. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of our targeted assets available to us, which could adversely affect our ability to originate and acquire assets that satisfy our objectives. Rising interest rates may also cause our targeted assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to originate or acquire a sufficient volume of our targeted assets with a yield that is above our borrowing cost, our ability to satisfy our objectives and to generate income and make distributions may be materially and adversely affected. Conversely, if interest rates decrease, we will be adversely affected to the extent that real estate-related loans are prepaid, because we may not be able to make new loans at the previously higher interest rate.
The relationship between short-term and longer-term interest rates is often referred to as the “yield curve.” Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because our loans and CMBS assets generally will bear, on average, interest based on longer-term rates than our borrowings, a flattening of the yield curve would tend to decrease our net income and the fair market value of our net assets. Additionally, to the extent cash flows from loans and CMBS assets that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new loans and CMBS assets and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion), in which event our borrowing costs may exceed our interest income and we could incur operating losses.
The values of our loans and CMBS assets may decline without any general increase in interest rates for a number of reasons, such as increases or expected increases in defaults, or increases or expected increases in voluntary prepayments for those loans and CMBS assets that are subject to prepayment risk or widening of credit spreads.
In addition, in a period of rising interest rates, our operating results will depend in large part on the difference between the income from our assets and our financing costs. We anticipate that, in most cases, the income from such assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates will tend to decrease our net income, which may have a material adverse effect on our results of operations, financial condition and cash flows.
New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to originate and acquire real estate-related loans at attractive risk-adjusted returns.
New entrants in the market for commercial loan originations and acquisitions could adversely impact our ability to execute our investment strategy on terms favorable to us. In originating and acquiring our targeted assets, we may compete with other REITs, numerous regional and community banks, specialty finance companies, savings and loan associations, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders and other entities, and we expect that others may be organized in the future. The effect of the existence of additional REITs and other institutions may be increased competition for the available supply of assets suitable for investment by us, which may cause the price for such assets to rise, which may limit our ability to generate desired returns. Additionally, origination of our target loans by our competitors may increase the availability of such loans which may result in a reduction of interest rates on these loans. Some competitors may have a lower cost of funds and access to funding sources that may not be available to us. Many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exclusion or exemption from the 1940 Act. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of real estate-related loans and establish more relationships than us.
We cannot assure you that the competitive pressures we may face will not have a material adverse effect on our results of operations, financial condition and cash flows. Also, as a result of this competition, desirable investments in our targeted assets may be limited in the future and we may not be able to take advantage of attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objectives.
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Our loans are dependent on the ability of the commercial property owner to generate net income from operating the property, which may result in the inability of such property owner to repay a loan, as well as the risk of foreclosure.
Our loans may be secured by office, multifamily, student housing, hotel, commercial or warehouse properties and are subject to risks of delinquency, foreclosure and of loss that may be greater than similar risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be adversely affected by, among other things:
•tenant mix;
•success of tenant businesses;
•property management decisions;
•property location, condition and design;
•competition from comparable types of properties;
•changes in national, regional or local economic conditions and/or specific industry segments;
•declines in regional or local real estate values;
•declines in regional or local rental or occupancy rates;
•increases in interest rates, real estate tax rates and other operating expenses;
•costs of remediation and liabilities associated with environmental conditions;
•the potential for uninsured or underinsured property losses;
•changes in governmental laws and regulations, including fiscal policies, zoning ordinances and environmental legislation and the related costs of compliance;
•pandemics or other calamities that may affect tenants’ ability to pay their rent; and
•acts of God, terrorism, social and political unrest, armed conflict, geopolitical events and civil disturbances.
In the event of any default under a mortgage loan held directly by us, we bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our results of operations, financial condition and cash flows. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure can be an expensive and lengthy process, and foreclosing on certain properties where we directly hold the mortgage loan and the borrower’s default under the mortgage loan is continuing could result in actions that could be costly to our operations, in addition to having a substantial negative effect on our anticipated return on the foreclosed mortgage loan. If property securing or underlying loans become real estate owned as a result of foreclosure, we bear the risk of not being able to sell the property and recovering our investment and of being exposed to the risks attendant to the ownership of real property.
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Our loan portfolio may at times be concentrated in certain property types or secured by properties concentrated in a limited number of geographic areas, which increases our exposure to economic downturn with respect to those property types or geographic locations.
We are not required to observe specific diversification criteria. Therefore, our portfolio of assets may, at times, be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations.
Our loans are concentrated in California, New York, New Jersey, Georgia and Utah representing approximately 23.4%, 17.8%, 16.2%, 14.6% and 9.7%, respectively, of our net loan portfolio as of December 31, 2023. Additionally, we own eight industrial buildings in Texas. If economic conditions in these or in any other state in which we have a significant concentration of borrowers were to deteriorate, such adverse conditions could have a material and adverse effect on our business by reducing demand for new financings, limiting the ability of customers to repay existing loans and impairing the value of our real estate collateral and real estate owned properties.
Further, our loans are concentrated in office, multifamily and industrial property types representing approximately 28.4%, 16.8% and 13.3%, respectively, of our net loan portfolio as of December 31, 2023. As a result, a downturn in any particular industry in which we are heavily invested may significantly impact the aggregate returns we realize. If an industry in which we are heavily invested suffers from adverse business or economic conditions, a material portion of our investment could be affected adversely, which, in turn, could adversely affect our results of operations, financial condition and cash flows.
In addition, from time to time, there have been proposals to base property taxes on commercial properties on their current market value, without any limit based on purchase price. In California, pursuant to an existing state law commonly referred to as Proposition 13, properties are reassessed to market value only at the time of change in ownership or completion of construction, and thereafter, annual property reassessments are limited to 2% of previously assessed values. As a result, Proposition 13 generally results in significant below-market assessed values over time. From time to time, lawmakers and political coalitions have initiated efforts to repeal or amend Proposition 13 to eliminate its application to commercial and industrial properties. If successful, a repeal of Proposition 13 could substantially increase the assessed values and property taxes for our customers in California which in turn could limit their ability to borrow funds.
To the extent that our portfolio is concentrated in any region, or by type of property, downturns relating generally to such region, type of borrower or security may result in defaults on a number of our assets within a short time period, which may reduce our net income, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
We expect that a significant portion of the mortgage loans invested in by us may be development mortgage loans on infill land, which are speculative in nature.
We expect that a significant portion of our assets may be mortgage loans for the development of real estate, which will initially be secured by infill land. These types of loans are speculative, because:
•until improvement, the property may not generate separate income for the borrower to make loan payments;
•the completion of planned development may require additional development financing by the borrower, which may not be available; and
•there is no assurance that we will be able to sell unimproved infill land promptly if we are forced to foreclose upon it.
If in fact the land is not developed, the borrower may not be able to refinance the loan and, therefore, may not be able to make the balloon payment when due. If a borrower defaults and we foreclose on the collateral, we may not be able to sell the collateral for the amount owed to us by the borrower. In calculating our loan-to-value ratios for the purpose of determining maximum borrowing capacity, we use the estimated value of the property at the time of completion of the project, which increases the risk that, if we foreclose on the collateral before it is fully developed, we may not be able to sell the collateral for the amount owed to us by the borrower, which in turn may have an adverse effect on our results of operations, financial condition and cash flows.
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Loans to small businesses involve a high degree of business and financial risk, which can result in substantial losses that would adversely affect our business, results of operation and financial condition.
Our operations and activities include loans to small, privately owned businesses to purchase real estate used in their operations or by investors seeking to acquire small office, multifamily, student housing, hotel, commercial or warehouse properties. Additionally, such loans are also often accompanied by personal guarantees. Often, there is little or no publicly available information about these businesses. Accordingly, we must rely on our own due diligence to obtain information in connection with our investment decisions. Our borrowers may not meet net income, cash flow and other coverage tests typically imposed by banks. A borrower’s ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative local or more general economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in the collateral for the loan. In addition, small businesses typically depend on the management talents and efforts of one person or a small group of people for their success. The loss of services of one or more of these persons could have a material and adverse impact on the operations of the small business. Small companies are typically more vulnerable to customer preferences, market conditions and economic downturns and often need additional capital to expand or compete. These factors may have an impact on loans involving such businesses. Loans to small businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses.
Our investments may include subordinated tranches of CMBS, which are subordinate in right of payment to more senior securities.
Our investments may include subordinated tranches of CMBS, which are subordinated classes of securities in a structure of securities collateralized by a pool of assets consisting primarily of commercial loans and, accordingly, are the first or among the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. As a result, such subordinated interests generally are not actively traded and may not provide holders thereof with liquid investments.
Any credit ratings assigned to our loans and CMBS assets will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded.
Some of our loan and CMBS assets may be rated by Moody’s Investors Service, Standard & Poor’s, or Fitch Ratings. Any credit ratings on our loans and CMBS assets are subject to ongoing evaluation by credit rating agencies, and we cannot assure you that any such ratings will not be changed or withdrawn by a rating agency in the future if, in its judgment, circumstances warrant. Rating agencies may assign a lower than expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our loans and CMBS assets in the future. In addition, we may originate or acquire assets with no rating or with below investment grade ratings. If the rating agencies take adverse action with respect to the rating of our loans and CMBS assets or if our unrated assets are illiquid, the value of these loans and CMBS assets could significantly decline, which would adversely affect the value of our investment portfolio and could result in losses upon disposition or the failure of borrowers to satisfy their debt service obligations to us.
The mezzanine loans, preferred equity and other subordinated loans in which we invest involve greater risks of loss than senior loans secured by income-producing commercial properties.
We invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to such loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is fully satisfied. As a result, we may not recover some or all of our investment. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the real property and increasing the risk of loss of principal.
Our investments in B-notes are generally subject to losses. The B-notes in which we may invest may be subject to additional risks relating to the privately negotiated structure and terms of the transaction, which may result in losses to us.
As part of our whole loan origination platform, we may retain from whole loans we originate or acquire, subordinate interests referred to as B-notes. B-notes are commercial real estate loans secured by a first mortgage on a single large
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commercial property or group of related properties and subordinated to a senior interest, referred to as an A-note. As a result, if a borrower defaults, there may not be sufficient funds remaining for B-note owners after payment to the A-note owners. In addition, our rights to control the process following a borrower default may be subject to the rights of A-note owners whose interests may not be aligned with ours. B-notes reflect similar credit risks to comparably rated CMBS. However, since each transaction is privately negotiated, B-notes can vary in their structural characteristics and risks. For example, the rights of holders of B-notes to control the process following a borrower default may be limited in certain investments. We cannot predict the terms of each B-note investment. Significant losses related to our B-notes would result in operating losses for us, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
Any disruption in the availability and/or functionality of our Manager’s technology infrastructure and systems and any failure or our security measures related to these systems could adversely impact our business.
Our ability to originate and acquire real estate-related loans and manage any related interest rate risks and credit risks is critical to our success and is highly dependent upon the efficient and uninterrupted operation of our computer and communications hardware and software systems. For example, we rely on our Manager’s proprietary database to track and maintain all loan performance and servicing activity data for loans in our portfolio. This data is used to manage the portfolio, track loan performance, and develop and execute asset disposition strategies. In addition, this data is used to evaluate and price new investment opportunities. If we lost access to our loan servicing activity data or other important business information due to a network or utility failure, our ability to effectively manage our business could be impaired.
Some of these systems are located at our facility and some are maintained by third-party vendors. Any significant interruption in the availability and functionality of these systems could harm our business. In the event of a systems failure or interruption by our third-party vendors, we will have limited ability to affect the timing and success of systems restoration. If such systems failures or interruptions continue for a prolonged period of time, there could be a material and adverse impact on results of operations, financial condition and cash flows.
In addition, some of our security measures may not effectively prohibit others from obtaining improper access to our information. If a person is able to circumvent our security measures, he or she could destroy or misappropriate valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and harm our reputation.
Cybersecurity risk and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information and/or damage to our business relationships, all of which could have an adverse effect on our results of operations, financial condition and cash flows. results.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance cost, litigation and damage to our relationships. As our reliance on technology has increased, so have the risks posed to our information systems both internal and those provided by our Manager, Terra Capital Partners, its affiliates and third-party service providers. With respect to cybersecurity risk oversight, our Board and our audit committee receive periodic reports and updates from management on the primary cybersecurity risks facing us and our Manager and the measures our Manager is taking to mitigate such risks. In addition to such periodic reports, our Board and our audit committee receive updates from management as to changes to our and our Manager’s and its affiliates’ cybersecurity risk profile or certain newly identified risks. However, these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations or confidential information will not be negatively impacted by such an incident.
Our acquisitions and the integration of acquired businesses subject us to various risks and may not result in all of the cost savings and benefits anticipated, which could adversely affect our financial condition or results of operations.
We have in the past and may in the future seek to grow our business by acquiring other businesses that we believe will complement or augment our existing businesses. For example, we completed the BDC Merger in October 2022. Acquisition targets may not have a history of synergistic business operations, practices or, if applicable, investment criteria and strategies. We may make strategic non-real estate-related investments that align with our investment objectives and criteria. We cannot predict with certainty the benefits of such acquisitions, which often constitute multi-year endeavors. There is risk that our acquisitions may not have the anticipated positive results, including results relating to: correctly assessing the asset quality of
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the assets being acquired; the total cost and time required to complete the integration successfully; being able to profitably deploy funds acquired in an acquisition; or the overall performance of the combined entity.
If we are unable to successfully integrate our acquisitions into our business, we may never realize their expected benefits. With each acquisition, we may discover unexpected costs, liabilities for which we are not indemnified, delays, lower than expected cost savings or synergies, or incurrence of other significant charges such as impairment of goodwill or other intangible assets and asset devaluation. We also may be unable to successfully integrate the diverse company cultures, retain key personnel, apply our expertise to new competencies, or react to adverse changes in industry conditions.
Acquisitions may also result in business disruptions that could cause customers to move their business to our competitors. It is possible that the integration process related to acquisitions could result in the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that could adversely affect our ability to maintain relationships with borrowers, clients, customers, and employees. The loss of key employees in connection with an acquisition could adversely affect our ability to successfully conduct our business. Acquisition and integration efforts could divert management attention and resources, which could have an adverse effect on our financial condition and results of operations. Additionally, the operation of the acquired businesses may adversely affect our existing profitability, and we may not be able to achieve results in the future similar to those achieved by our existing business or manage growth resulting from the acquisition effectively.
We may make strategic non-real estate-related investments that align with our investment objectives and criteria, which may expose us to risks from a number of diverse issuers, industries, and investment forms.
Though our investments are primarily in real estate-related loans and other commercial real estate assets or interests, we may strategically invest in non-real estate-related investments that align with our investment objectives and criteria. However, the underwriting process for non-real estate-related investments and the ongoing asset management and servicing of such investments is different from the investment process for real estate investments, and our Manager has not historically focused on non-real estate investing. We may not be able to achieve the returns on any non-real estate-related investments that we achieved on our real estate-related investments. Non-real estate-related investments are also not collateralized by real estate like our real estate investments and hence may be riskier because if the debt-like non-real estate-related investments default or do not perform, we may not have collateral to foreclose upon. Further, non-real estate-related investments will be subject to different regulatory risks which may distract the attention of our management, and be difficult and costly to comply with. As a result, to the extent we hold, acquire or transact in such non-real estate-related investments, we may be exposed to risks from a number of diverse issuers, industries and investment forms which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
We are subject to environmental, social and governance (“ESG”) risks that could adversely affect our reputation, business,
operations and earnings.
Certain organizations that provide corporate risk information to investors and shareholders have developed scores and ratings to evaluate companies based upon various ESG metrics. Currently, there are no universal standards for such scores or ratings, but ESG evaluations are increasingly being integrated into investment analysis. Views about ESG matters are diverse and rapidly changing, and companies are facing increasing scrutiny from regulators, investors, and other stakeholders related to their ESG practices and disclosure. If we fail to adapt to or comply with regulatory requirements or investor or stakeholder ESG standards, our reputation, ability to do business with certain partners, access to capital, operations and earnings could be adversely affected.
Risks Related to Regulation
The increasing number of proposed U.S. federal, state and local laws may affect certain mortgage-related assets in which we invest and could materially increase our cost of doing business.
Various bankruptcy legislation has been proposed that, among other provisions, could allow judges to modify the terms of residential mortgages in bankruptcy proceedings, could hinder the ability of the servicer to foreclose promptly on defaulted mortgage loans or permit limited assignee liability for certain violations in the mortgage loan origination process, any or all of which could adversely affect our business or result in us being held responsible for violations in the mortgage loan origination process even where we were not the originator of the loan. We do not know what impact this type of legislation, which has been primarily, if not entirely, focused on residential mortgage originations, would have on the commercial loan market. We are unable to predict whether U.S. federal, state or local authorities, or other pertinent bodies, will enact legislation, laws, rules,
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regulations, handbooks, guidelines or similar provisions that will affect our business or require changes in our practices in the future, and any such changes could have a material adverse effect on our results of operations, financial condition and cash flows.
Failure to obtain or maintain required approvals and/or state licenses necessary to operate our mortgage-related activities may adversely impact our investment strategy.
We may be required to obtain and maintain various approvals and/or licenses from federal or state governmental authorities, government sponsored entities or similar bodies in connection with some or all of our activities. There is no assurance that we can obtain and maintain any or all of the approvals and licenses that we desire or that we will avoid experiencing significant delays in seeking such approvals and licenses. Furthermore, we may be subject to various disclosure and other requirements to obtain and maintain these approvals and licenses, and there is no assurance that we will satisfy those requirements. Our failure to obtain or maintain licenses will restrict our options and ability to engage in desired activities, and could subject us to fines, suspensions, terminations and various other adverse actions if it is determined that we have engaged without the requisite approvals or licenses in activities that required an approval or license, which could have a material adverse effect on our results of operations, financial condition and cash flows.
The impact of financial reform legislation and legislation promulgated thereunder on us is uncertain.
U.S. Federal government agencies, including the Federal Reserve, the Treasury Department and the SEC, as well as other governmental and regulatory bodies, have taken, are taking or may in the future take, various actions to address financial crises or other areas of national regulatory concern. Such actions could materially and adversely impact our business and investments, and dramatically increase the costs of complying with any additional laws and regulations. The elimination or reduction in scope of various existing laws and regulations could similarly materially and adversely impact our business and investments, results of operations and financial condition. Any far-ranging government intervention in the U.S. economic and financial systems may carry unintended consequences and cause market distortions. We are unable to predict at this time the extent and nature of such unintended consequences and market distortions, if any. The inability to evaluate such potential impacts could have a material adverse effect on our results of operations, financial condition and cash flows.
Accounting rules for certain of our transactions are highly complex and involve significant judgment and assumptions, and changes in such rules, accounting interpretations or our assumptions could adversely impact our ability to timely and accurately prepare our consolidated financial statements.
We are subject to Financial Accounting Standards Board (“FASB”) interpretations that can result in significant accounting changes that could have a material and adverse impact on our results of operations and financial condition. Accounting rules for financial instruments, including the origination, acquisition and sales or securitization of mortgage loans, derivatives, investment consolidations and other aspects of our anticipated operations are highly complex and involve significant judgment and assumptions. For example, our estimates and judgments are based on a number of factors, including projected cash flows from the collateral securing our loans, the likelihood of repayment in full at the maturity of a loan, potential for a loan refinancing opportunity in the future and expected market discount rates for varying property types. These complexities could lead to a delay in the preparation of financial information and the delivery of this information to our investors.
Changes in accounting rules, interpretations or our assumptions could also undermine our ability to prepare timely and accurate financial statements, which could result in a lack of investor confidence in our financial information.
The CECL accounting standard requires us to make certain estimates and judgements, which may be difficult to determine and may have a material adverse effect on our financial condition and results of operations.
In June 2016, the FASB issued an Accounting Standards Update (“ASU”), Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which replaces the “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the CECL model. The new CECL standard became effective for us on January 1, 2023. Under the CECL model, we are required to present certain financial assets carried at amortized cost, such as performing loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current U.S. GAAP, which delays recognition until it is probable a loss has been incurred. Under the CECL model, if we are required to materially increase our level of allowance for credit losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
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We are an “emerging growth company,” and a “smaller reporting company” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies or smaller reporting companies will make an investment in us less attractive to investors. In particular, our independent registered public accounting firm is not required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act.
We are an “emerging growth company” as defined in the JOBS Act. We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07 billion, (ii) the date on which we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, (iii) the date on which we have issued more than $1.0 billion in nonconvertible debt during the preceding three-year period, and (iv) the end of the year in which the five-year anniversary of the initial public offering of our common stock occurs in the future, if applicable. We may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements.
Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting, and generally requires in the same report a report by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. Under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until we are no longer an “emerging growth company.”
In addition, we are also a smaller reporting company, as defined in Rule 12b-2 under the Exchange Act. In the event that we are still considered a smaller reporting company at such time as we cease being an emerging growth company, the disclosure we will be required to provide in our SEC filings will increase, but will still be less than it would be if we were not considered either an emerging growth company or a smaller reporting company.
Rule 12b-2 of the Exchange Act defines a “smaller reporting company” as an issuer that is not an investment company, an asset-backed issuer or a majority-owned subsidiary of a parent that is not a smaller reporting company and that:
(1)had a public float of less than $250 million; or
(2)had annual revenues of less than $100 million during the most recently completed fiscal year for which audited financial statements are available and either had no public float or a public float of less than $700 million.
Similar to emerging growth companies, smaller reporting companies are able to provide simplified executive compensation disclosures in their filings, and have certain other decreased disclosure obligations in their SEC filings, including, among other things, being required to provide only two years of audited financial statements in annual reports.
To the extent we take advantage of some or all of the reduced reporting requirements applicable to emerging growth companies or smaller reporting companies, an investment in our company may be less attractive to investors.
We may be exposed to environmental liabilities with respect to properties to which we take title, which may in turn decrease the value of the underlying properties.
In the course of our business, we may take title to real estate, and, as a result, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity, and results of operations could be materially and adversely affected. In addition, an owner or operator of real property may become liable under various federal, state and local laws, for the costs of removal of certain hazardous substances released on its property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of an underlying property becomes liable for removal costs, the ability of the owner to make debt payments may be reduced, which in turn may adversely affect the value of the relevant mortgage-related assets held by us.
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Insurance on the properties underlying our loans may not adequately cover all losses and uninsured losses could materially and adversely affect us.
Generally, our borrowers will be responsible for the costs of insurance coverage for the properties we lease, including for casualty, liability, fire, floods, earthquakes, extended coverage and rental or business interruption loss. However, there are certain risks, such as losses from terrorism, that are not generally insured against, or that are not generally fully insured against, because it is not deemed economically feasible or prudent to do so. In addition, changes in the cost or availability of insurance could expose us to uninsured casualty losses. Under certain circumstances insurance proceeds may not be sufficient to restore our economic position with respect to an affected property, and we could be materially and adversely affected. Furthermore, we do not have any insurance designated to limit any losses that we may incur as a result of known or unknown environmental conditions which are not caused by an insured event.
In addition, certain of the properties underlying our loans may be located in areas that are more susceptible to, and could be significantly affected by, natural disasters that could cause significant damage to the properties. If we or our borrowers experience a loss, due to such natural disasters or other relevant factors, that is uninsured or that exceeds policy limits, we could incur significant costs, which could have a material adverse effect on our results of operations, financial condition and cash flows.
Maintenance of our 1940 Act exclusion imposes limits on our operations.
We are not registered as an investment company under the 1940 Act. If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the 1940 Act that impose, among other things:
•limitations on our capital structure and the use of leverage;
•restrictions on specified investments;
•prohibitions on transactions with affiliates; and
•compliance with reporting, record keeping, and other rules and regulations that would significantly change our operations.
We conduct our operations so that neither we nor our subsidiaries are required to register as an investment company under the 1940 Act. Section 3(a) (1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of such issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. The value of the “investment securities” held by an issuer must be less than 40% of the value of such issuer’s total assets on an unconsolidated basis (exclusive of U.S. government securities and cash items). In addition, we conduct our operations so that neither we nor our subsidiaries will be considered an investment company under Section 3(a)(1)(A) of the 1940 Act, as neither we nor our subsidiaries are engaged primarily nor do we hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, we are primarily engaged in the non-investment company businesses of our subsidiaries.
We and certain of our subsidiaries may from time to time rely primarily on the exclusion from the definition of an investment company under Section 3(c)(5)(C) of the 1940 Act, or any other exclusions that may be available to us (other than the exclusions under Section 3(c)(1) or Section 3(c)(7)). Section 3(c)(5)(C) of the 1940 Act is available for entities primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. This exclusion generally requires that at least 55% of our portfolio must be comprised of “qualifying real estate” assets and at least 80% of our portfolio must be comprised of “qualifying real estate” assets and “real estate-related” assets (and no more than 20% comprised of miscellaneous assets). For purposes of the Section 3(c)(5)(C) exclusion, we classify our investments based in large measure on no-action letters issued by the staff of the SEC, and other SEC interpretive guidance and, in the absence of SEC guidance, on our view of what constitutes a “qualifying real estate” asset and a “real estate-related” asset. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we
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may face, and a number of these no-action letters were issued more than 20 years ago. Pursuant to this guidance, and depending on the characteristics of the specific investments, certain mortgage loans, participations in mortgage loans, mortgage-backed securities, mezzanine loans, joint venture investments, preferred equity and the equity securities of other entities may not constitute qualifying real estate assets and therefore our investments in these types of assets may be limited. No assurance can be given that the SEC or its staff will concur with our classification of the assets we hold for purposes of the 3(c)(5)(C) exclusion or any other exclusion or exemption under the 1940 Act. Future revisions to the 1940 Act or further guidance from the SEC or its staff may cause us to lose our exclusion from registration or force us to re-evaluate our portfolio and investment strategy. Such changes may prevent us from operating our business successfully.
In order to maintain an exclusion from registration under the 1940 Act, we may be unable to sell assets that we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income or loss generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire assets that we would otherwise want to acquire and would be important to our strategy.
Although we monitor our portfolio periodically and prior to each acquisition and disposition, we may not be able to maintain an exclusion from registration as an investment company. If we were required to register as an investment company, but failed to do so, we would be prohibited from engaging in our business, and legal proceedings could be instituted against us. In addition, our contracts may be unenforceable, and a court could appoint a receiver to take control of us and liquidate our business, all of which could have a material adverse effect on our results of operations, financial condition and cash flows.
Risks Related to Our Management and Our Relationship With Our Manager
We rely entirely on the management team and employees of our Manager for our day-to-day operations.
We have no employees and do not intend to have employees in the future. We rely entirely on the management team and employees of our Manager for our day-to-day operations, and our Manager has significant discretion as to the implementation of our operating policies and strategies. Our success depends substantially on the efforts and abilities of the management team of our Manager, including Messrs. Uppal, Pinkus and Cooperman, Ms. Schwarzschild and our Manager’s investment professionals. The loss of any of such individuals could have a material adverse effect on our results of operations, financial condition and cash flows
We face certain conflicts of interest with respect to our operations and our relationship with our Manager and its affiliates.
We are subject to conflicts of interest arising out of our relationship with our Manager. We may enter into additional transactions with our Manager, its affiliates, or entities managed by our Manager or its affiliates. In particular, we may invest in, or acquire, certain of our investments through joint ventures or co-investments with other affiliates or purchase assets from, sell assets to or arrange financing from or provide financing to other affiliates, or engage in other transactions with entities managed by our Manger or its affiliates. Future joint venture investments could be adversely affected by our lack of sole decision-making
authority, our reliance on our Manager’s and its affiliates’ financial condition and liquidity, and disputes between us and our Manager or its affiliates. There can be no assurance that any procedural protections will be sufficient to assure that these transactions will be made on terms that will be at least as favorable to us as those that would have been obtained in an arm’s-length transaction.
In addition, we will rely on our Manager for our day-to-day operations. Under the Management Agreement, our Manager has and will have a contractual, as opposed to a fiduciary, relationship with us that limits its obligations to us to those specifically set forth in the Management Agreement. Our Manager may be subject to conflicts of interest in making investment decisions on assets on our behalf as opposed to other entities that have similar investment objectives. Our Manager may have different incentives in determining when to sell assets with respect to which it is entitled to fees and compensation and such determinations may not be in our best interest.
Our Manager and its affiliates serve as manager of certain other funds and investment vehicles, all of which have investment objectives that overlap with ours. In addition, future programs may be sponsored by our Manager and its affiliates. As a result, our Manager and its affiliates may face conflicts of interest arising from potential competition with other programs for investors and investment opportunities. There may be periods during which one or more programs managed by our Manager or its affiliates will be raising capital and which might compete with us for investment capital. Such conflicts may not be resolved in our favor and our investors will not have the opportunity to evaluate the manner in which these conflicts of interest are resolved before or after making their investment.
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Our officers and the officers of our Manager are also officers of other affiliates of our Manager; therefore, our officers and the officers of our Manager will face competing demands based on the allocation of investment opportunities between us and our affiliates.
We rely on our officers and the officers of our Manager, including Messrs. Uppal, Pinkus and Cooperman, Ms. Schwarzschild and the other investment professionals of our Manager to identify suitable investments. Certain other companies managed by our Manager or its affiliates also rely on many of these same professionals. These funds have similar investment objectives as we do. Many investment opportunities that are suitable for us may also be suitable for other affiliates advised by our Manager.
When our officers or the officers of our Manager identify an investment opportunity that may be suitable for us as well as an affiliated entity, they, in their sole discretion, will first evaluate the investment objectives of each program to determine if the opportunity is suitable for each program. If the proposed investment is appropriate for more than one program, our Manager will then evaluate the portfolio of each program, in terms of diversity of geography, underlying property type, tenant concentration and borrower, to determine if the investment is most suitable for one program in order to create portfolio diversification. If such analysis is not determinative, our Manager will allocate the investment to the program with uncommitted funds available for the longest period or, to the extent feasible, prorate the investment between the programs in accordance with uninvested funds. As a result, our officers or the officers of our Manager could direct attractive investment opportunities to other affiliated entities or investors. Such events could result in our acquiring investments that provide less attractive returns, which would have a material adverse effect on our results of operations, financial condition and cash flows.
Our Manager, our officers and the investment professionals assembled by our Manager will face competing demands relating to their time and this may cause our operations and our investors’ investments to suffer.
We will rely on our Manager, its officers and on the investment professionals that our Manager retains to provide services to us for the day-to-day operation of our business. Messrs. Uppal, Pinkus and Cooperman and Ms. Schwarzschild are executive officers of our Manager as well as certain other funds managed by our Manager or its affiliates. As a result of their interests in other programs, their obligations to other investors and the fact that they engage in and will continue to engage in other business activities on behalf of themselves and others, Messrs. Uppal, Pinkus and Cooperman and Ms. Schwarzschild face conflicts of interest in allocating their time between us and other Terra Capital Partners-sponsored programs and other business activities in which they are involved. Should our Manager devote insufficient time or resources to our business, our returns on our direct or indirect investments, may decline, which in turn could have a material adverse effect on our results of operations, financial condition and cash flows.
The compensation that our Manager receives was not determined on an arm’s-length basis and therefore may not be on the same terms as we could achieve from a third-party.
Our Manager’s compensation for services it provides to us was not determined on an arm’s-length basis. We cannot assure you that a third-party unaffiliated with us would not be able to provide such services to us at a lower price.
The base management fees we pay our Manager may reduce its incentive to devote its time and effort to seeking attractive assets for our portfolio because the fees are payable regardless of our performance.
We pay our Manager base management fees regardless of the performance of our portfolio. Our Manager’s entitlement to the base management fee, which is not based upon performance metrics or goals, might reduce its incentive to devote its time and effort to seeking assets that provide attractive risk-adjusted returns for our portfolio. We would be required to pay the Manager the base management fee in a particular period even if we experienced a net loss or a decline in the value of our portfolio during that period.
We cannot predict the amounts of compensation to be paid to the Manager.
Because the fees that we pay to our Manager are based in part on the level of our business activity, it is not possible to predict the amounts of compensation that we will be required to pay our Manager. In addition, we have entered into a cost sharing and reimbursement agreement with Terra LLC, effective October 1, 2022, pursuant to which Terra LLC will be responsible for its allocable share of our expenses, including fees paid by us to our Manager. Because key employees of our Manager are given broad discretion to determine when to consummate a transaction, we will rely on these key persons to dictate the level of our business activity. Fees paid to our Manager reduce funds available for payment of distributions to our stockholders and principal and interest payments on our outstanding indebtedness. Because we cannot predict the amount of fees due our Manager, we cannot predict how precisely such fees will impact such payments.
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If our Manager causes us to enter into a transaction with an affiliate, our Manager may face conflicts of interest that would not exist if such transaction had been negotiated at arm’s-length with an independent party.
Our Manager may face conflicts of interests if we enter into transactions with affiliates of our Manager, or entities managed by our Manager or its affiliates. In these circumstances, the persons who serve as our Manager’s management team may have a fiduciary responsibility to both us and the affiliate. Transactions between us and our Manager’s affiliates, including entities managed by our Manager or its affiliates, will not have the benefit of arm’s-length negotiation of the type normally conducted between unrelated parties. This conflict of interest may cause our Manager to sacrifice our best interests in favor of its affiliate or the entity it or its affiliates manages, thereby causing us to enter into a transaction that is not in our best interest and that may negatively impact our performance.
Our Manager and its affiliates have limited prior experience operating a REIT and therefore may have difficulty in successfully and profitably operating our business or complying with regulatory requirements, including REIT provisions of the Code, which may hinder their ability to achieve our objectives or result in loss of our qualification as a REIT.
Prior to the completion of the REIT Formation Transaction, our Manager and its affiliates had no experience operating a REIT or complying with regulatory requirements, including the REIT provisions of the Code. The REIT rules and regulations are highly technical and complex, and the failure to comply with the income, asset, and other limitations imposed by these rules and regulations could prevent us from qualifying as a REIT or could force us to pay unexpected taxes and penalties. Our Manager and its affiliates have limited experience operating a business in compliance with the numerous technical restrictions and limitations set forth in the Code applicable to REITs or the 1940 Act. We cannot assure you that our Manager or our management team will perform on our behalf as they have in their previous endeavors. The inexperience of our Manager and its affiliates described above may hinder our Manager’s ability to achieve our objectives or result in loss of our qualification as a REIT or payment of taxes and penalties. As a result, we cannot assure you that we have been able to or will continue to be able to successfully operate as a REIT, execute our business strategies or comply with regulatory requirements applicable to REITs.
Risks Related to Financing and Hedging
Our Board may change our leverage policy and or investment strategy and guidelines, asset allocation and financing strategy without stockholder consent.
We currently have outstanding indebtedness and expect to deploy moderate amounts of additional leverage as part of our operating strategy. Our governing documents contain no limit on the amount of debt we may incur, and, subject to compliance with financial covenants under our borrowings, including under the term loan, the unsecured notes, the repurchase agreement and the revolving line of credit, we may significantly increase the amount of leverage we utilize at any time without approval of our stockholders. Depending on market conditions, additional borrowings may include credit facilities, senior notes (including both a reopening of the unsecured notes or the issuance of a new series), repurchase agreements, additional first mortgage loans and securitizations. In addition, we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business. To the extent that we use leverage to finance our assets, we would expect to have a larger portfolio of loan assets, but our financing costs relating to our borrowings will reduce our net income. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy such obligations. Any reduction in our ability to make principal and interest payments on our debt obligations, including the term loan, the unsecured notes and the revolving line of credit, may have a material adverse effect on our results of operations, financial condition and cash flows.
Our Manager is authorized to follow broad investment guidelines that have been approved by our Board. Those investment guidelines, as well as our target assets, investment strategy, financing strategy and hedging policies with respect to investments, originations, acquisitions, growth, operations, indebtedness, capitalization and distributions, may be changed at any time without notice to, or the consent of, our investors. We may make strategic non-real estate-related investments that align with our investment objectives and criteria. This could result in a portfolio with a different risk profile. A change in our investment strategy may increase our exposure to risks applicable to other industries. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from those described herein. These changes could have a material adverse effect on our results of operations, financial condition and cash flows.
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We may pursue and not be able to successfully complete securitization transactions, which could limit potential future sources of financing and could inhibit the growth of our business.
We may use additional credit facilities, senior notes (including both a reopening of the unsecured notes or the issuance of a new series), term loans, repurchase agreements, first mortgage loans or other borrowings to finance the origination and/or structuring of real estate-related loans until a sufficient quantity of eligible assets has been accumulated, at which time we may decide to refinance these short-term facilities or repurchase agreements through the securitization market which could include the creation of CMBS, collateralized debt obligations (“CDOs”), or the private placement of loan participations or other long-term financing. If we employ this strategy, we are subject to the risk that we would not be able to obtain, during the period that our short-term financing arrangements are available, a sufficient amount of eligible assets to maximize the efficiency of a CMBS, CDO or private placement issuance. We are also subject to the risk that we are not able to obtain short-term financing arrangements or are not able to renew any short-term financing arrangements after they expire should we find it necessary to extend such short-term financing arrangements to allow more time to obtain the necessary eligible assets for a long-term financing.
The inability to consummate securitizations of our portfolio to finance our real estate-related loans on a long-term basis could require us to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price, which could have a material adverse effect on our results of operations, financial condition and cash flows.
We may be required to repurchase loans or indemnify investors if we breach representations and warranties, which could harm our earnings.
We may, on occasion, consistent with our qualification as a REIT and our desire to avoid being subject to the “prohibited transaction” penalty tax, sell some of our loans in the secondary market or as a part of a securitization of a portfolio of our loans. If we sell loans, we would be required to make customary representations and warranties about such loans to the loan purchaser. Our loan sale agreements may require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a loan. Likewise, we may be required to repurchase or substitute loans if we breach a representation or warranty in connection with our securitizations, if any.
The remedies available to a purchaser of loans are generally broader than those available to us against the originating broker or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have against the sellers. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if at all. They are also typically sold at a significant discount to the unpaid principal balance (“UPB”). Significant repurchase activity could have a material adverse effect on our results of operations, financial condition and cash flows.
Covenants in our debt agreements may restrict our operating activities and adversely affect our financial condition, operating results and cash flows.
Our debt agreements contain various financial and operating covenants, including, among other things, certain coverage ratios and limitations on our ability to incur secured and unsecured debt. These restrictive covenants and operating restrictions could have a material adverse effect on our operating results, cause us to lose our REIT status, restrict our ability to finance or securitize new originations and acquisitions, force us to liquidate collateral and negatively affect our financial condition and our ability to pay dividends. We have received waivers of certain covenants in our debt agreements, but there can be no assurance we will receive similar waivers in the future. For additional information concerning these waivers, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial Condition, Liquidity and Capital Resources — Summary of Financing” included in this Annual Report on Form 10-K. The breach of any of these covenants, if not cured within any applicable cure period, could result in a default, including a cross-default, and acceleration of certain of our indebtedness. Accelerating repayment and terminating the agreements will require immediate repayment by us of the borrowed funds, which may require us to liquidate assets at a disadvantageous time, causing us to incur further losses and adversely affecting our results of operations and financial condition, which may impair our ability to make principal and interest payments on our debt obligations. Any failure to make payments when due or upon acceleration could result in the foreclosure upon our assets by our lenders.
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Our inability to access funding could have a material adverse effect on our results of operations, financial condition and cash flows. We may rely on short-term financing and thus are especially exposed to changes in the availability of financing.
We currently have outstanding indebtedness and expect to use additional borrowings, such as first mortgage financings, credit facilities, senior notes, term loans and repurchase agreements, and other financings, as part of our operating strategy. Our use of financings exposes us to the risk that our lenders may respond to market conditions by making it more difficult for us to renew or replace on a continuous basis our maturing short-term borrowings. If we are not able to renew our then existing short-term facilities or arrange for new financing on terms acceptable to us, or if we default on our covenants or are otherwise unable to access funds under these types of financing, we may have to curtail our asset origination activities and/or dispose of assets.
It is possible that the lenders that provide us with financing could experience changes in their ability to advance funds to us, independent of our performance or the performance of our portfolio of assets. Further, if many of our potential lenders are unwilling or unable to provide us with financing, we could be forced to sell our assets at an inopportune time when prices are depressed. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability. Moreover, the amount of financing we receive under our short-term borrowing arrangements will be directly related to the lenders’ valuation of our targeted assets that cover the outstanding borrowings.
This could increase our financing costs and reduce our access to liquidity, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
An increase in our borrowing costs relative to the interest we receive on our leveraged assets may have a material adverse effect on our results of operations, financial condition and cash flows.
As our financings mature, we will be required either to enter into new borrowings or to sell certain of our assets. An increase in short-term interest rates at the time that we seek to enter into new borrowings would reduce the spread between the returns on our assets and the cost of our borrowings. This would adversely affect the returns on our assets, which would reduce our net income and, in turn, have a material adverse effect on our results of operations, financial condition and cash flows.
We may enter into hedging transactions that could expose us to contingent liabilities in the future and adversely impact our financial condition.
Subject to maintaining our qualification as a REIT, part of our strategy may involve entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of a hedging instrument caused by an event of default or other early termination event). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges, and these economic losses will be reflected in our results of operations. We may also be required to provide margin to our counterparties to collateralize our obligations under hedging agreements. Our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. The need to fund these obligations could have a material adverse effect on our results of operations, financial condition and cash flows.
If we attempt to qualify for fair value hedge accounting treatment for any derivative instruments, but we fail to so qualify, we may suffer because losses on the derivatives that we enter into may not be offset by a change in the fair value of the related hedged transaction.
If we attempt to qualify for hedge accounting treatment for any derivative instruments, but we fail to so qualify for a number of reasons, including if we use instruments that do not meet the definition of a derivative (such as short sales), if we fail to satisfy hedge documentation and hedge effectiveness assessment requirements, or if our instruments are not highly effective, we may suffer because losses on any derivatives we hold which may not be offset by a change in the fair value of the related hedged transaction.
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Risks Related to Our Organization and Structure
Our rights to take action against our directors and officers are limited.
Our charter limits the liability of our present and former directors and officers to us for money damages to the maximum extent permitted under Maryland law. Under Maryland law, our present and former directors and officers will not have any liability to us for money damages other than liability resulting from:
•actual receipt of an improper benefit or profit in money, property or services; or
•active and deliberate dishonesty by the director or officer that was established by a final judgment and was material to the cause of action adjudicated.
Our charter authorizes us to indemnify our directors and officers for actions taken by them in those and other capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each present and former director or officer, and each person who served any predecessor of our company, including the Terra Funds, in a similar capacity, to the maximum extent permitted by Maryland law, in connection with the defense of any proceeding to which he or she is made, or threatened to be made, a party or a witness by reason of his or her service to us or such predecessor. In addition, we may be obligated to pay or reimburse the expenses incurred by such persons in any such proceedings without requiring a preliminary determination of their ultimate entitlement to indemnification.
Rapid changes in the values of our assets may make it more difficult for us to maintain our qualification as a REIT or our exclusion from the 1940 Act.
If the fair market value or income potential of our assets declines as a result of increased interest rates, prepayment rates, general market conditions, government actions or other factors, we may need to increase our real estate assets and income or liquidate our non-qualifying assets to maintain our REIT qualification or our exclusion from the 1940 Act. If the decline in real estate asset values or income occurs quickly, this may be especially difficult to accomplish. We may have to make decisions that we otherwise would not make absent the REIT and 1940 Act considerations.
Our ownership limitations may restrict our change of control or business combination opportunities.
In order for us to qualify as a REIT under the Code, shares of our stock must be owned by 100 or more persons during at least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been made) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares of our stock may be owned, directly or constructively, by five or fewer individuals (as defined in the Code to include certain entities) during the last half of a taxable year (other than the first year for which an election to be a REIT has been made). To assist us in preserving our REIT qualification, among other purposes, our charter generally prohibits any person from directly or indirectly owning more than 9.8% by value or number of shares, whichever is more restrictive, of the outstanding shares of our common stock, the outstanding shares of any class or series of our preferred stock or the aggregate outstanding shares of all classes and series of our capital stock. These ownership limits could have the effect of discouraging a takeover or other transaction.
Risks Related to Our Qualification as a REIT
Our failure to qualify or remain qualified as a REIT would subject us to U.S. federal income tax and applicable state and local taxes, which could have a material adverse effect on our results of operations, financial condition and cash flows.
We believe that we have been organized and operated in a manner that has enabled us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2016, and we intend to continue to operate in a manner that will allow us to continue to so qualify. So long as we qualify as a REIT, we generally are not subject to U.S. federal income tax on our net taxable income to the extent that we annually distribute all of our net taxable income (determined without regard to our net capital gain and the dividends paid deduction) to our stockholders. We have not requested, and do not intend to request, a ruling from the IRS that we qualify as a REIT. The U.S. federal income tax laws governing REITs are complex, and judicial and administrative interpretations of the U.S. federal income tax laws governing REIT qualification are limited.
To qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding shares and the amount of our distributions. Our compliance with the annual income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our
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income and assets on an ongoing basis. Our ability to satisfy these asset tests depends upon our analysis of the characterization of our assets for U.S. federal income tax purposes and fair market values of our assets. The fair market values of certain of our assets are not susceptible to a precise determination, and we will generally not obtain independent appraisals of such assets. Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it difficult or impossible for us to qualify as a REIT. Thus, while we believe that we have been organized and operated and intend to continue to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations and the possibility of future changes in our circumstances, no assurance can be given that we have qualified or will qualify as a REIT for any particular year.
If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief, we would be required to pay U.S. federal income tax, including applicable state and local taxes, on our taxable income at regular corporate rates, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money, sell assets, or reduce or even cease making principal and interest payments on our outstanding indebtedness in order to pay our taxes. Our payment of income tax would significantly reduce the amount of operating cash flow available for principal and interest payments on our indebtedness and distributions to our stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to be taxed as a REIT until the fifth calendar year following the year in which we failed to qualify.
REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or sell assets to make such distributions.
In order to qualify as a REIT, we must distribute dividends to our stockholders, each calendar year, equal to at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax laws. We intend to distribute our taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax.
Differences in timing between our recognition of taxable income and the actual receipt of cash may occur. For example, we may be required to accrue income from mortgage loans before we receive any payments of interest or principal on such assets. We generally are required to recognize certain amounts in income no later than the time such amounts are reflected on our financial statements. The application of this rule may require the accrual of income with respect to our loans earlier than would be the case under the otherwise applicable tax rules. Also, in certain circumstances, our ability to deduct interest expenses for U.S. federal income tax purposes may be limited. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In particular, where we experience differences in timing between the recognition of taxable income and the actual receipt of cash, the requirement to distribute a substantial portion of our taxable income could cause us to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash or (v) use cash reserves, in order to comply with the REIT distribution requirements and to avoid U.S. federal corporate income tax and the 4% nondeductible excise tax. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could have a material adverse effect on our results of operations, financial condition and cash flows.
Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from certain activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. In addition, we could, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Code to maintain our qualification as a REIT. Any of these taxes would reduce cash available for principal and interest payments on our outstanding indebtedness or distributions to our stockholders. In addition, we will be subject to a 100% tax on gains derived from the disposition of dealer property or inventory. In order to meet the REIT qualification requirements, we may hold some of our assets or engage in certain activities that would otherwise be nonqualifying for REIT purposes through a TRS or other subsidiary corporation that will be subject to corporate-level income tax at regular rates. In addition, although the BDC Merger was intended to be treated as a “reorganization” within the meaning
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of Section 368(a) of the Code for U.S. federal income tax purposes, if the BDC Merger is determined not to have qualified as a reorganization, or if Terra BDC is determined to have failed to qualify as a REIT, we could be subject to additional tax liabilities. In addition, we would inherit any liability with respect to unpaid taxes of Terra BDC for any periods prior to the BDC Merger for which Terra BDC did not qualify as a REIT. Any resulting taxes would decrease the cash available for distributions to our stockholders.
Complying with the REIT requirements may force us to liquidate or forego otherwise attractive investments.
In order to qualify as a REIT, we annually must satisfy two gross income requirements. First, at least 75% of our gross income for each taxable year, excluding gross income from prohibited transactions and certain hedging and foreign currency transactions, must be derived from investments relating to real property or mortgages on real property, including interest income derived from mortgage loans secured by real property (including certain types of qualified mezzanine loans and mortgage-backed securities), “rents from real property,” dividends received from and gain from the disposition of shares of other REITs, and gains from the sale of real estate assets, as well as income from certain kinds of qualified temporary investments. Second, at least 95% of our gross income in each taxable year, excluding gross income from prohibited transactions and certain hedging and foreign currency transactions, must be derived from some combination of income that qualifies under the 75% gross income test described above, as well as other dividends, interest, and gain from the sale or disposition of stock or securities, which need not have any relation to real property. We may receive various fees in connection with our operations. The fees generally will be qualifying income for purposes of both the 75% and 95% gross income tests if they are received in consideration for entering into an agreement to make a loan secured by real property and the fees are not determined by income or profits. In addition, we also treat any origination fees we receive as a reduction in the principal balance of our loans, which we accrue over the life of the relevant loan under the original issue discount rules, discussed below. We treat any exit fees and other fees representing charges for the use or forbearance of money as additional interest. Other fees which are considered compensation for services are not qualifying income for purposes of either the 75% or 95% gross income test.
Further, at the end of each calendar quarter, at least 75% of the value of our total assets must consist of cash, cash items, government securities, shares in other REITs and other qualifying real estate assets, including certain mortgage loans, mezzanine loans and certain mortgage-backed securities. The remainder of our investment in securities (other than government securities, TRS securities and securities that are qualifying real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, TRS securities and securities that are qualifying real estate assets) can consist of the securities of any one issuer, no more than 20% of the value of our total assets can be represented by securities of one or more TRSs, and no more than 25% of the value of our assets can consist of debt instruments issued by publicly offered REITs that are not otherwise secured by real property. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.
As a result, we may be required to liquidate from our portfolio, or contribute to a TRS, otherwise attractive investments, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make, and, in certain cases, maintain ownership of certain attractive investments. These actions could have the effect of reducing our income, which could have a material adverse effect on our results of operations, financial condition and cash flows.
Our preferred equity and mezzanine loan investments may fail to qualify as real estate assets for purposes of the REIT gross income and asset tests, which could jeopardize our ability to qualify as a REIT.
The IRS has issued Revenue Procedure 2003-65, which provides a safe harbor pursuant to which a mezzanine loan that is secured by interests in a partnership or other pass-through entity will be treated by the IRS as a real estate asset for purposes of the assets tests, and interest derived from such a loan will be treated as qualifying mortgage interest for purposes of the 75% and 95% gross income tests. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We own, and may acquire in the future, certain mezzanine loans and preferred equity investments (which we treat as mezzanine loans for U.S. federal income tax purposes) that do not satisfy all of the requirements for reliance on the safe harbor set forth in the Revenue Procedure. Consequently, there can be no assurance that the IRS will not successfully challenge the tax treatment of such mezzanine loans or preferred equity investments as qualifying real estate assets. To the extent that such mezzanine loans or preferred equity investments do not qualify as real estate assets, the interest income from such mezzanine loans or preferred equity investments would be qualifying income for the 95% gross income test, but not
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for the 75% gross income test, and such mezzanine loans or preferred equity investments would not be qualifying assets for the 75% asset test and would be subject to the 5% and 10% asset tests, which could jeopardize our ability to qualify as a REIT.
The IRS may successfully challenge the treatment of our preferred equity and mezzanine loan investments as debt for U.S. federal income tax purposes.
We invest in certain real estate-related investments, including mezzanine loans, first mortgage loans, and preferred equity investments. There is limited case law and administrative guidance addressing whether certain preferred equity investments or mezzanine loans will be treated as equity or debt for U.S. federal income tax purposes. Our Manager received an opinion of prior tax counsel regarding the treatment of one of our fixed return preferred equity investments and future similarly structured investments as debt for U.S. federal income tax purposes. We treat preferred equity investments which we currently hold as debt for U.S. federal income tax purposes and as mezzanine loans that qualify as real estate assets, as discussed above. No private letter rulings have been obtained on the characterization of these investments for U.S. federal income tax purposes and an opinion of counsel is not binding on the IRS; therefore, no assurance can be given that the IRS will not successfully challenge the treatment of such preferred equity investments as debt and as qualifying real estate assets. If a preferred equity investment or mezzanine loan owned by us was treated as equity for U.S. federal income tax purposes, we would be treated as owning a proportionate share of the assets and earning a proportionate share of the gross income of the partnership or limited liability company that issued the preferred equity interest. Certain of these partnerships and limited liability companies are engaged in activities that could cause us to be considered as earning significant nonqualifying income, which would likely cause us to fail to qualify as a REIT or pay a significant penalty tax to maintain our REIT qualification.
The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to qualify as a REIT.
We have entered into, and may in the future enter into additional, financing arrangements that are structured as sale and repurchase agreements pursuant to which we nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase such assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that we will be treated for REIT asset and gross income test purposes as the owner of the assets that are the subject of such sale and repurchase agreements notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we are not the owner of the assets during the term of the sale and repurchase agreement, in which case we could fail to qualify as a REIT.
We may be required to report taxable income from certain investments in excess of the economic income we ultimately realize from them.
We may acquire or originate loans that will be treated as having “original issue discount” for U.S. federal income tax purposes because interest on such securities will not be payable currently, but rather will be added to the outstanding loan balance as it accrues. We will be required to accrue such interest income based on a constant yield method notwithstanding the fact that such interest income is not yet payable, and we will therefore be taxed based on the assumption that all future projected interest payments due on such securities will be made. If such securities turn out not to be fully collectible, an offsetting loss deduction will become available only in the later year that uncollectability is provable. While we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income in that later year or thereafter.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate and currency risks will generally be excluded from gross income for purposes of the 75% and 95% gross income tests if (i) the instrument (A) hedges interest rate risk or foreign currency exposure on liabilities used to carry or acquire real estate assets, (B) hedges risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the 75% or 95% gross income tests or (C) hedges an instrument described in clause (A) or (B) for a period following the extinguishment of the liability or the disposition of the asset that was previously hedged by the hedged instrument, and (ii) such instrument is properly identified under the applicable Treasury Regulations.
As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement those hedges through a TRS. This could increase the cost of our hedging activities because a TRS would be subject to corporate tax on its income. Moreover, the limits on our use of hedging techniques could expose us to greater risks associated
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with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS would generally not provide any tax benefit to us since such losses may not be used to offset our taxable income, although such losses may be carried forward to offset future taxable income of the TRS.
The tax on prohibited transactions will limit our ability to engage in transactions, including sales of participation interests in loans and securitizations, that would be treated as sales of dealer property for U.S. federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including loans, held as inventory or primarily for sale to customers in the ordinary course of business. We occasionally sell participation interests in loans which we have originated; however, we do not expect to engage in a significant number of such sales or that such sales will generate significant gains, if any. To the extent that we were to sell loans or participations therein in a manner that we believe could expose us to the prohibited transaction tax, we intend to conduct such activities through a TRS. In addition, we may decide to pursue securitization transactions to finance our real estate-related loans. To the extent that the securitization transactions were structured in a manner that we believe could expose us to the prohibited transactions tax, we intend to conduct such activities through a TRS.
A failure to comply with the limits on our ownership of and relationship with our TRSs, if any, would jeopardize our REIT qualification and may result in the application of a 100% excise tax.
Although our use of TRSs may be able to partially mitigate the impact of meeting the requirements necessary to maintain our qualification as a REIT, our ownership of and relationship with any TRSs is subject to limitations, and a failure to comply with the limits would jeopardize our REIT qualification and our transactions with such TRSs may result in the application of a 100% excise tax if such transactions are not conducted on arm’s-length terms.
A REIT may own up to 100% of the stock of one or more TRSs. Subject to certain exceptions, a TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. Both the subsidiary corporation and the REIT must jointly elect to treat the subsidiary corporation as a TRS. Any TRS that we form will pay U.S. federal, state and local income tax on its taxable income, and its after-tax net income will be available for distribution to us but is not required to be distributed to us.
Overall, no more than 20% of the value of a REIT’s total assets may consist of stock or securities of one or more TRSs. We intend to limit the aggregate value of the stock and securities of our TRSs, if any, to less than 20% of the value of our total assets (including such TRS stock and securities). Furthermore, we will monitor the value of our respective investments in our TRSs for the purpose of ensuring compliance with TRS ownership limitations.
In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis. To the extent we form a TRS, we will scrutinize all of our transactions with such TRS to ensure that they are entered into on arm’s length terms to avoid incurring the 100% excise tax.
We may engage in transactions with a TRS, in which case we intend to conduct our affairs so that we will not be subject to the 100% excise tax with respect to transactions with such TRS and so that we will comply with all other requirements applicable to our ownership of TRSs. There can be no assurance, however, that we will be able to comply with the 20% limitation discussed above or to avoid application of the 100% excise tax discussed above.
Legislative, regulatory or administrative changes could adversely affect us.
The U.S. federal income tax laws and regulations governing REITs and their investors, as well as the administrative interpretations of those laws and regulations, are constantly under review and may be changed at any time, possibly with retroactive effect. No assurance can be given as to whether, when, or in what form, the U.S. federal income tax laws applicable to us and our investors may be enacted. Changes to the U.S. federal income tax laws and interpretations of U.S. federal income tax laws could adversely affect an investment in us.
Prospective investors are urged to consult with their tax advisors regarding the potential effects of legislative, regulatory or administrative developments on an investment in our company.
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Your investment has various U.S. federal income tax risks.
An investment in us involves complex U.S. federal, state and local income tax considerations that will differ for each investor. Prospective investors should consult with their tax advisors regarding the U.S. federal, state, local and foreign income and other tax consequences applicable to an investment in us.
General Risk Factors
COVID-19, or the future outbreak of other highly infectious or contagious diseases, could materially and adversely impact or disrupt our investments, business, financial condition and results of operations.
As a result of a significant portion of our investments being in preferred equity, mezzanine loans and first mortgages secured by office, multifamily and hospitality properties located in the United States, any future local, regional, national or international outbreak of a contagious disease, including COVID-19 and its variants or any other similar diseases, will impact our investments and operating results to the extent that it reduces occupancy, increases the cost of operation or results in limited hours or necessitates the closure of such properties. The borrowers under the first mortgages, mezzanine loans or preferred equity in which we invest may fail to make timely and required payments under the terms of such instruments. In addition, quarantines, states of emergencies and other measures taken to curb the spread of any such future outbreak may negatively impact the ability of such properties to continue to obtain necessary goods and services or provide adequate staffing, which may also adversely affect our investments, business, financial condition and results of operations.
Future recessions, downturns, disruptions or instability could have a materially adverse effect on our results of operations, financial condition and cash flows.
From time to time, the global capital markets may experience periods of disruption and instability, which could cause disruptions in liquidity in the debt capital markets, significant write-offs in the financial services sector, the re-pricing of credit risk in the broadly syndicated credit market and the failure of major financial institutions. Despite actions of U.S. and foreign governments, these events could contribute to worsening general economic conditions that materially and adversely impact the broader financial and credit markets and reduce the availability of debt and equity capital for the market as a whole and financial services firms in particular.
Deterioration of economic and market conditions in the future could negatively impact credit spreads as well as our ability to obtain financing, particularly from the debt markets, which in turn may have a material adverse effect on our results of operations, financial condition and cash flows.
Disruptions in the financial and banking sectors may adversely impact our access to capital and our cost of borrowing, which could adversely affect us, our business or our results of operations.
Disruptions and uncertainty in the financial and banking sectors, including due to recent regional bank failures and decreased consumer confidence in the banking system, may hinder our ability to access capital on reasonable terms or at all. The U.S. and global financial and banking sectors have experienced periods of increased turmoil and volatility in the recent past and may experience similar periods of disruption in the future due to factors beyond our control. Such periods of increased turmoil and volatility may adversely impact liquidity in the financial markets and make financings less attractive or, in some cases, unavailable. If our financing counterparties become capital constrained, tighten their lending standards or become insolvent, they may be unable or unwilling to fulfill their commitments to us. A material disruption to the banking system and financial markets could result in liquidity issues across the sector, which could adversely impact our access to capital and our cost of borrowing and adversely affect us, our business or our results of operations.
Continued concerns over U.S. fiscal and political policy could, among other things, lead to future downgrades of the U.S. government’s sovereign credit rating and contribute to a U.S. economic slowdown, which could have a material adverse effect on our business, financial condition and results of operations.
In recent years, financial markets were affected by significant uncertainty relating to the stability of U.S. fiscal and political policy. On August 1, 2023, Fitch Ratings Inc. downgraded the U.S. government’s sovereign credit rating to AA+, down one notch from its highest rating of AAA, citing the country’s growing debt obligations, deterioration in governance and political polarization. Concerns related to political turmoil, federal borrowing and the federal budget deficit have increased the possibility of future credit rating downgrades and economic slowdowns in the U.S. Any continuing uncertainty, together with the continuing U.S. debt and budget deficit concerns, could contribute to a U.S. economic slowdown. The impact of U.S. fiscal
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and political uncertainty is inherently unpredictable and could adversely affect U.S. and global financial markets and economic conditions. These developments could cause interest rates and borrowing costs to rise, which may negatively impact our ability to access the debt markets on favorable terms. Continued adverse economic conditions could have a material adverse effect on our business, financial condition and results of operations.
Cybersecurity risk and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of the security, confidentiality, or integrity of our company, employee, customer or third-party confidential information and/or damage to our reputation or business relationships, any of which could negatively impact our financial results.
Risk of a cyber incident or disruption, particularly through cyber-attacks or cyber intrusions, including by computer hackers, nation-state affiliated actors and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. The result of these incidents may include disrupted operations, misstated or unreliable financial data, misappropriation of assets, liability for stolen assets or information, increased cybersecurity protection and insurance cost, regulatory enforcement, litigation and damage to our relationships and reputation. These risks require continuous and likely increasing attention and other resources from us to, among other actions, identify and quantify these risks, upgrade and expand our technological capabilities, systems and processes to adequately address them. Such attention diverts time and other resources from other activities and there is no assurance that our efforts will be effective. Potential sources for disruption, damage or failure of our information technology systems include, without limitation, computer viruses, cyber incidents, human error, natural disasters and defects in design. In addition, we cannot be certain that our existing cyber insurance coverage will continue to be available on acceptable terms or that our insurers will not deny coverage as to all or part of any future claim or loss.
Additionally, we rely on third-party service providers for many aspects of our business. Notwithstanding our efforts to oversee and mitigate risks associated with our use of third-party service providers, we can provide no assurance that the networks and systems that our third-party vendors have established or use will be effective. As our reliance on technology has increased, so have the risks posed to both our information systems and those provided by third-party service providers. We have implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations or confidential information will not be negatively impacted by such an incident.
Further, the SEC has recently adopted rules requiring public companies to disclose material cybersecurity incidents that they experience on a Current Report on Form 8-K within four business days of determining that a material cybersecurity incident has occurred and to disclose on an annual basis material information regarding their cybersecurity risk management, strategy and governance. These new reporting requirements will become effective for us on June 15, 2024. If we fail to comply with these new requirements, we could incur regulatory fines and our reputation, business, financial condition and results of operations could be harmed.
Returns on our real estate-related loans may be limited by regulations.
Our loan investments may be subject to regulation by federal, state and local authorities and subject to various laws and judicial and administrative decisions. We may determine not to make or invest in real estate-related loans in any jurisdiction in which we believe we have not complied in all material respects with applicable requirements, which reduce the amount of income we would otherwise receive.
Item 1B. Unresolved Staff Comments.
None.
Item 1C. Cybersecurity.
Our management recognizes the importance of implementing and maintaining robust cybersecurity measures designed to address cybersecurity threats that pose risks to our business and operations. Therefore, we have established a comprehensive framework to identify, protect against, detect, respond to, and recover from cybersecurity incidents (“Incidents”). Our cybersecurity measures are designed to provide a structured approach to managing cybersecurity risks for an effective, efficient, an orderly response to any Incident.
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As a critical component of our overall risk management process, we have adopted a framework that shares existing reporting channels and governance processes to identify, assess, manage and report cybersecurity threats on an ongoing basis. This risk management process is led by our Manager’s Chief Compliance Officer and Cyber Security Committee (“CSC”).
Our management, including our Manager’s Chief Compliance Officer and CSC, is authorized to take the appropriate steps deemed necessary to identify, assess, contain, mitigate, and resolve cybersecurity threats including by (a) maintaining (i) an Incident Response Plan in the event of an Incident and (ii) a Cybersecurity Policy which governs information technology security policies, (b) regularly monitoring our systems and user accounts for any suspected Incidents, (c) performing annual audits on certain of our systems, and (d) providing general cybersecurity awareness and data protection training. In addition, depending on the circumstances of an Incident, we may engage third parties such as insurance carriers, outside legal counsel, forensic investigators, crisis communications or public relations firms, investor relations firms and response vendors and we may coordinate with regulators or law enforcement. We also assess third party risks when determining the selection and oversight of applicable third-party service providers.
Increased cybersecurity risk due to the diversification of our data across external service providers and cyber incidents may adversely affect our business by causing a disruption to our operations, compromise our confidential information and/or damage to our business relationships, all of which could negatively impact our financial results. As of the date of this Form 10-K, we are not aware of any risks from cybersecurity threats that have materially affected or are reasonably likely to materially affect us, including our financial position, results of operations and/or business strategy. While we have not, as of the date of this Form 10-K, experienced a cybersecurity threat or incident that resulted in a material adverse impact to our business or operations, there can be no guarantee that we will not experience such an incident in the future where we may be unable to implement effective preventative measures in a timely manner.
Further discussion of the potential impacts on our business from cyber intrusions is provided in “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
Item 2. Properties.
Our administrative and principal executive offices are located at 205 West 28th Street, 12th Floor, New York, New York 10001. We believe that our office facilities are suitable and adequate for our business as it is presently conducted.
Item 3. Legal Proceedings.
We previously owned a multi-tenant office building that is subject to a ground lease. The ground lease provides for a new base rent every 5 years based on the greater of the annual base rent for the prior lease year or 9% of the fair market value of the land. The next rent reset on the ground lease is scheduled for November 1, 2025. We were litigating with the landlord with respect to the appropriate method for determining the fair value of the land for purposes of setting the ground rent. On October 19, 2023, we conveyed our interest in the property to a subsidiary of Centennial Bank by deed-in-lieu of foreclosure. Accordingly, we are no longer a party to the ground lease and have taken the necessary steps to terminate the associated litigation (styled Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217).
Additionally, from time to time, we and individuals employed by us and our Manager may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our borrowers and investees. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that such proceedings will have a material effect upon our financial condition or results of operations.
Item 4. Mine Safety Disclosures.
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
There is no established trading market for our Class B Common Stock. As of March 15, 2024, we had 24,336,033 shares of Class B Common Stock outstanding held by 5,379 investors. As of March 15, 2024, there were no outstanding options, warrants to purchase our common stock or securities convertible into our shares of common stock.
Sales of Unregistered Equity Securities
There were no sales of unregistered equity securities during the year ended December 31, 2023.
Issuer Purchases of Equity Securities
There were no issuer purchases of equity securities during the year ended December 31, 2023.
Item 6. [Reserved].
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information contained in this section should be read in conjunction with our audited consolidated financial statements and related notes thereto and other financial information included elsewhere in this annual report on Form 10-K.
Overview
We are a real estate investment trust that originates, invests in and manages a diverse portfolio of real estate and real estate-related assets. We focus primarily on commercial real estate credit investments, including first mortgage loans, subordinated loans (including B-notes, mezzanine and preferred equity) and credit facilities throughout the United States, which we collectively refer to as our targeted assets. Our loans finance the acquisition, development or recapitalization of high-quality commercial real estate in the United States. We focus on middle market loans in the approximately $10 million to $50 million range, which we believe are subject to less competition, offer higher risk-adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. Our investment objective is to provide attractive risk-adjusted returns to our stockholders, primarily by earning high current income that allows for regular distributions, and, in certain instances, benefiting from potential capital appreciation. There can be no assurances that we will be successful in meeting our investment objective. We may also make strategic real estate equity and non-real estate-related investments that align with our investment objectives and criteria.
As of December 31, 2023, we held a net loan portfolio (gross loans less obligations under participation agreements and secured borrowing) comprised of 21 loans in nine states with an aggregate net principal balance of $509.5 million, a weighted average coupon rate of 12.9% and a weighted average remaining term to maturity of 0.8 years.
Each of our loans was originated by Terra Capital Partners or its affiliates. Our portfolio is diversified based on location of the underlying properties, loan structure and property type. As of December 31, 2023, our portfolio included underlying properties located in 21 markets, across nine states and includes property types such as multifamily housing, student housing, commercial offices, medical offices, mixed-use, industrial and infrastructure properties. The profile of these properties ranges from stabilized and value-added properties to pre-development and construction. Our loans are structured across mezzanine debt, first mortgages, preferred equity investments and credit facilities.
We were incorporated under the Maryland General Corporation Law on December 31, 2015. Through December 31, 2015, our business was conducted through a series of predecessor private partnerships. At the beginning of 2016, we completed the merger of these private partnerships into a single entity as part of our plan to reorganize our business as a REIT for federal income tax purposes. Following the REIT Formation Transaction, Terra Fund 5 contributed the consolidated portfolio of net assets of certain Terra Funds to our company in exchange for all of the shares of our common stock. On March 2, 2020, we engaged in a series of transactions pursuant to which we issued an aggregate of 4,574,470.35 shares of common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans held by us, cash of $25.5 million and other working capital.
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As of December 31, 2023, Terra Fund 7 and Terra Offshore REIT held approximately 8.7% and 10.1%, respectively, of our issued and outstanding Class B Common Stock.
We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2016. So long as we qualify as a REIT, we generally are not subject to U.S. federal income tax on our net taxable income to the extent that we annually distribute all of our net taxable income to our stockholders.
Recent Developments
Merger Agreements
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022, Terra BDC merged with and into Terra LLC, our wholly owned subsidiary, with Terra LLC continuing as the surviving entity of the merger and as our wholly owned subsidiary.
At the Effective Time, except for any shares of Terra BDC Common Stock held by us or any of our wholly owned subsidiaries or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of our newly designated Class B Common Stock, and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38.
Pursuant to the terms of the transactions described in the Merger Agreement, approximately 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as of the Closing Date. Following the consummation of the BDC Merger, former Terra BDC stockholders owned approximately 19.9% of our common equity.
On June 28, 2023, we announced we entered into an Agreement and Plan of Merger, dated as of June 27, 2023 (the “WMC Merger Agreement”), with Western Asset Mortgage Capital Corporation, a Delaware corporation (“WMC”). On August 8, 2023, WMC terminated the WMC Merger Agreement pursuant to its terms (the “Termination”), and we were paid a termination fee of $3.0 million.
Distribution of Class B Common Stock by Terra Fund 5
Prior to undertaking the REIT Formation Transaction, the Terra Funds distributed a consent solicitation memorandum disclosing the details of the proposed transactions and received the requisite consent of investors in each of the Terra Funds to engage in the REIT Formation Transaction. The consent solicitation memorandum disclosed that Terra Fund 5 could in the future make a distribution-in-kind to its members of shares of our company, rather than a cash distribution. The limited liability company agreement of Terra Fund 5 provides that the term of Terra Fund 5 expires on December 31, 2023.
On December 20, 2023, Terra Fund 5 announced that effective December 29, 2023, Terra Fund 5 would distribute all its shares of Class B Common Stock to its members as part of the winding up of Terra Fund 5. On the Distribution Date, each member of Terra Fund 5 received 2,252.02 shares of Class B Common Stock for each unit of membership interest in Terra Fund 5 held by such member. Because Terra Fund 5 previously owned its interests in the shares of Class B Common Stock indirectly through its ownership of interests in Terra JV, prior to the Distribution Date, Terra JV first distributed the shares of Class B Common Stock to Terra Fund 5, and Terra Fund 5 then distributed those shares to its members on the Distribution Date. On February 8, 2024, each of Terra Fund 5 and Terra JV were dissolved.
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Portfolio Summary
Net Loan Portfolio
The following tables provide a summary of our net loan portfolio as of:
| December 31, 2023 | |||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total Gross Loans | Obligations under Participation Agreements | Total Net Loans | |||||||||||||||||||||||||
| Number of loans | 5 | 16 | 21 | — | 21 | ||||||||||||||||||||||||
| Principal balance | $ | 53,998,648 | $ | 455,462,178 | $ | 509,460,826 | $ | — | $ | 509,460,826 | |||||||||||||||||||
| Carrying value | 54,095,173 | 402,377,085 | 456,472,258 | — | 456,472,258 | ||||||||||||||||||||||||
| Fair value | 53,435,742 | 403,904,207 | 457,339,949 | — | 457,339,949 | ||||||||||||||||||||||||
| Weighted average coupon rate | 12.95 | % | 12.92 | % | 12.93 | % | — | % | 12.93 | % | |||||||||||||||||||
| Weighted-average remaining term (years) | 1.18 | 0.70 | 0.77 | — | 0.77 | ||||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total Gross Loans | Obligations under Participation Agreements | Total Net Loans | |||||||||||||||||||||||||
| Number of loans | 8 | 23 | 31 | 1 | 31 | ||||||||||||||||||||||||
| Principal balance | $ | 90,990,183 | $ | 554,805,276 | $ | 645,795,459 | $ | 12,584,958 | $ | 633,210,501 | |||||||||||||||||||
| Carrying value | 92,274,998 | 534,215,769 | 626,490,767 | 12,680,594 | 613,810,173 | ||||||||||||||||||||||||
| Fair value | 90,729,098 | 532,416,656 | 623,145,754 | 12,680,595 | 610,465,159 | ||||||||||||||||||||||||
| Weighted average coupon rate | 13.82 | % | 11.23 | % | 11.59 | % | 16.36 | % | 11.50 | % | |||||||||||||||||||
| Weighted-average remaining term (years) | 1.35 | 1.10 | 1.14 | 1.69 | 1.13 | ||||||||||||||||||||||||
_______________
(1)These loans pay a coupon rate of London Interbank Offered Rate (“LIBOR”), Secured Overnight Financing Rate (“SOFR”), or forward-looking term rate SOFR (“Term SOFR”) plus a fixed spread. Coupon rates shown were determined using LIBOR of 5.47%, average SOFR of 5.34% and Term SOFR of 5.35% as of December 31, 2023, and LIBOR of 4.39%, average SOFR of 4.06% and Term SOFR of 4.36% as of December 31, 2022.
(2)As of December 31, 2023 and 2022, amount included $342.9 million and $413.1 million of senior mortgages used as collateral for $204.9 million and $261.0 million of borrowings under credit facilities, respectively.
(3)As of December 31, 2023 and 2022, 14 and 21 loans, respectively, are subject to a LIBOR, SOFR, or Term SOFR floor, as applicable.
Real Estate Ownership
In addition to our net loan portfolio, as of December 31, 2023, through two investments, we owned eight industrial buildings acquired in 2023; and as of December 31, 2022, we owned a multi-tenant office building acquired pursuant to a foreclosure. As of December 31, 2023 and 2022, the real estate and related lease intangible assets and liabilities had a net carrying value of $129.8 million and $40.6 million, respectively, and the mortgage loans payable encumbering the real estate properties had an outstanding principal amount of $73.5 million and $29.3 million, respectively.
Equity Investments
Additionally, as of December 31, 2023 and 2022, we owned 14.9% and 27.9%, respectively, of equity interest in a limited partnership that invests primarily in performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. We also beneficially owned equity interests in three joint ventures that invest in real estate properties. In 2022, in connection with a $10.0 million mezzanine loan we originated, we entered into a residual profit sharing arrangement with the borrower. We accounted for this arrangement as an equity investment. In May 2023, we purchased the underlying assets and the $10.0 million mezzanine loan was settled in connection with the purchase. In November 2023, in connection with a loan restructuring, we contributed $5.0 million to another joint venture that owns a real estate property. We account for our equity interest in the joint ventures as equity method investments because we do not have a
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controlling financial interest in the entities. As of December 31, 2023 and 2022, these equity investments had total carrying value of $37.2 million and $62.5 million, respectively.
Book Value Per Share
We calculate our book value per share by dividing our net equity by the number of outstanding shares of our common stock, unless otherwise determined by our Board. Our book value per share of Class B Stock Common Stock as of December 31, 2023 and 2022 was $9.93 and $13.23, respectively.
Portfolio Investment Activity
Net Loan Portfolio
For the years ended December 31, 2023 and 2022, we invested $19.2 million and $126.9 million in new and add-on investments and had $10.3 million and $33.3 million of repayments, resulting in net investments of $8.9 million and $93.6 million, respectively. Amounts are net of obligations under participation agreements and secured financing.
Real Estate Ownership
For the year ended December 31, 2023, we made two investments for eight industrial buildings for a total capital cost of $132.1 million. In connection with these acquisitions, we obtained mortgage financing totaling $72.6 million.
Net Loan Portfolio Information
The tables below set forth the types of loans in our loan portfolio, as well as the property type and geographic location of the properties securing these loans, on a net loan basis, which represents our proportionate share of the loans, based on our economic ownership of these loans as of:
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Loan Structure | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| First mortgages | $ | 365,465,500 | $ | 368,918,890 | 80.9 | % | $ | 456,408,889 | $ | 461,299,182 | 75.1 | % | ||||||||||||||||||||||||||
| Preferred equity investments | 126,550,969 | 127,105,312 | 27.8 | % | 121,231,434 | 122,132,177 | 19.9 | % | ||||||||||||||||||||||||||||||
| Mezzanine loans | 17,444,357 | 17,424,081 | 3.8 | % | 26,767,345 | 26,770,521 | 4.4 | % | ||||||||||||||||||||||||||||||
| Credit facility | — | — | — | % | 28,802,833 | 29,080,183 | 4.7 | % | ||||||||||||||||||||||||||||||
| Allowance for credit losses | — | (56,976,025) | (12.5) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 509,460,826 | $ | 456,472,258 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Property Type | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Office | $ | 144,812,619 | $ | 144,853,769 | 31.7 | % | $ | 171,611,750 | $ | 172,042,063 | 27.9 | % | ||||||||||||||||||||||||||
| Multifamily | 85,660,082 | 86,210,868 | 18.9 | % | 104,589,464 | 105,570,432 | 17.2 | % | ||||||||||||||||||||||||||||||
| Industrial | 67,579,869 | 67,612,621 | 14.8 | % | 147,796,164 | 148,891,742 | 24.3 | % | ||||||||||||||||||||||||||||||
| Mixed-use | 63,096,365 | 63,531,806 | 13.9 | % | 64,880,450 | 65,838,965 | 10.7 | % | ||||||||||||||||||||||||||||||
| Infill land | 52,839,509 | 54,172,663 | 11.9 | % | 48,860,291 | 49,565,437 | 8.1 | % | ||||||||||||||||||||||||||||||
| Hotel - full/select service | 43,222,382 | 43,801,303 | 9.6 | % | 43,222,382 | 43,758,804 | 7.1 | % | ||||||||||||||||||||||||||||||
| Student housing | 31,000,000 | 31,821,832 | 7.0 | % | 31,000,000 | 31,774,261 | 5.2 | % | ||||||||||||||||||||||||||||||
| Infrastructure | 21,250,000 | 21,443,421 | 4.7 | % | 21,250,000 | 21,840,359 | 3.6 | % | ||||||||||||||||||||||||||||||
| Allowance for credit losses | — | (56,976,025) | (12.5) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 509,460,826 | $ | 456,472,258 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
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| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Geographic Location | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| United States | ||||||||||||||||||||||||||||||||||||||
| California | $ | 119,093,246 | $ | 120,296,944 | 26.4 | % | $ | 151,668,387 | $ | 153,158,967 | 24.9 | % | ||||||||||||||||||||||||||
| New York | 90,483,672 | 90,483,672 | 19.8 | % | 91,845,479 | 91,877,084 | 14.9 | % | ||||||||||||||||||||||||||||||
| New Jersey | 82,419,378 | 83,489,049 | 18.3 | % | 62,228,622 | 62,958,482 | 10.3 | % | ||||||||||||||||||||||||||||||
| Georgia | 74,335,828 | 74,602,328 | 16.3 | % | 72,401,718 | 73,101,964 | 11.9 | % | ||||||||||||||||||||||||||||||
| Utah | 49,250,000 | 50,329,949 | 11.0 | % | 49,250,000 | 50,698,251 | 8.3 | % | ||||||||||||||||||||||||||||||
| Washington | 34,052,223 | 34,020,449 | 7.5 | % | 56,671,267 | 57,027,639 | 9.3 | % | ||||||||||||||||||||||||||||||
| Arizona | 31,000,000 | 31,296,235 | 6.9 | % | 31,000,000 | 31,276,468 | 5.1 | % | ||||||||||||||||||||||||||||||
| North Carolina | 21,826,479 | 21,929,657 | 4.8 | % | 43,520,028 | 44,041,162 | 7.2 | % | ||||||||||||||||||||||||||||||
| Massachusetts | 7,000,000 | 7,000,000 | 1.5 | % | 7,000,000 | 7,000,000 | 1.1 | % | ||||||||||||||||||||||||||||||
| Texas | — | — | — | % | 67,625,000 | 68,142,046 | 11.1 | % | ||||||||||||||||||||||||||||||
| Allowance for credit losses | — | (56,976,025) | (12.5) | % | — | (25,471,890) | (4.1) | % | ||||||||||||||||||||||||||||||
| Total | $ | 509,460,826 | $ | 456,472,258 | 100.0 | % | $ | 633,210,501 | $ | 613,810,173 | 100.0 | % | ||||||||||||||||||||||||||
Factors Impacting Operating Results
Our results of operations are affected by a number of factors and primarily depend on, among other things, the level of the interest income from targeted assets, the market value of our assets and the supply of, and demand for, real estate-related loans, including mezzanine loans, first mortgage loans, subordinated mortgage loans, preferred equity investments and other loans related to high quality commercial real estate in the United States, and the financing and other costs associated with our business. Interest income and borrowing costs may vary as a result of changes in interest rates, which could impact the net interest we receive on our assets. Our operating results may also be impacted by conditions in the financial markets and unanticipated credit events experienced by borrowers under our loan assets.
Credit Risk
Our loans and investments are subject to credit risk. The performance and value of our loans and investments depend upon the owners’ ability to operate the properties that serve as our collateral so that they produce cash flows adequate to pay interest and principal due to us. To monitor this risk, our asset management team reviews our investment portfolios and is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary.
In addition, we are exposed to the risks generally associated with the commercial real estate market, including variances in occupancy rates, capitalization rates, absorption rates, and other macroeconomic factors beyond our control. We seek to manage these risks through our Manager's underwriting and asset management processes.
We maintain all of our cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Concentration Risk
We hold real estate and real estate-related loans. Thus, our investment portfolio may be subject to a more rapid change in value than would be the case if it were required to maintain a wide diversification among industries, companies and types of loans. The result of such concentration in real estate assets is that a loss in such investments could materially reduce our capital.
Interest Rate Risk
Interest rate risk represents the effect from a change in interest rates, which could result in an adverse change in the fair value of our interest-bearing financial instruments. With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to increase; (ii) the value of real estate and real estate-related loans to decline; (iii) coupons on variable rate loans to reset, although on a delayed basis, to higher interest rates; (iv) to the extent applicable under the terms of our investments, prepayments on real estate-related loans to slow;
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and (v) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase.
Conversely, decreases in interest rates, in general, may over time cause: (i) the interest expense associated with variable rate borrowings to decrease; (ii) the value of real estate and real estate-related loans to increase; (iii) coupons on variable rate real estate-related loans to reset, although on a delayed basis, to lower interest rates; (iv) to the extent applicable under the terms of our investments, prepayments on real estate-related loans to increase; and (v) to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.
Prepayment Risk
Prepayments can either positively or adversely affect the yields on our loans. Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. If we do not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain loans.
Extension Risk
Extension risk is the risk that our assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent we have financed the acquisition of an asset, we may have to finance our asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest spread, and thus our net interest income.
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other acts of god. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.
Use of Leverage
We deploy moderate amounts of leverage as part of our operating strategy, which may consist of borrowings under first mortgage financings, warehouse facilities, term loans, repurchase agreements and other credit facilities. While borrowing and leverage present opportunities for increasing total return, they may have the effect of potentially creating or increasing losses.
Market Risk
Our loans are highly illiquid, and there is no assurance that we will achieve our investment objectives, including targeted returns. Due to the illiquidity of the loans, valuation of our loans may be difficult, as there generally will be no established markets for these loans.
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Results of Operations
The following table presents the comparative results of our operations:
| Years Ended December 31, | ||||||||||||||||||||
| 2023 | 2022 | Change | ||||||||||||||||||
| Revenues | ||||||||||||||||||||
| Interest income | $ | 56,140,437 | $ | 42,591,972 | $ | 13,548,465 | ||||||||||||||
| Real estate operating revenue | 11,050,716 | 11,451,914 | (401,198) | |||||||||||||||||
| Prepayment fee income | — | 1,984,061 | (1,984,061) | |||||||||||||||||
| Other operating income | 722,881 | 586,499 | 136,382 | |||||||||||||||||
| 67,914,034 | 56,614,446 | 11,299,588 | ||||||||||||||||||
| Operating expenses | ||||||||||||||||||||
| Operating expenses reimbursed to Manager | 9,234,357 | 8,076,321 | 1,158,036 | |||||||||||||||||
| Asset management fee | 7,807,198 | 6,556,492 | 1,250,706 | |||||||||||||||||
| Asset servicing fee | 1,857,765 | 1,560,044 | 297,721 | |||||||||||||||||
| Provision for credit losses | 45,548,803 | 11,813,409 | 33,735,394 | |||||||||||||||||
| Real estate operating expenses | 4,586,245 | 5,005,551 | (419,306) | |||||||||||||||||
| Depreciation and amortization | 6,968,985 | 6,530,595 | 438,390 | |||||||||||||||||
| Impairment charge | 11,765,540 | 1,604,989 | 10,160,551 | |||||||||||||||||
| Professional fees | 3,741,720 | 3,697,792 | 43,928 | |||||||||||||||||
| Directors’ fees | 347,714 | 192,497 | 155,217 | |||||||||||||||||
| Other | 539,957 | 747,535 | (207,578) | |||||||||||||||||
| 92,398,284 | 45,785,225 | 46,613,059 | ||||||||||||||||||
| Operating (loss) income | (24,484,250) | 10,829,221 | (35,313,471) | |||||||||||||||||
| Other income and expenses | ||||||||||||||||||||
| Interest expense on secured financing | (28,113,245) | (14,793,540) | (13,319,705) | |||||||||||||||||
| Interest expense on unsecured notes payable | (9,643,974) | (6,682,937) | (2,961,037) | |||||||||||||||||
| Interest expense on obligations under participation agreements | (1,353,006) | (3,180,771) | 1,827,765 | |||||||||||||||||
| Gain on extinguishment of participation liability | 14,079,379 | 3,435,902 | 10,643,477 | |||||||||||||||||
| Unrealized losses on investments, net | (316,573) | (122,299) | (194,274) | |||||||||||||||||
| (Loss) income from equity investment in unconsolidated investments | (2,383,938) | 2,731,477 | (5,115,415) | |||||||||||||||||
| Gain on sale of interests in unconsolidated investments | — | 799,827 | (799,827) | |||||||||||||||||
| Loss on disposal of real estate | (4,211,153) | (51,984) | (4,159,169) | |||||||||||||||||
| Realized (losses) gains on investments, net | (459,279) | 83,411 | (542,690) | |||||||||||||||||
| (32,401,789) | (17,780,914) | (14,620,875) | ||||||||||||||||||
| Net loss | $ | (56,886,039) | $ | (6,951,693) | $ | (49,934,346) | ||||||||||||||
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Net Loan Portfolio
In assessing the performance of our loans, we believe it is appropriate to evaluate the loans on an economic basis, that is, gross loans net of obligations under participation agreements, notes payable, term loan payable, revolving credit facility and repurchase agreements payable.
The following table presents a reconciliation of our loan portfolio on a weighted average basis from gross to net:
| Year Ended December 31, 2023 | Year Ended December 31, 2022 | |||||||||||||||||||||||||
Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | Weighted Average Principal Amount (1) | Weighted Average Coupon Rate (2) | |||||||||||||||||||||||
| Total portfolio | ||||||||||||||||||||||||||
| Gross loans | $ | 569,511,789 | 12.7 | % | $ | 550,062,087 | 10.7 | % | ||||||||||||||||||
| Obligations under participation agreements and secured borrowing | (9,987,566) | 17.4 | % | (59,931,021) | 12.1 | % | ||||||||||||||||||||
| Promissory notes payable | (13,002,573) | 10.7 | % | — | — | % | ||||||||||||||||||||
| Repurchase agreements payable | (134,030,835) | 8.3 | % | (167,507,961) | 6.2 | % | ||||||||||||||||||||
| Term loan payable | — | — | % | (10,303,678) | 5.3 | % | ||||||||||||||||||||
| Revolving line of credit payable | (87,114,331) | 8.7 | % | (47,383,467) | 7.6 | % | ||||||||||||||||||||
Net loans (3) | $ | 325,376,484 | 15.5 | % | $ | 264,935,960 | 14.0 | % | ||||||||||||||||||
| Senior loans | ||||||||||||||||||||||||||
| Gross loans | $ | 443,674,795 | 12.2 | % | $ | 408,607,321 | 9.7 | % | ||||||||||||||||||
| Obligations under participation agreements and secured borrowing | (9,987,566) | 17.4 | % | (24,800,580) | 8.1 | % | ||||||||||||||||||||
| Promissory notes payable | (13,002,573) | 10.7 | % | — | — | % | ||||||||||||||||||||
| Repurchase agreements payable | (134,030,835) | 8.3 | % | (167,507,962) | 6.2 | % | ||||||||||||||||||||
| Term loan payable | — | — | % | (10,303,678) | 5.3 | % | ||||||||||||||||||||
| Revolving line of credit payable | (87,114,331) | 8.7 | % | (47,383,467) | 7.6 | % | ||||||||||||||||||||
Net loans (3) | $ | 199,539,490 | 16.2 | % | $ | 158,611,634 | 14.6 | % | ||||||||||||||||||
Subordinated loans (4) | ||||||||||||||||||||||||||
| Gross loans | $ | 125,836,994 | 14.5 | % | $ | 141,454,766 | 13.6 | % | ||||||||||||||||||
| Obligations under participation agreements | — | — | % | (35,130,441) | 13.7 | % | ||||||||||||||||||||
Net loans (3) | $ | 125,836,994 | 14.5 | % | $ | 106,324,325 | 13.6 | % | ||||||||||||||||||
_______________
(1)Amount is calculated based on the number of days each loan is outstanding.
(2)Amount is calculated based on the underlying principal amount of each loan.
(3)The weighted average coupon rate represents net interest income over the period calculated using the weighted average coupon rate and weighted average principal amount shown on the table (interest income on the loans less interest expense) divided by the weighted average principal amount of the net loans during the period.
(4)Subordinated loans include mezzanine loans, preferred equity investments and credit facilities.
Interest Income
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, interest income increased by $13.5 million, primarily due to an increase in contractual interest income as a result of an increase in the weighted average principal balance of gross loans due to loans originated in 2022 and loans we acquired in connection with the BDC Merger, as well as an increase in the weighted average coupon rate due to increases in the underlying index rates.
Real Estate Operating Revenue
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, real estate operating revenue decreased by $0.4 million, primarily due to lease termination income recognized in 2022 (there was no such lease termination income recognized in 2023), partially offset by rental income contributed by the industrial buildings acquired in 2023.
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Prepayment Fee Income
For the year ended December 31, 2023, there was no early repayment of loans and we did not recognize any prepayment fee income. For the year ended December 31, 2022, we recognized prepayment fee income of $2.0 million on loans with minimum yield provisions repaid before maturity.
Other Operating Income
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, other operating income increased by $0.1 million, primarily due to an increase in dividend income recognized on marketable securities, partially offset by a decrease in application fees income on deals under application.
Operating Expenses Reimbursed to Manager
Under the terms of a management agreement (the “Management Agreement”) with our Manager, we reimburse our Manager for operating expenses incurred in connection with services provided to us, including our allowable share of our Manager’s overhead, such as rent, employee costs, utilities and technology costs.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, operating expenses reimbursed to our Manager increased by $1.2 million, primarily due to an increase in the allocation ratio resulting from an increase in total assets under management primarily due to loans acquired in connection with the BDC Merger.
Asset Management Fee
Under the terms of the Management Agreement with our Manager, we paid our Manager a monthly asset management fee at an annual rate of 1% of the aggregate funds under management, which included the aggregate gross acquisition price, net of participation interest sold to affiliates, for each real estate-related investment and cash held by us.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, asset management fees increased by $1.3 million, primarily due to an increase in total assets under management primarily resulting from loans acquired in connection with the BDC Merger.
Asset Servicing Fee
Under the terms of the Management Agreement with our Manager, we paid our Manager a monthly servicing fee at an annual rate of 0.25% of the aggregate gross origination price or acquisition price for each real estate-related loan held by us.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, asset servicing fees increased by $0.3 million, primarily due to an increase in total assets under management resulting from loans acquired in connection with the BDC Merger.
Provision for Credit Losses
On January 1, 2023, we adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. Prior to the adoption of ASU 2016-13, we recorded an allowance for credit losses equal to (i) 1.5% of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5% of the aggregate carrying amount of loans rated as a “5”, plus (iii) past due loan reserves, if any.
For the year ended December 31, 2023, provision for credit losses increased by $33.7 million, primarily related to the decline in fair value of collateral underlying three loans in the investment portfolio due to a decline in the macroeconomic outlook for commercial real estate.
Real Estate Operating Expenses
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, real estate operating expenses increased by $0.4 million, primarily due to expenses incurred on the industrial buildings that we acquired in 2023, partially offset by a reduction in expenses due to the disposal of the office building in October 2023 and a real estate tax refund related to the overpayment of real estate tax in the prior year.
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Depreciation and Amortization
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, depreciation and amortization increased by $0.4 million, primarily due to the industrial buildings that we acquired in 2023, partially offset by a reduction in depreciation and amortization due to the disposal of the office building in October 2023.
Impairment Charge
For the year ended December 31, 2023, we recognized an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value. In October 2023, we conveyed our interest in the office building to the lender by deed-in-lieu of foreclosure and accordingly, we no longer own the office building. For the year ended December 31, 2022, we recognized an impairment charge of $1.6 million, on 4.9 acres of the development land located in Pennsylvania in order to reduce the carrying value of the land to its estimated fair value, which is the estimated selling price less the cost of sale. The development land was sold in the second quarter of 2022.
Directors’ Fees
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, directors’ fees increased by $0.2 million, as a result of an increase in the size of our Board due to the BDC Merger.
Other
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, other expenses decreased by $0.2 million, primarily as a result of a fee paid in 2022 to a third-party in connection with the sale of a parcel of land in June 2022.
Interest Expense on Secured Financing
Our secured financing consists of repurchase agreements, revolving line of credit, term loan, promissory notes and property mortgages.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, interest expense on secured financing increased by $13.3 million as a result of an increase in the weighted average principal amount outstanding as well as an increase in the index rate on secured financing agreements.
Interest Expense on Unsecured Notes Payable
In June 2021, we issued $85.1 million in aggregate principal amount of 6.00% notes due 2026. In connection with the BDC Merger, we assumed $38.4 million in aggregate principal amount of 7.00% notes due in 2026.
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, interest expense on unsecured notes payable increased by $3.0 million, as a result of an increase in the weighted average principal amount outstanding due to the assumption of unsecured notes payable in connection with the BDC Merger.
Interest from Obligations under Participation Agreements
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, interest expense from obligations under participation agreements decreased by $1.8 million, as a result of a decrease in the weighted average principal amount outstanding, primarily due to the release of obligations under participation agreements with Terra BDC in connection with the BDC Merger, partially offset by an increase in the index rate on the outstanding obligations under participation agreements.
Gain on Extinguishment of Participation Liability
In September 2023, the counterparty to a participation agreement conveyed its interest in the obligation under participation agreement to us and we recognized a gain on extinguishment of participation liability of $10.6 million for the year ended December 31, 2023.
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In connection with the BDC Merger, the obligations under participation agreements with Terra BDC totaling $37.0 million were effectively extinguished and we recognized a net gain of $3.4 million for the year ended December 31, 2022, representing the difference between the carrying value of the Company’s obligations under participation agreements and the fair value of Terra BDC’s investments acquired through participation agreements.
Unrealized Losses on Investments, Net
For the year ended December 31, 2023, as compared to the year ended December 31, 2022, unrealized losses on investments, net increased by $0.2 million, primarily due to a decrease in the fair value of our marketable securities at period end.
(Loss) Income from Equity Investment in Unconsolidated Investments
In August 2020, we entered into a subscription agreement with RESOF, an affiliate managed by our Manager, whereby we committed to fund up to $50.0 million to purchase partnership interest in RESOF. RESOF’s primary investment objective is to generate attractive risk-adjusted returns by purchasing performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. RESOF may also opportunistically originate high-yield mortgages or loans in real estate special situations including rescue financings, bridge loans, restructurings and bankruptcies (including debtor-in-possession loans). As of December 31, 2023 and 2022, we owned 14.9% and 27.9% of the equity interest in RESOF, respectively.
We also own beneficial equity interests in three joint ventures that invest in real estate properties. In 2022, in connection with a mezzanine loan we originated, we entered into a residual profit sharing arrangement with the borrower. We account for this arrangement as an equity investment. In May 2023, the mezzanine loan that was accounted for as an equity investment and five senior loans that were held for investment were settled and exchanged for five industrial buildings. In November 2023, we contributed $5.0 million to a joint venture that owns a real estate property. We account for our equity interest in the joint ventures as equity method investments because we do not have a controlling financial interest in the entities.
For the year ended December 31, 2023, we recognized loss from equity investment in unconsolidated investments of $2.4 million, which consisted of net equity loss from the joint ventures and the mezzanine loan of $3.5 million, partially offset by equity income from RESOF of $1.1 million. The equity loss from the joint ventures was the result of depreciation and amortization and interest expense recognized by the joint ventures. The equity income from RESOF included adjustments made due to the dilution of our ownership interest in RESOF as new investors were admitted in 2022 and 2023. For the year ended December 31, 2022, we recognized income from equity investment in unconsolidated investments of $2.7 million, which consisted of equity income from RESOF of $5.2 million, partially offset by equity loss from the joint ventures of $2.5 million.
Gain on Sale of Interests in Unconsolidated Investments
In September 2022, we sold a 53% effective interest in two joint ventures and 59% effective interest in another joint venture for a total of $33.7 million and recognized a gain on sale of $0.8 million for the year ended December 31, 2022. There was no such gain for the year ended December 31, 2023.
Loss on Disposal of Real Estate
In October 2023, we conveyed our interest in an office building to the lender by deed in lieu of foreclosure and recognized a net loss on disposal of real estate of $4.2 million for the year ended December 31, 2023. In June 2022, we sold 4.9 acres of adjacent land located in Pennsylvania for net proceeds of $8.6 million, and recognized a net loss on sale of $0.1 million for the year ended December 31, 2022.
Realized (Losses) Gains On Investments, Net
For the year ended December 31, 2023, we sold a portion of our investments in common stock and recognized a net loss on sale of $0.5 million. For year ended December 31, 2022, we sold our investments in common and preferred stocks and recognized a net gain on sale of $0.1 million.
Net Loss
For the year ended December 31, 2023 as compared to the year ended December 31, 2022, the resulting net loss increased by $49.9 million.
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Financial Condition, Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, funding and maintaining our assets and operations, making distributions to our stockholders and other general business needs. We use significant cash to purchase our target assets, repay principal and interest on our borrowings, make distributions to our investors and fund our operations. Our primary sources of cash generally consist of payments of principal and interest we receive on our portfolio of investments, cash generated from our operating results and unused borrowing capacity under our financing sources. We deploy moderate amounts of leverage as part of our operating strategy and use a number of sources to finance our target assets, including our senior notes, term loan, repurchase agreement and revolving line of credit. We may use other sources to finance our target assets, including bank financing and arranged financing facilities with domestic or international financing providers. In addition, we may divide the loans we originate into senior and junior tranches and dispose of the more senior tranches as an additional means of providing financing to our business.
We may also issue additional equity, equity-related and debt securities to fund our investment strategies. We may issue these securities to unaffiliated third parties or to vehicles advised by affiliates of Terra Capital Partners or third parties. As part of our capital raising transactions, we may grant to one or more of these vehicles certain control rights over our activities including rights to approve major decisions we take as part of our business. In order to qualify as a REIT, we must distribute to our stockholders, each calendar year, dividends equal to at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for our business.
We expect to fund approximately $22.4 million of the unfunded commitments to borrowers during the next twelve months. We expect to maintain sufficient liquidity to fund such commitments through matching these commitments with principal repayments on outstanding loans or draw downs on our credit facilities. In connection with the BDC Merger, we assumed a $25.0 million term loan. The term loan currently bears interest at an annual rate of SOFR plus 7.375% with a SOFR floor of 5.0% and matures on March 31, 2024. We expect to either maintain sufficient liquidity to repay the facility or refinance the facility. Our revolving line of credit with outstanding principal balance of $47.5 million was to come due on March 12, 2024 and our Goldman Sachs Bank repurchase agreement with outstanding principal balance of $75.5 million was to come due on February 18, 2024 (see “Summary of Financing” below). On March 7, 2024, the facility term of our revolving line of credit was extended to September 12, 2024 with an option to extend the facility term for an additional 12-month period and the facility term of the Goldman Sachs Bank facility was extended to February 18, 2025.
Summary of Financing
The table below summarizes our debt financing as of December 31, 2023:
| Type of Financing | Maximum Amount Available | Outstanding Balance | Amount Remaining Available | Interest Rate | Maturity Date | |||||||||||||||||||||||||||
| Fixed Rate: | ||||||||||||||||||||||||||||||||
| Unsecured notes payable | N/A | $ | 85,125,000 | N/A | 6.00% | June 2026 | ||||||||||||||||||||||||||
| Unsecured notes payable | N/A | 38,375,000 | N/A | 7.00% | March 2026 | |||||||||||||||||||||||||||
| Property mortgages | N/A | 40,250,000 | N/A | 6.25% | June 2028 | |||||||||||||||||||||||||||
| $ | 163,750,000 | |||||||||||||||||||||||||||||||
| Variable Rate: | ||||||||||||||||||||||||||||||||
| Property mortgages | N/A | $ | 33,256,885 | N/A | Term SOFR +3.5% (Term SOFR Floor of 3.75%) | April 2027 | ||||||||||||||||||||||||||
| Term loan | N/A | 15,000,000 | N/A | SOFR + 7.375% (SOFR floor of 5.0%) | March 2024 | |||||||||||||||||||||||||||
| Promissory notes payable | N/A | 63,509,518 | N/A | Term SOFR plus a spread ranging from 4.75% to 5.6% with a combined floor rate ranging from 9.0% to 10.9%. | March 2025 - March 2026 | |||||||||||||||||||||||||||
Revolving line of credit (1) | $ | 125,000,000 | 47,461,730 | $ | 77,538,270 | Term SOFR + 3.35% (combined floor rate of 6.0%) | March 2024 | |||||||||||||||||||||||||
UBS AG repurchase agreement (2) | 195,000,000 | 18,480,000 | 176,520,000 | Term SOFR + 1.965% | November 2024 | |||||||||||||||||||||||||||
Goldman Sachs Bank repurchase agreement(3) | 200,000,000 | 75,455,624 | 124,544,376 | Term SOFR (subject to underlying loan floors on a case-by-case basis) plus a spread ranging from 2.0% to 5.00%) | February 2024 | |||||||||||||||||||||||||||
| $ | 520,000,000 | $ | 253,163,757 | $ | 378,602,646 | |||||||||||||||||||||||||||
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_______________
(1)On March 7, 2024, we amended the facility agreement to waive the quarterly minimum net worth covenant for the purposes of the December 31, 2023 measurement date, decrease the minimum net worth covenant for future quarterly measurement dates, reduce the credit line, increase the coupon rate, revise the minimum profitability covenant and extend the facility term to September 12, 2024 with an option to extend the facility term for an additional 12-month period.
(2)In February 2024, the outstanding balance was repaid. On March 7, 2024, we amended the side letter to the UBS AG facility agreement to reduce the maximum amount available under the facility to zero. In connection with this amendment, UBS AG waived the payment of any fees and the meeting of any representations, warranties or covenants for the period commencing on December 31, 2023 until such time as there are amounts outstanding under the UBS AG facility agreement.
(3)On March 7, 2024, we amended the Goldman Sachs Bank facility agreement to extend the maturity date to February 18, 2025 and to reduce the minimum interest coverage ratio covenant.
Cash Flows Provided by Operating Activities
For the year ended December 31, 2023, as compared to the year ended December 31, 2022, cash flows provided by operating activities increased by $8.2 million, primarily due to an increase in net contractual interest income.
Cash Flows Used in Investing Activities
For the year ended December 31, 2023, cash flows used in investing activities were $10.0 million, primarily related to origination and purchase of loans of $78.9 million, purchase of real estate properties of $52.5 million, purchase of held-to-maturity securities of $20.0 million, purchase of marketable securities of $7.9 million, purchase of equity interests in unconsolidated investments of $7.3 million, and funding for promissory note receivable of $3.8 million, partially offset by proceeds from repayments of loans of $126.1 million, proceeds from redemption of held-to-maturity securities of $20.0 million, return of capital on unconsolidated investments of $11.3 million, and proceeds from sale of marketable equity securities of $2.4 million.
For the year ended December 31, 2022, cash flows used in investing activities were $49.1 million, primarily related to origination and purchase of loans of $290.0 million and purchase of equity interests in unconsolidated investments of $25.5 million, partially offset by proceeds from repayments of loans of $197.5 million, proceeds from sale of interests in joint ventures of $33.7 million, cash and restricted cash acquired in connection with the BDC Merger of $24.6 million, proceeds from sale of real estate of $8.6 million and proceeds from sale of marketable securities of $1.3 million.
Cash Flows (Used in) Provided by Financing Activities
For the year ended December 31, 2023, cash flows used in financing activities were $15.5 million, primarily related to principal repayments on secured financing of $205.3 million, distributions paid of $18.6 million and payment for financing costs of $3.3 million, partially offset by proceeds from secured financing of $211.0 million.
For the year ended December 31, 2022, cash flows provided by financing activities were $34.1 million, primarily due to proceeds from secured financing of $286.6 million and proceeds from obligations under participation agreements of $29.6 million, partially offset by principal repayments on secured financing of $239.7 million, repayments of obligations under participation agreements of $22.2 million and distributions paid of $16.1 million.
Distribution Reinvestment Plan
On January 20, 2023, our Board adopted a distribution reinvestment plan (the “Plan”), pursuant to which our stockholders may elect to reinvest cash distributions payable by us in additional shares of Class A Common Stock and Class B Common Stock, at the price per share determined pursuant to the Plan.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in conformity with United States generally accepted accounting principles, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may
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change in subsequent periods. In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing the consolidated financial statements, management has utilized available information, including industry standards and the current economic environment, among other factors, in forming its estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operations to those of companies in similar businesses. As we execute our expected operating plans, we will describe additional critical accounting policies in the notes to our future consolidated financial statements in addition to those discussed below.
Allowance for Credit Losses
On January 1, 2023, we adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology.
We use a model based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which we do not have the unconditional right to cancel, as these loans share similar risk characteristics. We utilize information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for our loan portfolio. We utilize a commercial mortgage based, third-party loan loss model and because we do not have a meaningful history of realized credit losses on our loan portfolio, we subscribe to a database service to provide historical proxy loan loss information. We employ logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. We have chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into our allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. We select certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated by applying the loan loss rate to the total outstanding loan balance of each loan. These results require a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance for credit losses. Changes in such estimates can significantly affect the expected credit losses.
Management Agreement with Terra REIT Advisors
We currently pay the following fees to Terra REIT Advisors pursuant to the Management Agreement:
Origination and Extension Fee. An origination fee in the amount of 1.0% of the amount used to originate, acquire, fund or structure real estate-related investments, including any third-party expenses related to such loan. In the event that the term of any real estate-related loan is extended, our Manager also receives an origination fee equal to the lesser of (i) 1.0% of the principal amount of the loan being extended or (ii) the amount of fee paid by the borrower in connection with such extension.
Asset Management Fee. A monthly asset management fee at an annual rate equal to 1.0% of the aggregate funds under management, which includes the loan origination amount or aggregate gross acquisition cost, as applicable, for each real estate-related loan and cash held by us.
Asset Servicing Fee. A monthly asset servicing fee at an annual rate equal to 0.25% of the aggregate gross origination price or aggregate gross acquisition price for each real estate related loan then held by us (inclusive of closing costs and expenses).
Disposition Fee. A disposition fee in the amount of 1.0% of the gross sale price received by our company from the disposition of each loan, but not upon the maturity, prepayment, workout, modification or extension of a loan unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of (i) 1.0% of the principal amount of the loan and (ii) the amount of the fee paid by the borrower in connection with such transaction. If we take ownership of a
51
property as a result of a workout or foreclosure of a loan, we will pay a disposition fee upon the sale of such property equal to 1.0% of the sales price.
Transaction Breakup Fee. In the event that we receive any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, our Manager will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by our Manager with respect to its evaluation and pursuit of such transactions.
In addition to the fees described above, we reimburse our Manager for operating expenses incurred in connection with services provided to the operations of our company, including our allocable share of our Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
The following table presents a summary of fees paid and costs reimbursed to our Manager in connection with providing services to us:
| Years Ended December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
Origination and extension fee expense (1) | $ | 2,312,656 | $ | 3,189,291 | ||||||||||
| Asset management fee | 7,807,198 | 6,556,492 | ||||||||||||
| Asset servicing fee | 1,857,765 | 1,560,044 | ||||||||||||
| Operating expenses reimbursed to Manager | 9,234,357 | 8,076,321 | ||||||||||||
Disposition fee (2) | 1,451,063 | 890,194 | ||||||||||||
| Total | $ | 22,663,039 | $ | 20,272,342 | ||||||||||
_______________
(1)Origination and extension fee expense is generally offset with origination and extension fee income. Any excess is deferred and amortized to interest income over the term of the loan.
(2)Disposition fee is generally offset with exit fee income and included in interest income on the consolidated statements of operations.
Management Agreement Amendment
On March 11, 2024, we and our Manager entered into an amendment to the Management Agreement, effective as of January 1, 2024 (the “Amendment”), in order to extend the term of the Management Agreement and modify the terms upon which the Management Agreement may be terminated. Except as discussed below, the terms of the Management Agreement remain unchanged by the Amendment. Except where the context requires otherwise, all references herein to the “Management Agreement” are to the Management Agreement as modified by the Amendment.
The term of the Management Agreement will expire on December 31, 2027 (the “Initial Term”) and will automatically renew for an unlimited number of additional one-year terms upon each anniversary date of the last day of the Initial Term (each, a “Renewal Term”), unless terminated by us or the Manager during the Initial Term or a Renewal Term in accordance with the terms of the Management Agreement (as described below).
The Management Agreement may be terminated by us during the Initial Term or any Renewal Term upon a finding by either (i) at least two-thirds of the independent directors on our Board or (ii) the holders of a majority of the outstanding shares of our common stock (other than those shares held by members of the our senior management team or affiliates of our Manager) that either (a) there has been unsatisfactory performance by our Manager that is materially detrimental to us, or (b) the compensation payable to our Manager pursuant to the Management Agreement is unfair; provided, however, that we will not have the right to terminate the Management Agreement on the basis of unfair compensation to our Manager if our Manager agrees to continue to provide its services under the Management Agreement in exchange for reduced fees that at least two-thirds of the independent directors on our Board determine to be fair pursuant to the procedures set forth in the Management Agreement. We must deliver prior written notice of any such termination to our Manager at least 180 days prior to the last calendar day of the Initial Term or the then-current Renewal Term, as applicable, and the Management Agreement will terminate effective as of the last calendar day of the Initial Term or the then-current Renewal Term, as applicable.
Upon any termination of the Management Agreement by us as discussed above, we will pay our Manager, on the date on which such termination is effective, a termination fee in an amount equal to three times the average annual fees of all types and expense reimbursements received by or owed to our Manager pursuant to the Management Agreement during the 24-month
52
period immediately preceding such termination (the “Termination Fee”), calculated as of the end of the most recently completed monthly prior to the date of such termination.
We may also terminate the Management Agreement, effective upon 30 calendar days’ prior written notice from our Board to our Manager, without payment of any Termination Fees or other penalties, upon (i) the material breach of the Management Agreement by our Manager or its affiliates that continues for 30 days after written notice thereof to our Manager (or 45 days after delivery of written notice thereof if our Manager takes diligent steps to cure such breach within 30 days of delivery of the written notice), (ii) any fraud or other criminal conduct, gross negligence or breach of fiduciary duty by our Manager or its affiliates in connection with the Management Agreement, as determined by a final, non-appealable judgment of a court of competent jurisdiction, (iii) our Manager’s bankruptcy, insolvency or dissolution, or (iv) an Internalization Event (as defined in the Management Agreement). No Termination Fee or other penalty is payable upon such a termination by us.
Our Manager may terminate the Management Agreement, effective upon 60 days’ prior written from our Manager to us, if we breach the Management Agreement and such breach continues for 30 days after written notice thereof. We will pay our Manager the Termination Fee upon such termination by our Manager.
Cost Sharing and Reimbursement Agreement with Terra LLC
We have entered into a cost sharing and reimbursement agreement with Terra LLC, effective October 1, 2022 pursuant to which Terra LLC will be responsible for its allocable share of our expenses, including fees paid by us to our Manager based on relative assets under management. These fees are eliminated in consolidation and therefore have no impact on our consolidated financial statements.
Participation Agreements
We have further diversified our exposure to loans and borrowers by entering into participation agreements whereby we transferred a portion of certain of our loans on a pari passu basis to related parties, primarily other affiliated funds managed by our Manager or its affiliates, and to a lesser extent, unrelated parties. We have also sold a portion of a loan to a third party that did not qualify for sale accounting. In connection with the BDC Merger, the obligations under participation agreements with Terra BDC totaling $37.0 million were effectively extinguished.
As of December 31, 2023, there was no participation obligation.
The loans that are subject to participation agreements are held in our name, but each of the participant’s rights and obligations, including with respect to interest income and other income (e.g., exit fee, prepayment income) and related fees/expenses (e.g., disposition fees, asset management and asset servicing fees), are based upon their respective pro rata participation interest in such participated investments, as specified in the respective participation agreements. We do not have direct liability to a participant with respect to the underlying loan and the participants’ share of the investments is repayable only from the proceeds received from the related borrower/issuer of the investments and, therefore, the participants also are subject to credit risk (i.e., risk of default by the underlying borrower/issuer).
Pursuant to the participation agreement with these entities, we receive and allocate the interest income and other related investment income to the participants based on their respective pro rata participation interest. The affiliated fund participant pays related expenses also based on their respective pro rata participation interest (i.e., asset management and asset servicing fees, disposition fees) directly to our Manager, as per the terms of each respective affiliate’s management agreement.
Other than for U.S. federal income tax purposes, our loan participations do not qualify for sale treatment. As such, the investments remain on our combined consolidated balance sheets and the proceeds are recorded as obligations under participation agreements. Similarly, interest earned on the entire loan balance is recorded within “Interest income” and the interest related to the participation interest is recorded within “Interest expense from obligations under participation agreements” in the consolidated statements of operations.
For the year ended December 31, 2023, the weighted average outstanding principal balance on obligations under participation agreements was approximately $10.0 million and the weighted average interest rate was approximately 17.4%, compared to the weighted average outstanding principal balance on obligations under participation agreements and secured borrowing of approximately $59.9 million and the weighted average interest rate was approximately 12.1% for the year ended December 31, 2022. The secured borrowing was repaid in August 2022.
53
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We may be subject to financial market risks, including changes in interest rates. To the extent that we borrow money to make investments, our net investment income will be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of rising interest rates, our cost of funds would increase, which may reduce our net investment income. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income.
The following table summarizes the aggregate principal balance of variable rate investments and indebtedness as of:
| December 31, 2023 | ||||||||
| Variable rate investments | $ | 438,839,001 | ||||||
| Variable rate debt | $ | 253,163,757 | ||||||
The following table summarizes estimated changes in net investment income on our variable rate investments and indebtedness as of December 31, 2023 assuming hypothetical increases or decreases in Term SOFR or SOFR:
| 1.00% Decrease | 1.00% Increase | |||||||||||||
| Investment income from variable rate investments | $ | (4,517,751) | $ | 4,554,622 | ||||||||||
| Interest expense from variable rate debt | 1,913,391 | (2,531,638) | ||||||||||||
| Net investment income from variable rate instruments | $ | (2,604,360) | $ | 2,022,984 | ||||||||||
We may hedge against interest rate fluctuations by using standard hedging instruments, such as futures, options and forward contracts. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. For the years ended December 31, 2023 and 2022, we did not engage in interest rate hedging activities.
Prepayment Risks
Prepayments can either positively or adversely affect the yields on our loans. Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. If we do not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain loans.
Extension Risk
Extension risk is the risk that our assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent we have financed the acquisition of an asset, we may have to finance our asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest spread, and thus our net interest income.
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other acts of god. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.
54
Credit Risk
We are subject to varying degrees of credit risk in connection with holding a portfolio of our target assets. With respect to our loan portfolio, we seek to manage credit risk by limiting exposure to any one individual borrower and any one asset class.
Additionally, our Manager employs an asset management approach and monitors the portfolio of investments through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value, debt service coverage ratio and the debt yield. Our Manager also requires certain borrowers to establish a cash reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments.
Item 8. Financial Statements and Supplementary Data.
Our financial statements are annexed to this Annual Report on Form 10-K beginning on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including both our Chief Executive Officer and Chief Investment Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2023. Based on that evaluation, our management concluded that our disclosure controls and procedures were effective to provide reasonable assurance that we would meet our disclosure obligations. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.
Evaluation of Internal Controls over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our Manager, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements in our consolidated financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including both our Chief Executive Officer and Chief Investment Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of the end of the fiscal year covered by this Annual Report on Form 10-K.
This Annual Report on Form 10-K does not include an attestation report of our independent registered accounting firm due to a transition period established by the rules of the SEC for “emerging growth companies.”
55
Changes in Internal Control Over Financial Reporting
During the most recent fiscal quarter, there was no change in our internal controls over financial reporting, as defined under
Rule 13a-15(f) under the Exchange Act, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B. Other Information.
Management Agreement Amendment
On March 11, 2024, we and our Manager entered into an amendment to the Management Agreement, effective as of January 1, 2024, in order to extend the term of the Management Agreement and modify the terms upon which the Management Agreement may be terminated. For additional information on the Amendment, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Management Agreement Amendment” in this Annual Report on Form 10‑K.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The information regarding our executive officers required by Item 401 of Regulation S-K is located under Part I, Item 1 within the caption “Information About our Executive Officers” of this annual report on Form 10-K.
The information regarding our directors and certain other matters required by Item 401 of Regulation S-K is incorporated herein by reference to our definitive proxy statement relating to our 2024 annual meeting of stockholders (the “Proxy Statement”), to be filed with the SEC within 120 days after December 31, 2023.
The information regarding compliance with Section 16(a) of the Exchange Act required by Item 405 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
The information regarding our Code of Business Conduct and Ethics required by Item 406 of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
The information regarding certain matters pertaining to our corporate governance required by Items 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
Item 11. Executive Compensation.
The information regarding executive compensation and other compensation related matters required by Items 402 and 407(e)(4) and(e)(5) of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The tables on our equity compensation plan information and beneficial ownership required by Items 201(d) and 403 of Regulation S-K are incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information regarding transactions with related persons, promoters and certain control persons and director independence required by Items 404 and 407(a) of Regulation S-K is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
56
Item 14. Principal Accounting Fees and Services.
The information concerning principal accounting fees and services and the Audit Committee’s pre-approval policies and procedures required by Item 14 is incorporated herein by reference to the Proxy Statement to be filed with the SEC within 120 days after December 31, 2023.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
The following exhibits are included, or incorporated by reference, in this Annual Report on Form 10-K:
(1) Financial Statements
The index to our financial statements is on page F-1 of this Annual Report on Form 10-K.
(2) Financial Statement Schedule
The index to our financial schedules is on page F-1 of this Annual Report on Form 10-K.
(3) Exhibits
The following exhibits are filed with this report. Documents other than those designated as being filed herewith are incorporated herein by reference.
| Exhibit No. | Description and Method of Filing | |||||||
| 2.1 | ||||||||
| 2.2 | ||||||||
| 2.3 | ||||||||
| 2.4 | ||||||||
| 3.1 | ||||||||
| 3.2 | ||||||||
| 3.3 | ||||||||
| 4.1* | ||||||||
| 4.2 | ||||||||
| 4.3 | ||||||||
57
| Exhibit No. | Description and Method of Filing | |||||||
| 4.4 | ||||||||
| 4.5 | ||||||||
| 4.6 | ||||||||
| 4.7 | ||||||||
| 10.1 | ||||||||
| 10.2 | ||||||||
| 10.3 | ||||||||
| 10.4 | ||||||||
| 10.5 | ||||||||
| 10.6 | ||||||||
| 10.7 | ||||||||
| 10.8 | ||||||||
| 10.9 | ||||||||
| 10.1 | ||||||||
| 10.11* | ||||||||
| 10.12 | ||||||||
| 10.13* | ||||||||
| 10.14* | ||||||||
| 10.15 | ||||||||
58
| Exhibit No. | Description and Method of Filing | |||||||
| 10.16 | ||||||||
| 10.17 | ||||||||
| 10.18 | ||||||||
| 10.19 | ||||||||
| 10.20 | ||||||||
| 21.1 * | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32** | ||||||||
| 101.INS** | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document | |||||||
| 101.SCH** | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL** | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.LAB** | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE** | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 101.DEF** | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 104 | Cover Page Interactive Data File Included as Exhibit 101 (embedded within the Inline XBRL document) | |||||||
______________
* Filed herewith.
** Furnished herewith.
Item 16. Form 10-K Summary.
None.
59
Terra Property Trust, Inc.
Index to Consolidated Financial Statements
Schedules other than those listed are omitted as they are not applicable for the required or equivalent information has been included in the consolidated financial statements or notes thereto.
F-1
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Terra Property Trust, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Terra Property Trust, Inc. and subsidiaries (the Company) as of December 31, 2023 and 2022, the related consolidated statements of operations, changes in equity, and cash flows for the years then ended, and the related notes and financial statement schedules III and IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for credit losses as of January 1, 2023 due to the adoption of FASB Accounting Standard Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by
F-2
management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2016.
New York, New York
March 15, 2024
F-3
Terra Property Trust, Inc.
Consolidated Balance Sheets
| December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Assets | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Cash held in escrow by lender | |||||||||||
| Marketable securities | |||||||||||
Loans held for investment, net of allowance for credit losses of $ and $ | |||||||||||
Loans held for investment acquired through participation, net of allowance for credit losses of $ | |||||||||||
| Equity investment in unconsolidated investments | |||||||||||
| Land, building and building improvements, net | |||||||||||
| Lease intangible assets, net | |||||||||||
| Operating lease right-of-use asset | |||||||||||
| Deal deposit | |||||||||||
| Interest receivable | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Equity | |||||||||||
| Liabilities: | |||||||||||
| Unsecured notes payable, net | $ | $ | |||||||||
| Secured financing agreements, net | |||||||||||
| Interest reserve and other deposits held on investments | |||||||||||
| Operating lease liability | |||||||||||
| Interest payable | |||||||||||
| Accounts payable and accrued expenses | |||||||||||
| Unearned income | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Equity: | |||||||||||
Preferred stock, $ | |||||||||||
December 31, 2023 and 2022, respectively | |||||||||||
Class A Common Stock, $ shares issued, at both December 31, 2023 and 2022 | |||||||||||
Class B Common Stock, $ and 2022, respectively | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Total equity | |||||||||||
| Total liabilities and equity | $ | $ | |||||||||
See notes to consolidated financial statements.
F-4
Terra Property Trust, Inc.
Consolidated Statements of Operations
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Revenues | |||||||||||
| Interest income | $ | $ | |||||||||
| Real estate operating revenue | |||||||||||
| Prepayment fee income | |||||||||||
| Other operating income | |||||||||||
| Operating expenses | |||||||||||
| Operating expenses reimbursed to Manager | |||||||||||
| Asset management fee | |||||||||||
| Asset servicing fee | |||||||||||
| Provision for credit losses | |||||||||||
| Real estate operating expenses | |||||||||||
| Depreciation and amortization | |||||||||||
| Impairment charge | |||||||||||
| Professional fees | |||||||||||
| Directors’ fees | |||||||||||
| Other | |||||||||||
| Operating (loss) income | ( | ||||||||||
| Other income and expenses | |||||||||||
| Interest expense on secured financing | ( | ( | |||||||||
| Interest expense on unsecured notes payable | ( | ( | |||||||||
| Interest expense on obligations under participation agreements | ( | ( | |||||||||
| Gain on extinguishment of participation liability | |||||||||||
| Unrealized losses on investments, net | ( | ( | |||||||||
| (Loss) income from equity investment in unconsolidated investments | ( | ||||||||||
| Gain on sale of interests in unconsolidated investments | |||||||||||
| Loss on disposal of real estate | ( | ( | |||||||||
| Realized (losses) gains on investments, net | ( | ||||||||||
| ( | ( | ||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Series A preferred stock dividend declared | $ | ( | $ | ( | |||||||
| Net loss allocable to common stock | $ | ( | $ | ( | |||||||
Loss per share — basic and diluted | $ | ( | $ | ( | |||||||
Weighted-average shares — basic and diluted | |||||||||||
| Distributions declared per common share | $ | $ | |||||||||
See notes to consolidated financial statements.
F-5
Terra Property Trust, Inc.
Consolidated Statements of Changes in Equity
| Preferred Stock | Class A Common Stock | Class B Common Stock | Additional Paid-in Capital | Accumulated Deficit | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
$ | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Total equity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2023 | $ | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| — | — | — | — | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares issued from reinvestment of shareholder distributions | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Redemption of Series A Preferred Stock | — | ( | ( | — | — | — | — | — | — | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions declared on preferred shares | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2023 | $ | $ | $ | $ | $ | $ | ( | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Class A Common Stock | Class B Common Stock | Additional Paid-in Capital | Accumulated Deficit | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
$ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | Total equity | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2022 | $ | $ | $ | $ | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Common stock converted into newly authorized Class B Common Stock | — | — | — | ( | ( | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Shares issued in connection with the BDC Merger (Note 3) | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Distributions declared on common shares ($ | — | — | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Distributions declared on preferred shares | — | — | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | — | $ | — | $ | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
See notes to consolidated financial statements.
F-6
Terra Property Trust, Inc.
Consolidated Statements of Cash Flows
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net loss | $ | ( | $ | ( | |||||||
| Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Provision for credit losses | |||||||||||
| Impairment charges | |||||||||||
| Amortization of net purchase premiums on loans | |||||||||||
| Straight-line rent adjustments | ( | ||||||||||
| Amortization of deferred financing costs | |||||||||||
| Amortization of discount on unsecured notes payable | |||||||||||
| Amortization of above- and below-market rent intangibles | ( | ( | |||||||||
| Amortization and accretion of investment-related fees, net | ( | ( | |||||||||
| Amortization of above-market rent ground lease | ( | ( | |||||||||
| Gain on extinguishment of participation liability | ( | ( | |||||||||
| Gain on sale of interests in unconsolidated investments | ( | ||||||||||
| Realized loss (gain) on investments, net | ( | ||||||||||
| Unrealized losses on investments, net | |||||||||||
| Loss on sale of real estate | |||||||||||
| Distributions received from equity investment in unconsolidated investments | |||||||||||
| Loss (income) from equity investment in unconsolidated investments | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Deal deposits | ( | ||||||||||
| Interest receivable | ( | ( | |||||||||
| Due from related party | |||||||||||
| Other assets | ( | ( | |||||||||
| Due to Manager | |||||||||||
| Unearned income | ( | ( | |||||||||
| Interest payable | ( | ||||||||||
| Accounts payable and accrued expenses | ( | ||||||||||
| Other liabilities | ( | ( | |||||||||
| Net cash provided by operating activities | |||||||||||
| Cash flows from investing activities: | |||||||||||
| Proceeds from repayments of loans | |||||||||||
| Origination and purchase of loans | ( | ( | |||||||||
| Purchase of real estate properties | ( | ||||||||||
| Purchase of held-to-maturity securities | ( | ||||||||||
| Proceeds from redemption of held-to-maturity securities | |||||||||||
| Return of capital on equity interests in unconsolidated investments | |||||||||||
| Purchase of marketable securities | ( | ( | |||||||||
| Purchase of equity interests in unconsolidated investments | ( | ( | |||||||||
| Funding for promissory note receivable | ( | ( | |||||||||
| Proceeds from sale of marketable securities | |||||||||||
| Cash acquired in purchase of real estate | |||||||||||
| Capital expenditures on real estate | ( | ||||||||||
| Proceeds from sale of interests in unconsolidated investments | |||||||||||
| Cash and restricted cash acquired in connection with the BDC Merger | |||||||||||
| Proceeds from sale of real estate | |||||||||||
| Distributions in excess of equity income | |||||||||||
| Proceeds from repayment of promissory note receivable | |||||||||||
| Cash paid to stockholders of Terra BDC in connection with the BDC Merger | ( | ||||||||||
| Net cash used in investing activities | ( | ( | |||||||||
F-7
Terra Property Trust, Inc.
Consolidated Statements of Cash Flows (Continued)
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Cash flows from financing activities: | |||||||||||
| Proceeds from secured financing | |||||||||||
| Principal repayments on secured financing | ( | ( | |||||||||
| Distributions paid | ( | ( | |||||||||
| Payment of financing costs | ( | ( | |||||||||
| Proceeds from obligations under participation agreements | |||||||||||
| Change in interest reserve and other deposits held on investments | ( | ( | |||||||||
| Redemption of Series A Preferred Stock | ( | ||||||||||
| Repayments of obligations under participation agreements | ( | ||||||||||
| Net cash (used in) provided by financing activities | ( | ||||||||||
| Net decrease in cash, cash equivalents and restricted cash | ( | ( | |||||||||
| Cash, cash equivalents and restricted cash at beginning of period | |||||||||||
| $ | $ | ||||||||||
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
Supplemental Disclosure of Cash Flows Information: | |||||||||||
| Cash paid for interest | $ | $ | |||||||||
| Supplemental non-cash information: | |||||||||||
| Reinvestment of shareholder distributions | $ | $ | |||||||||
Supplemental Non-Cash Investing Activities:
In May 2023, the Company acquired five industrial buildings for a $3.5 million cash payment and the settlement of a mezzanine loan that was accounted for as an equity investment and five senior loans that were held for investment. The following table presents a summary of the total capitalized costs and the values of the net assets acquired:
| Total Capitalized Costs: | ||||||||
| Cash and cash equivalents | $ | |||||||
| Loans held for investment | ||||||||
| Equity investment in unconsolidated investment | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| $ | ||||||||
| Net Assets Acquired | ||||||||
| Cash and cash equivalents | $ | |||||||
| Other assets | ||||||||
| Land | ||||||||
| Buildings and Improvements | ||||||||
| Intangible asset and liability: | ||||||||
| In-please lease | ||||||||
| Below-market rent | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| $ | ||||||||
F-8
BDC Merger
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 (the “Merger Agreement”), Terra Income Fund 6, Inc. merged with and into Terra Income Fund 6, LLC, a wholly owned subsidiary of Terra Property Trust, Inc. with Terra Income Fund 6, LLC continuing as the surviving entity of the merger and as a wholly owned subsidiary of the Company (Note 3). The following table presents a summary of the consideration exchanged and assets acquired and liabilities assumed as a result of the merger:
| Total Consideration | ||||||||
| Fair value of Terra Property Trust, Inc. shares of common stock issued | $ | |||||||
| Cash paid for fractional shares | ||||||||
| Transaction costs | ||||||||
| Assets Acquired and Liabilities Assumed at Fair Value | ||||||||
| Loans held for investment | ||||||||
| Loans held for investment acquired through participation | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| Term loan payable | ( | |||||||
| Unsecured notes payable | ( | |||||||
| Obligations under participation agreements | ( | |||||||
| Interest reserve and other deposits held on investments | ( | |||||||
| Due to manager | ( | |||||||
| Interest payable | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| Other liabilities | ( | |||||||
| Net assets acquired excluding cash and restricted cash | ||||||||
| Cash and restricted cash acquired | $ | |||||||
See notes to consolidated financial statements.
F-9
Terra Property Trust, Inc.
Notes to Consolidated Financial Statements
December 31, 2023
Note 1. Business
Terra Property Trust, Inc. (and, together with its consolidated subsidiaries, the “Company” or “Terra Property Trust”) is a real estate investment trust (“REIT”) that originates, invests in and manages a diverse portfolio of real estate and real estate-related assets. The Company was incorporated under the Maryland General Corporation Law on December 31, 2015. The Company focuses primarily on commercial real estate credit investments, including first mortgage loans, subordinated loans (including B-notes, mezzanine and preferred equity) and credit facilities throughout the United States. The Company’s loans finance the acquisition, development or recapitalization of high-quality commercial real estate in the United States. The Company focuses on middle market loans in the approximately $10 million to $50 million range, which it believes are subject to less competition, offer higher risk-adjusted returns than larger loans with similar risk metrics and facilitate portfolio diversification. The Company may also make strategic real estate equity and non-real estate-related investments that align with its investment objectives and criteria.
On January 1, 2016, Terra Secured Income Fund 5, LLC (“Terra Fund 5”), the Company’s then parent, contributed its consolidated portfolio of net assets to the Company pursuant to a contribution agreement in exchange for shares of the Company’s common stock. Upon receipt of the contribution of the consolidated portfolio of net assets from Terra Fund 5, the Company commenced its operations on January 1, 2016. On March 2, 2020, the Company engaged in a series of transactions pursuant to which the Company issued an aggregate of 4,574,470.35 shares of its common stock in exchange for the settlement of an aggregate of $49.8 million of participation interests in loans held by the Company, cash of $25.5 million and other working capital.
The Company has elected to be taxed, and to qualify annually thereafter, as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), commencing with the taxable year ended December 31, 2016. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. The Company also operates its business in a manner that permits it to maintain its exemption from registration as an “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”).
The Company’s investment activities are externally managed by Terra REIT Advisors, LLC (“Terra REIT Advisors” or the “Manager”), a subsidiary of the Company’s sponsor, Terra Capital Partners, LLC (“Terra Capital Partners”), pursuant to a management agreement (the “Management Agreement”), under the oversight of the Company’s board of directors (the “Board”) (Note 8). The Company does not currently have any employees and does not expect to have any employees. Services necessary for the Company’s business are provided by individuals who are employees of the Manager or by individuals who were contracted by the Company or by the Manager to work on behalf of the Company pursuant to the terms of the Management Agreement.
On October 1, 2022, pursuant to that certain Agreement and Plan of Merger, dated as of May 2, 2022 (the “Merger Agreement”), Terra Income Fund 6, Inc. (“Terra BDC”), merged with and into Terra Income Fund 6, LLC (“Terra LLC”), a wholly owned subsidiary of the Company, with Terra LLC continuing as the surviving entity of the merger (the “BDC Merger”) and as a wholly owned subsidiary of the Company (Note 3).
On December 20, 2023, Terra Fund 5 announced that effective December 29, 2023 (the “Distribution Date”), Terra Fund 5 would distribute all of its shares of the Company’s Class B Common Stock to its members as part of the winding up of Terra Fund 5. On the Distribution Date, each member of Terra Fund 5 received 2,252.02 shares of the Company’s Class B Common Stock for each unit of membership interest in Terra Fund 5 held by such member. Because Terra Fund 5 previously owned its interests in the shares of Class B Common Stock indirectly through its ownership of interests in Terra JV, LLC (“Terra JV”), prior to the Distribution Date, Terra JV first distributed the shares of Class B Common Stock to Terra Fund 5 and Terra Secured Income Fund 7, LLC (“Terra Fund 7”), and Terra Fund 5 then distributed those shares to its members on the Distribution Date and Terra Fund 7 became a direct stockholder of the Company’s Class B Common Stock.
As of December 31, 2023, Terra Fund 7 and Terra Offshore Funds REIT, LLC (“Terra Offshore REIT”) held 8.7 % and 10.1 %, respectively, of the issued and outstanding shares of the Company’s common stock.
F-10
Notes to Consolidated Financial Statements
As previously disclosed, the Company continues to explore alternative liquidity transactions on an opportunistic basis to maximize stockholder value. Examples of the alternative liquidity transactions that, depending on market conditions, may be available to the Company include a listing of the Company’s shares of common stock on a national securities exchange, adoption of a share repurchase plan, a liquidation of the Company’s assets, a sale of the Company or a strategic business combination, in each case, which may include the further in-kind distribution of the Company’s shares of common stock indirectly owned by certain of its affiliate funds to the ultimate investors in such affiliate funds. The Company cannot provide any assurance that any alternative liquidity transaction will be available or, if available, that the Company will pursue or be successful in completing any such alternative liquidity transaction.
One of the potential future liquidity transactions that the Company continues to evaluate is a “direct listing” of the Class A Common Stock on a national securities exchange (i.e., a listing not involving a concurrent public offering of newly issued shares). If market conditions are not supportive of a direct listing that would in the Company’s view lead to a constructive trading environment for the Class A Common Stock, the Company will explore alternative paths to pursue its investment strategy and provide liquidity to its investors, including converting the Company into a traditional “non-traded REIT.” As part of a potential conversion to a non-traded REIT, the Company would adopt a customary share repurchase plan pursuant to which its investors could request to have their shares of its common stock redeemed for cash.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include all of the Company’s accounts and those of its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation.
The Company consolidates entities in which it has a controlling financial interest based on either the variable interest entity (“VIE”) or voting interest model. The Company is required to first apply the VIE model to determine whether it holds a variable interest in an entity, and if so, whether the entity is a VIE. If the Company determines it does not hold a variable interest in a VIE, it then applies the voting interest model. Under the voting interest model, the Company consolidates an entity when it holds a majority voting interest in an entity.
The Company accounts for investments in which it has significant influence but not a controlling financial interest using the equity method of accounting (see Note 5).
VIE Model
An entity is considered to be a VIE if any of the following conditions exist: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) the holders of the equity investment at risk, as a group, lack either the direct or indirect ability through voting rights or similar rights to make decisions that have a significant effect on the success of the entity or the obligation to absorb the entity’s expected losses or right to receive the entity’s expected residual returns, or (c) the voting rights of some equity investors are disproportionate to their obligation to absorb losses of the entity, their rights to receive returns from an entity, or both and substantially all of the entity’s activities either involve or are conducted on behalf of an investor with disproportionately few voting rights.
Loans Held for Investment
The Company originates, acquires, and structures, or acquires through participations, real estate-related loans generally to be held to maturity (collectively the “loans”). Loans held for investment are carried at the principal amount outstanding, adjusted for the accretion of discounts on investments and exit fees, and the amortization of premiums on investments and origination fees. The Company’s preferred equity investments, which are economically similar to mezzanine loans and subordinate to any loans but senior to common equity, are accounted for as loans held for investment. Loans are carried at amortized cost less allowance for credit losses. Amortized cost is the amount at which a financing receivable or a loan is
F-11
Notes to Consolidated Financial Statements
originated or acquired, adjusted for accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash and write-offs.
Allowance for Credit Losses
On January 1, 2023, the Company adopted the provisions of Accounting Standards Codification (“ASC”) 326, Financial Instruments – Credit Losses. ASC 326 mandates the use of a current expected credit loss (“CECL”) methodology for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” methodology previously required under United States generally accepted accounting principles (“U.S. GAAP”). The CECL methodology requires the consideration of possible credit losses over the life of an instrument as opposed to estimating credit losses upon the occurrence of an actual loss event under the previous “incurred loss” methodology. As permitted by ASC 326, the Company elected not to measure an allowance for credit losses on accrued interest receivable (which is presented separately on the consolidated balance sheet), but rather write off in a timely manner by reversing interest income that would likely be uncollectible. The Company’s adoption of the ASC 326 resulted in a $4.6 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to member’s capital as of January 1, 2023. Subsequent to the adoption of the CECL methodology, any increase or decrease to the allowance for credit losses is recorded in earnings on the consolidated statement of operations.
Performing Loans
The Company uses a model based approach for estimating the allowance for credit losses on performing loans on a collective basis, including future funding commitments for which the Company does not have the unconditional right to cancel, as these loans share similar risk characteristics. The Company utilizes information obtained from internal and external sources relating to past events, current economic conditions and reasonable and supportable forecasts about the future to determine the expected credit losses for its loan portfolio. The Company utilizes a commercial mortgage based, third-party loan loss model and because the Company does not have a meaningful history of realized credit losses on its loan portfolio, it subscribes to a database service to provide historical proxy loan loss information. The Company employs logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. The Company has chosen to incorporate a weighted average macroeconomic forecast that encompasses baseline, optimistic and pessimistic scenarios, into its allowance for credit losses on performing loans estimate during the reasonable and supportable forecast period which is currently eight quarters. The Company selects certain economics variables from a group of independent variables such as Commercial Real Estate Price Index, unemployment and interest rate which are included in the model as part of macroeconomic forecast and updated regularly based on current economic trends. For the year ended December 31, 2023, adjustments to the weights ascribed to the multiple macroeconomic forecast scenarios were made in response to changes in expectations of macroeconomic conditions such as inflation and interest rates. The specific loan level information input into the model includes loan-to-value and debt service coverage ratio metrics, as well as principal balances, property type, location, coupon rate, coupon rate type, original or remaining term, expected repayment dates and contractual future funding commitments. Based on the inputs, the loan loss model determines a loan loss rate through the generation of a probability of default (PD) and loss given default (LGD) for each loan. The allowance for credit losses on performing loans is then calculated by applying the loan loss rate to the total outstanding loan balance of each loan. These results require a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance for credit losses. Changes in such estimates can significantly affect the expected credit losses.
Beyond the Company’s reasonable and supportable forecast period, the Company reverts to historical loss information on a straight-line basis over the remaining contractual loan term, taken from a period that most accurately reflects the expectation of conditions expected to exist during the period of reversion. The Company may adjust historical loss information for differences in risk that may not reflect the characteristics of its current portfolio, including but not limited to, loan-to-value and debt service coverage ratios, among other relevant factors. The method of reversion selected represents the best estimate of the collectability of the investments and is reevaluated each reporting period.
The determination of the performing loans credit loss estimate considers historical loss information and current economic conditions for each loan, reversion period and reasonable and supportable forecasts about the future. The reasonable and supportable forecast period is determined based on the Company’s assessment of the most likely scenario of assumptions and plausible outcomes for the U.S. economy. The Company regularly evaluates the reasonable and supportable forecast period to determine if a change is needed.
The Company also performs a qualitative assessment and applies qualitative adjustments as necessary, usually due to limitations of the loan loss model. The Company’s qualitative analysis includes a review of data that may directly impact its estimates including internal and external information about the loan or property including current market conditions, asset specific conditions, property operations or borrower/sponsor details (i.e., refinance, sale, bankruptcy) which allows the
F-12
Notes to Consolidated Financial Statements
Company to determine the amount of the expected loss more accurately and reasonably for these investments. The Company also evaluates the contractual life of its loans to determine if changes are needed for certain contractual extension options, renewals, modifications, and prepayments.
Unfunded Commitments
Some of the Company’s performing loans include commitments to fund incremental proceeds to the borrowers over the life of the loan and these unfunded commitments are also subject to the CECL methodology because the Company does not have an unconditional right to cancel such commitments. The allowance for credit losses related to unfunded commitments is recorded as a component of other liabilities on the Company’s consolidated balance sheets. This allowance for credit losses is estimated using the same method outlined above for the Company’s outstanding performing loan balances and increases or decreases are also recorded in earnings on the consolidated statements of operations.
Non-Performing Loans
During the loan review process, if the Company determines that it is not able to collect all amounts due for both principal and interest according to the contractual terms of a loan, the Company considers that loan non-performing. For all non- performing loans, such as those in default, collateral-dependent or modified loans, including historical troubled debt restructurings, the Company removes these loans from the industry loss rate approach described above and analyzes them separately. The credit loss reserve for these loans is calculated as any excess of the amortized cost of the loan over (i) the present value of expected future cash flows discounted at the appropriate discount rate or (ii) the fair value of collateral, if repayment is expected solely from the collateral.
As discussed below in Recent Accounting Pronouncements, the Company adopted the provisions of Accounting Standards Update (“ASU”) 2022-02 Financial Instruments—Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) concurrently with the adoption of CECL on January 1, 2023, prospectively.
Loans Not Secured by Real Estate
The Company has two loans that are not secured by real estate. These loans, which are included in other assets on the consolidated balance sheets, are recorded at amortized cost. The Company performs a separate analysis based on recoverability to determine the allowance for credit losses on these loans. As of December 31, 2023, the Company did not record any allowance for credit losses on these two loans because the Company believes that it will be able to collect all outstanding interest and principal on or before the maturity date.
Allowance for Loan Losses Prior to 2023
Prior to the adoption of the CECL methodology on January 1, 2023, the Company recorded an allowance for loan losses using the incurred loss methodology equal to (i) 1.5 % of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5 % of the aggregate carrying amount of loans rated as a “5”, plus (iii) non-performing loan reserves, if any.
The Company assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and (iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk, as follows:
| Risk Rating | Description | |||||||
| 1 | Very low risk | |||||||
| 2 | Low risk | |||||||
| 3 | Moderate/average risk | |||||||
| 4 | Higher risk | |||||||
| 5 | Highest risk | |||||||
Equity Investment in Unconsolidated Investments
The Company accounts for its equity interests in unconsolidated investments under the equity method of accounting, i.e., at cost, increased or decreased by its share of earnings or losses, less distributions, plus contributions and other adjustments required by equity method accounting.
F-13
Notes to Consolidated Financial Statements
The Company evaluates its equity investment unconsolidated investments on a periodic basis to determine if there are any indicators that the value of its equity investments may be impaired and whether or not that impairment is other-than-temporary. To the extent an impairment has occurred and is determined to be other-than-temporary, the Company measures the charge as the excess of the carrying value of its investment over its estimated fair value, which is determined by calculating its share of the estimated fair market value of the underlying net assets based on the terms of the applicable partnership or joint venture agreements.
Held-to-Maturity Debt Securities
The Company classifies debt securities for which it has both the positive intent and ability to hold until maturity of the security as held-to-maturity debt securities. These securities are recorded at amortized cost with changes in amortized cost recognized in earnings until realized. Held-to-maturity debt securities are subject to the allowance for credit losses described above.
Marketable Securities
Real Estate Owned, Net
Real estate acquired is recorded at its estimated fair value at acquisition and is shown net of accumulated depreciation and impairment charges.
Acquisition of properties generally are accounted for as asset acquisitions. Under asset acquisition accounting, the costs to acquire real estate, including transaction costs, are accumulated and then allocated to individual assets and liabilities acquired based upon their relative fair value. The Company allocates the purchase price of its real estate acquisitions to land, building, tenant improvements, acquired in-place leases, intangibles for the value of any above or below market leases at fair value and to any other identified intangible assets or liabilities. The Company amortizes the value allocated to in-place leases over the remaining lease term, which is reported in depreciation and amortization expense on its consolidated statements of operations. The value allocated to above or below market leases are amortized over the remaining lease term as an adjustment to rental income.
Real estate assets are depreciated using the straight-line method over their estimated useful lives: buildings and improvements - not to exceed 40 years, and tenant improvements - shorter of the lease term or life of the asset. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their estimated useful life.
Leases
The Company determines if an arrangement is a lease at inception. Operating leases in which the Company is the lessee are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in the consolidated balance sheets.
ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company’s lease typically does not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company uses the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made in advance and excludes lease incentives if there were any. The Company’s lease term may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. Lease expense is recognized on a straight-line basis over the lease term.
F-14
Notes to Consolidated Financial Statements
On October 19, 2023, in connection with the deed in lieu of foreclosure discussed in Note 6, the Company is no longer a party to the ground lease and the related ROU assets and liabilities were written off.
Revenue Recognition
Revenue is recognized 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.
Interest Income: Interest income is accrued based upon the outstanding principal amount and contractual terms of the loans and preferred equity investments that the Company expects to collect, and it is accrued and recorded on a daily basis. Discounts and premiums on investments purchased are accreted or amortized over the expected life of the respective loan using the effective yield method, and are included in interest income in the consolidated statements of operations. Loan origination fees and exit fees, net of portions attributable to obligations under participation agreements, are capitalized and amortized or accreted to interest income over the life of the investment using the effective yield method. Outstanding interest receivable is assessed for recoverability. The Company generally reverses the accrued and unpaid interest against interest income and no longer accrues for the interest when, in the opinion of the Manager, recovery of income and principal becomes doubtful. Interest is then recorded on the basis of cash received until accrual is resumed when the loan becomes contractually current and performance is demonstrated. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability.
The Company holds loans in its portfolio that may contain paid-in-kind (“PIK”) interest provisions. The PIK interest, which represents contractually deferred interest that is added to the principal balance that is due at maturity, is recorded on the accrual basis.
Real Estate Operating Revenues: Real estate operating revenue is derived from leasing of space to various types of tenants. The leases are for fixed terms of varying length and generally provide for annual rent increases and expense reimbursements to be paid in monthly installments. Lease revenue, or rental income from leases, is recognized on a straight-line basis over the term of the respective leases. Additionally, the Company recorded above- and below-market lease intangibles, which are included in real estate owned, net, in connection with the acquisition of the real estate properties. These intangible assets and liabilities are amortized to lease revenue over the remaining contractual lease term.
Other Revenues: Prepayment fee income is recognized as prepayments occur. All other income is recognized when earned.
Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments, with original maturities of ninety days or less when purchased, as cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. The Company maintains all of its cash at financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation.
Restricted cash represents cash held as additional collateral by the Company on behalf of the borrowers related to the investments in loans or preferred equity instruments for the purpose of such borrowers making interest and property-related operating payments. Restricted cash is not available for general corporate purposes. The related liability is recorded in “Interest reserve and other deposits held on investments” on the consolidated balance sheets.
| December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Cash and cash equivalents | $ | $ | ||||||||||||
| Restricted cash | ||||||||||||||
| Cash held in escrow by lender | ||||||||||||||
| Total cash, cash equivalents and restricted cash shown in the consolidated statements of cash flows | $ | $ | ||||||||||||
F-15
Notes to Consolidated Financial Statements
Secured Financing Agreements, Net
Fair Value Measurements
U.S. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The Company has not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, obligations under participation agreements, secured borrowing, unsecured notes, mortgage loan payable, term loan payable, repurchase agreement payment and revolving line of credit. Such financial instruments are carried at amortized cost, less impairment, where applicable. Marketable securities are financial instruments that are reported at fair value.
Deferred Financing Costs
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code commencing with the taxable year ended December 31, 2016. In order to qualify as a REIT, the Company is required, among other things, to distribute dividends equal to at least 90% of its REIT net taxable income to the stockholders and meet certain tests regarding the nature of its income and assets. As a REIT, the Company is not subject to federal income taxes on income and gains distributed to the stockholders as long as certain requirements are satisfied, principally relating to the nature of income and the level of distributions, as well as other factors. If the Company fails to continue to qualify as a REIT in any taxable year and does not qualify for certain statutory relief provisions, the Company will be subject to U.S. federal and state income taxes at regular corporate rates (including any applicable alternative minimum tax) beginning with the year in which it fails to qualify and may be precluded from being able to elect to be treated as a REIT for the Company’s four subsequent taxable years. Any gains from the sale of foreclosed properties within two years are subject to U.S. federal and state income taxes at regular corporate rates. As of December 31, 2023, the Company has satisfied all the requirements for a REIT.
F-16
Notes to Consolidated Financial Statements
Earnings Per Share
The Company has a simple equity capital structure with only common stock outstanding as of December 31, 2023 and common stock and preferred stock outstanding as of December 31, 2022. As a result, earnings per share, as presented, represent both basic and dilutive per-share amounts for the periods presented in the consolidated financial statements. Income per basic share of common stock is calculated by dividing net income allocable to common stock by the weighted-average number of shares of common stock issued and outstanding during such period.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may ultimately differ from those estimates, and those differences could be material.
Segment Information
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. In April 2019, the FASB issued additional amendments to clarify the scope of ASU 2016-13 and address issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other things. In May 2019, the FASB issued ASU 2019-05 — Targeted Transition Relief, which provides an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. In October 2019, the FASB decided that for smaller reporting companies, ASU 2016-13 and related amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company meets the definition of a smaller reporting company under the regulation of the Securities and Exchange Commission. The Company adopted this ASU and related amendments on January 1, 2023. The adoption of ASU 2016-13 resulted in an incremental reserve of approximately $4.6 million, which included a reserve on future loan funding commitments. The Company recorded the cumulative effect of initially applying this guidance as an adjustment to Accumulated deficit using the modified retrospective method of adoption.
London Interbank Offered Rate (“LIBOR”) is a benchmark interest rate referenced in a variety of agreements that are used by all types of entities. In July 2017, the U.K. Financial Conduct Authority, which regulates the LIBOR administrator, ICE Benchmark Administration Limited (“IBA”), announced that it would cease to compel banks to participate in setting LIBOR as a benchmark by the end of 2021, which was subsequently delayed to June 30, 2023. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) — Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendments in ASU 2020-04 provide optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848), which expanded the scope of Topic 848 to include derivative instruments impacted by discounting transition (“ASU 2021-01”). As of December 31, 2023, all of the Company’s floating rate loans and related financings have transitioned to the applicable replacement benchmark rate, or reference a benchmark rate that is not expected to be replaced.
F-17
Notes to Consolidated Financial Statements
Note 3. Mergers
BDC Merger
On October 1, 2022 (the “Closing Date”), pursuant to the Merger Agreement, Terra BDC merged with and into Terra LLC, with Terra LLC surviving as a wholly owned subsidiary of the Company. The Certificate of Merger and Articles of Merger with respect to the BDC Merger were filed with the Secretary of State of the State of Delaware and State Department of Assessments and Taxation of Maryland (the “SDAT”), respectively, with an effective time and date of 12:02 a.m., Eastern Time, on the Closing Date (the “Effective Time”).
At the Effective Time, except for any shares of common stock, par value $0.001 per share, of Terra BDC (“Terra BDC Common Stock”) held by the Company or any wholly owned subsidiary of the Company or Terra BDC, which shares were automatically retired and ceased to exist with no consideration paid therefor, each issued and outstanding share of Terra BDC Common Stock was automatically cancelled and retired and converted into the right to receive (i) 0.595 shares of the newly designated Class B Common Stock, par value $0.01 per share (“Class B Common Stock”) and (ii) cash, without interest, in lieu of any fractional shares of Class B Common Stock otherwise issuable in an amount, rounded to the nearest whole cent, determined by multiplying (x) the fraction of a share of Class B Common Stock to which such holder would otherwise be entitled by (y) $14.38 .
Pursuant to the terms of the transactions described in the Merger Agreement, approximately 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders in connection with the BDC Merger, based on the number of outstanding shares of Terra BDC Common Stock as of the Closing Date. Following the consummation of the BDC Merger, former Terra BDC stockholders owned approximately 19.9 % of the common equity of the Company.
The Company and Terra BDC prepared their respective financial statements in accordance with generally accepted accounting principles in the United States. The BDC Merger is accounted for using the acquisition method of accounting, with the Company being treated as the accounting acquirer. In identifying the Company as the acquiring entity for accounting purposes, the Company and Terra BDC took into account a number of factors, including the relative size of the merging companies, which entity issues additional shares in conjunction with the BDC Merger, the relative voting interests of the respective stockholders after consummation of the BDC Merger, and the composition of the Board and senior management of the combined company after consummation of the BDC Merger.
The Company, as the acquirer, accounted for the BDC Merger as an asset acquisition and all direct acquisition-related costs are capitalized to the total cost of the assets acquired and liabilities assumed. Pursuant to ASC Topic 805, Business Combination, total cost is allocated to the assets acquired and liabilities assumed on a relative fair value basis.
F-18
Notes to Consolidated Financial Statements
The following table summarizes the total consideration and the fair values of assets acquired and liabilities assumed in the BDC Merger:
| Total Consideration | ||||||||
Fair value of Terra Property Trust shares of common stock issued | $ | |||||||
| Cash paid for fractional shares | ||||||||
| Transaction costs | ||||||||
| $ | ||||||||
| Assets Acquired and Liabilities Assumed at Fair Value | ||||||||
| Cash and cash equivalents | $ | |||||||
| Restricted cash | ||||||||
| Loans held for investment | ||||||||
| Loans held for investment acquired through participation | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| Term loan payable | ( | |||||||
| Unsecured notes payable | ( | |||||||
| Obligations under participation agreements | ( | |||||||
| Interest reserve and other deposits held on investments | ( | |||||||
| Due to manager | ( | |||||||
| Interest payable | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| Other liabilities | ( | |||||||
| Net assets acquired | $ | |||||||
The fair value of the 4,847,910 shares of the Class B Common Stock was determined based on the Company’s net asset value per share of $14.66 as of October 1, 2022.
Net Gain on Extinguishment of Participation Liability
As discussed in Note 8, in the normal course of business, the Company may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties. As a result of the BDC Merger, the obligations under participation agreements with Terra BDC totaling $37.0 million were effectively extinguished and the Company recognized a net gain of $3.4 million, representing the difference between the carrying value of the Company’s obligations under participation agreements and the fair value of Terra BDC’s investments acquired through participation agreements.
Appointment of Directors
As of the Effective Time and in accordance with the Merger Agreement, the size of the Board was increased by three members and each of Spencer Goldenberg, Adrienne Everett and Gaurav Misra (each a “Terra BDC Designee”, and collectively, the “Terra BDC Designees”) were elected to the Board to fill the vacancies created by such increase, with each Terra BDC Designee to serve until the Company’s next annual meeting of stockholders and until his or her successor is duly elected and qualifies. Each of the other members of the Board immediately prior to the Effective Time continued as members following the Effective Time.
Indemnification Agreements
The Company has entered into customary indemnification agreements with each member of the Board (including each Terra BDC Designee). These agreements, among other things, require the Company to indemnify each director to the maximum
F-19
Notes to Consolidated Financial Statements
extent permitted by Maryland law, including indemnification of expenses such as attorney’s fees, judgments, fines and settlement amounts incurred in any action or proceeding, including any action or proceeding by or in right of the Company, arising out of his or her service as a director.
WMC Merger Agreement
On June 28, 2023, the Company announced it entered into an Agreement and Plan of Merger, dated as of June 27, 2023 (the “WMC Merger Agreement”), with Western Asset Mortgage Capital Corporation, a Delaware corporation (“WMC”). On July 27, 2023, WMC notified the Company that its board of directors determined that a proposal from AG Mortgage Investment Trust, Inc. (“MITT”) to acquire WMC was a “Parent Superior Proposal” under the WMC Merger Agreement and that WMC’s board of directors intended to terminate the WMC Merger Agreement unless WMC received a revised proposal from the Company by a specified deadline such that WMC’s board of directors determined that MITT’s proposal was no longer a “Parent Superior Proposal.”
On July 25, 2023, the Company disclosed that it acquired approximately 5.2 % of the outstanding shares of common stock of MITT as of July 24, 2023.
On August 8, 2023, WMC terminated the WMC Merger Agreement pursuant to its terms (the “Termination”), and the Company was paid a termination fee of $3.0 million. The termination fee was used to pay the professional fees incurred in connection with contemplated merger.
Note 4. Loans Held for Investment
The Company elected the practical expedient under ASC 326 to exclude accrued interest from amortized cost. As of December 31, 2023 and 2022, accrued of $6.5 million and $4.1 million, respectively, is included in interest receivable on the consolidated balance sheets, and is excluded from the amortized cost of loans held for investment.
Portfolio Summary
The following table provides a summary of the Company’s loan portfolio as of:
| December 31, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Fixed Rate | Floating Rate (1)(2)(3) | Total | Fixed Rate | Floating Rate (1)(2)(3) | Total | ||||||||||||||||||||||||||||||
| Number of loans | |||||||||||||||||||||||||||||||||||
| Principal balance | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Carrying value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Fair value | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Weighted-average coupon rate | % | % | % | % | % | % | |||||||||||||||||||||||||||||
| Weighted-average remaining term (years) | |||||||||||||||||||||||||||||||||||
_______________
(1)These loans pay a coupon rate of LIBOR, Secured Overnight Financing Rate (“SOFR”), or forward-looking term rate based on SOFR (“Term SOFR”), as applicable, plus a fixed spread. Coupon rates shown were determined using LIBOR of 5.47 %, average SOFR of 5.34 % and Term SOFR of 5.35 % as of December 31, 2023 and LIBOR of 4.39 %, average SOFR of 4.06 % and Term SOFR of 4.36 % as of December 31, 2022.
(2)As of December 31, 2023 and 2022, amount included $342.9 million and $413.1 million of senior mortgages used as collateral for $204.9 million and $261.0 million of borrowings under secured financing arrangements, respectively (Note 9).
(3)As of December 31, 2023 and 2022, 14 and 21 loans, respectively, were subject to a LIBOR, SOFR or Term SOFR floor, as applicable.
F-20
Notes to Consolidated Financial Statements
Lending Activities
The following tables present the activities of the Company’s loan portfolio:
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, January 1, 2023 | $ | $ | $ | ||||||||||||||
Cumulative effect of credit loss accounting standard effective | ( | ( | ( | ||||||||||||||
| Principal repayments received | ( | ( | ( | ||||||||||||||
| New loans made | |||||||||||||||||
Settlement of loans (1)(2) | ( | ( | |||||||||||||||
| Net amortization of premiums on loans | ( | ( | |||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | ( | ( | ( | ||||||||||||||
| Provision for credit losses | ( | ( | ( | ||||||||||||||
Balance, December 31, 2023 | $ | $ | $ | ||||||||||||||
_______________
(1)In May 2023, the Company settled $68.7 million of senior loans in exchange for ownership interest in the underlying real estate properties (Note 6).
(2)In November 2023, the Company settled a $20.8 million mezzanine loan and wrote off the related allowance for credit losses of $18.3 million in exchange for a $2.5 million note from the sponsor. On the date of closing, the sponsor made a payment of $0.5 million. The remaining $2.0 million is included in Other assets on the consolidated balance sheets.
| Loans Held for Investment | Loans Held for Investment through Participation Interests | Total | |||||||||||||||
| Balance, January 1, 2022 | $ | $ | $ | ||||||||||||||
| New loans made | |||||||||||||||||
| Principal repayments received | ( | ( | |||||||||||||||
| Loans acquired and contributed in connection with the BDC Merger | ( | ||||||||||||||||
| Net amortization of premiums on loans | ( | ( | ( | ||||||||||||||
| Accrual, payment and accretion of investment-related fees and other, net | |||||||||||||||||
| Provision for credit losses | ( | ( | |||||||||||||||
Balance, December 31, 2022 | $ | $ | $ | ||||||||||||||
F-21
Notes to Consolidated Financial Statements
Portfolio Information
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Loan Structure | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| First mortgages | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| Preferred equity investments | % | % | ||||||||||||||||||||||||||||||||||||
| Mezzanine loans | % | % | ||||||||||||||||||||||||||||||||||||
| Credit facility | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Property Type | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| Office | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| Multifamily | % | % | ||||||||||||||||||||||||||||||||||||
| Industrial | % | % | ||||||||||||||||||||||||||||||||||||
| Mixed-use | % | % | ||||||||||||||||||||||||||||||||||||
| Infill land | % | % | ||||||||||||||||||||||||||||||||||||
| Hotel - full/select service | % | % | ||||||||||||||||||||||||||||||||||||
| Student housing | % | % | ||||||||||||||||||||||||||||||||||||
| Infrastructure | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||
| Geographic Location | Principal Balance | Carrying Value | % of Total | Principal Balance | Carrying Value | % of Total | ||||||||||||||||||||||||||||||||
| United States | ||||||||||||||||||||||||||||||||||||||
| California | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
| New York | % | % | ||||||||||||||||||||||||||||||||||||
| New Jersey | % | % | ||||||||||||||||||||||||||||||||||||
| Georgia | % | % | ||||||||||||||||||||||||||||||||||||
| Utah | % | % | ||||||||||||||||||||||||||||||||||||
| Washington | % | % | ||||||||||||||||||||||||||||||||||||
| Arizona | % | % | ||||||||||||||||||||||||||||||||||||
| North Carolina | % | % | ||||||||||||||||||||||||||||||||||||
| Massachusetts | % | % | ||||||||||||||||||||||||||||||||||||
| Texas | % | % | ||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | — | ( | ( | % | — | ( | ( | % | ||||||||||||||||||||||||||||||
| Total | $ | $ | % | $ | $ | % | ||||||||||||||||||||||||||||||||
Allowance for Credit Losses
As described in Note 2, on January 1, 2023, the Company adopted the provisions of ASU 2016-13, which requires entities to recognize credit losses on financial instruments based on an estimate of current expected credit losses. The adoption of ASU
F-22
Notes to Consolidated Financial Statements
2016-13 resulted in a $4.6 million increase to total reserve, including reserve on future funding commitments, which was recognized as a cumulative-effect adjustment to accumulated deficits as of January 1, 2023.
The following table presents the activity in allowance for credit loss for funded loans:
| Years Ended December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Allowance for credit losses, beginning of period | $ | $ | ||||||||||||
Cumulative effect of credit loss accounting standard effective | — | |||||||||||||
Provision for credit losses (1) | ||||||||||||||
Charge-offs (2) | ( | |||||||||||||
| Recoveries | ||||||||||||||
| Allowance for credit losses, end of period | $ | $ | ||||||||||||
_______________
(1)Prior to the adoption of the CECL model on January 1, 2023, the Company recorded an allowance for credit losses equal to (i) 1.5 % of the aggregate carrying amount of loans rated as a “4”, plus (ii) 5 % of the aggregate carrying amount of loans rated as a “5”, plus (iii) non-performing loan reserves, if any.
(2)Amount is related to the settlement of a mezzanine loan described in “Lending Activities” above.
Certain of the Company’s performing loans contain provisions for future fundings, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These unfunded commitments amounted to approximately $35.7 million and $47.3 million as of December 31, 2023 and 2022, respectively. The following table presents the activity in the liability for credit losses on unfunded commitments:
| Year Ended December 31, 2023 | ||||||||
| Liability for credit losses on unfunded commitments, beginning of period | $ | |||||||
| Reversal of provision for credit losses | ( | |||||||
| Liability for credit losses on unfunded commitments, end of period | $ | |||||||
The liability for credit losses on unfunded commitments is included in other liabilities on the consolidated balance sheets.
Accrued Interest Receivable
The Company elected not to measure a CECL reserve on accrued interest receivable due to the Company’s policy of writing off uncollectible accrued interest receivable balances in a timely matter. If the Company determines it has uncollectible accrued interest receivable, it generally would reverse the accrued and unpaid interest against interest income and no longer accrue for interest. For the years ended December 31, 2023 and 2022, the Company did not reverse any interest income accrual because all accrued interest income was deemed collectible. As of December 31, 2023 and 2022, the Company had four and two loans that were in default, and suspended interest income accrual of $18.4 million and $8.5 million for the years ended December 31, 2023 and 2022, respectively, because recovery of such income was doubtful. As of December 31, 2023 and 2022, there was no
Non-Performing Loans
As discussed in Note 2, for loans that are considered non-performing, the Company removes them from the industry loss rate approach and analyzes them separately for recoverability. As of December 31, 2023 and 2022, the Company had six and four non-performing loans with total carrying value of $209.3 million and $89.9 million, respectively. Accordingly, the Company utilized the estimated fair value of the loan collateral or sponsor’s guarantee to estimate the total allowance for credit losses of $54.6 million and $25.5 million as of December 31, 2023 and 2022, respectively. Please see “Note 7. Fair Value Measurements – Significant Unobservable Inputs” for information on how the fair value of these loans were determined.
Loan Risk Rating
The Company assesses the risk factors of each loan and assigns each loan a risk rating between 1 and 5, which is an average of the numerical ratings in the following categories: (i) sponsor capability and financial condition; (ii) loan and collateral performance relative to underwriting; (iii) quality and stability of collateral cash flows and/or reserve balances; and
F-23
Notes to Consolidated Financial Statements
(iv) loan to value. Based on a 5-point scale, the Company’s loans are rated “1” through “5”, from less risk to greater risk, as follows:
| Risk Rating | Description | |||||||
| 1 | Very low risk | |||||||
| 2 | Low risk | |||||||
| 3 | Moderate/average risk | |||||||
| 4 | Higher risk | |||||||
| 5 | Highest risk | |||||||
| December 31, 2023 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan Risk Rating | Number of Loans | Amortized Cost | % of Total | Amortized Cost by Year Originated | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2023 | 2022 | 2021 | 2020 | 2019 | Prior | |||||||||||||||||||||||||||||||||||||||||||||||||||
| 1 | $ | % | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||
| 2 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 3 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 4 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 5 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Non-performing | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| % | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for credit losses | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total, net of allowance for credit losses | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
The following table presents the principal balance and the amortized cost of the Company’s loans based on the loan risk rating as of December 31, 2022:
| December 31, 2022 | ||||||||||||||||||||||||||
| Loan Risk Rating | Number of Loans | Principal Balance | Amortized Cost | % of Total | ||||||||||||||||||||||
| 1 | $ | $ | % | |||||||||||||||||||||||
| 2 | % | |||||||||||||||||||||||||
| 3 | % | |||||||||||||||||||||||||
| 4 | % | |||||||||||||||||||||||||
| 5 | % | |||||||||||||||||||||||||
Non-performing (1) | % | |||||||||||||||||||||||||
| $ | % | |||||||||||||||||||||||||
| Allowance for credit losses | ( | |||||||||||||||||||||||||
| Total, net of allowance for credit losses | $ | |||||||||||||||||||||||||
_______________
Troubled Debt Restructuring
As of December 31, 2022, there was one investment that qualified as troubled debt restructuring.
In December 2022, the borrower of a $40.1 million senior loan experienced financial difficulty and offered to repay the loan for $38.7 million. The remaining $1.4 million was converted to subordinated equity that accrues dividends at 8.0 % and the
F-24
Notes to Consolidated Financial Statements
Company is entitled to receive waterfall profit upon a sale. The Company does not anticipate a full recovery of the equity position and does not expect to receive any additional income. As a result, the remaining $1.4
The following table summarizes the recorded investment of TDR as of the date of restructuring:
| Number of loans modified | ||||||||
| Pre-modified recorded carrying value | $ | |||||||
Post-modified recorded carrying value (1) | $ | |||||||
(1) As of December 31, 2023 and 2022, the principal balance of this loan was the same as the carrying value. The Company recorded an allowance for credit losses of $1.4
Note 5. Equity Investment in Unconsolidated Investments
The Company owns interests in a limited partnership and three
Equity Investment in a Limited Partnership
On August 3, 2020, the Company entered into a subscription agreement with Mavik Real Estate Special Opportunities Fund, LP (“RESOF”) whereby the Company committed to fund up to $50.0 million to purchase a limited partnership interest in RESOF. RESOF’s primary investment objective is to generate attractive risk-adjusted returns by purchasing performing and non-performing mortgages, loans, mezzanines and other credit instruments supported by underlying commercial real estate assets. RESOF may also opportunistically originate high-yield mortgages or loans in real estate special situations including rescue financings, bridge loans, restructurings and bankruptcies (including debtor-in-possession loans). The general partner of RESOF is Mavik Real Estate Special Opportunities Fund GP, LLC, which is a subsidiary of the Company’s sponsor, Terra Capital Partners. As of December 31, 2023 and 2022, the unfunded commitment was $37.4 million and $22.4 million, respectively.
The Company evaluated its equity interest in RESOF and determined it does not have a controlling financial interest and is not the primary beneficiary. Accordingly, the equity interest in RESOF is accounted for as an equity method investment. As of December 31, 2023 and 2022, the Company owned 14.9 % and 27.9 % of the equity interest in RESOF, respectively. As of December 31, 2023 and 2022, the carrying value of the Company’s investment in RESOF was $18.2 million and $36.8 million, respectively. For the year ended December 31, 2023, the Company recorded equity income from RESOF of $1.1 million. The equity income for the year ended December 31, 2023 included the negative adjustments made due to the dilution in the Company’s ownership interest in RESOF as new investors were admitted in 2022 and 2023. For the year ended December 31, 2023, the Company received distributions from RESOF of $6.6 million. For the year ended December 31, 2022, the Company recorded equity income from RESOF of $5.2 million and received no distributions from RESOF.
In connection with the equity investment in RESOF, the Company paid origination fees to the Manager totaling $0.5 million, to be amortized to equity income on a straight-line basis over the life of RESOF.
F-25
Notes to Consolidated Financial Statements
The following tables present summarized financial information of the Company’s equity investment in RESOF. Amounts provided are the total amounts attributable to the investment and do not represent the Company’s proportionate share:
| As of December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
Investments at fair value (cost of $ | $ | $ | ||||||||||||
| Other assets | ||||||||||||||
| Total assets | ||||||||||||||
| Revolving line of credit, net of financing costs | ||||||||||||||
Obligations under participation agreement (proceeds of $ $ | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Partners’ capital | $ | $ | ||||||||||||
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Total investment income | $ | $ | |||||||||
| Total expenses | |||||||||||
| Net investment income | |||||||||||
| Unrealized appreciation (depreciation) on investments | ( | ||||||||||
| Provision for income tax | ( | ||||||||||
| Net increase in partners’ capital resulting from operations | $ | $ | |||||||||
Equity Investment in Joint Ventures
As of December 31, 2023 and 2022, the Company beneficially owned equity interests in three 53 % effective interest in two joint ventures and 59 % effective interest in another joint venture for a total of $33.7 million and recognized a gain on sale of $0.8 million.
In December 2022, the Company originated a $10.0 million mezzanine loan to a borrower to finance the acquisition of a real estate portfolio. In connection with this mezzanine loan, the Company entered into a residual profit sharing agreement with the borrower where the borrower would pay the Company an additional amount of 35.0 % of remaining net cash flow from the sale of the real estate portfolio. The Company accounted for this arrangement using the equity method of accounting. In May 2023, the Company purchased the underlying asset (Note 8) and the $10.0 million mezzanine loan was settled in connection with the purchase. In November 2023, in connection with a loan restructuring, the Company contributed $5.0 million to another joint venture that owns a real estate property. The Company accounted for its investment in this joint venture as an equity method investment because it does not have a controlling financial interest in the entity.
F-26
Notes to Consolidated Financial Statements
The following table presents a summary of the Company’s equity investment in unconsolidated investments as of:
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||
| Entity | Co-owner | Beneficial Ownership Interest | Carrying Value | Beneficial Ownership Interest | Carrying Value | |||||||||||||||||||||||||||
| LEL Arlington JV LLC | Third party/Affiliate | $ | $ | |||||||||||||||||||||||||||||
| LEL NW 49th JV LLC | Third party/Affiliate | |||||||||||||||||||||||||||||||
| TCG Corinthian FL Portfolio JV LLV | Third party/Affiliate | |||||||||||||||||||||||||||||||
Windy Hill PV Five CM, LLC (1) | Third party | N/A | ||||||||||||||||||||||||||||||
SF-Dallas Industrial, LLC (2) | N/A | N/A | N/A | |||||||||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||||||||
_______________
(1)This investment was acquired in November 2023.
(2)This investment that meets the definition of an equity investment was entered into in December 2022. As discussed above, this investment was settled in May 2023.
The following tables present estimated combined summarized financial information of the Company’s equity investment in the joint ventures. Amounts provided are the total amounts attributable to the joint ventures and do not represent the Company’s proportionate share:
| As of December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Net investments in real estate | $ | $ | ||||||||||||
| Other assets | ||||||||||||||
| Total assets | ||||||||||||||
| Mortgage loan payable | ||||||||||||||
| Other liabilities | ||||||||||||||
| Total liabilities | ||||||||||||||
| Members’ capital | $ | $ | ||||||||||||
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Revenues | $ | $ | |||||||||
| Operating expenses | ( | ( | |||||||||
| Depreciation and amortization expense | ( | ( | |||||||||
| Interest expense | ( | ( | |||||||||
| Unrealized (losses) gains | ( | ||||||||||
| Net loss | $ | ( | $ | ( | |||||||
For the year ended December 31, 2023, the Company recorded net equity loss from the joint ventures and the mezzanine loan of $3.5 million, and did not receive any distributions from the joint ventures. For the year ended December 31, 2022, the Company recorded net equity loss from the joint ventures of $2.5 million, and received distributions from the joint ventures of $0.9 million. In connection with these investments, the Company paid origination fee to the Manager totaling $0.6 million, to be amortized to equity income over the life of the respective joint venture.
F-27
Notes to Consolidated Financial Statements
Note 6. Real Estate Owned, Net
Real Estate Activities
2023 — During the year ended December 31, 2023, the Company recorded an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value. In October 2023, the Company conveyed its interest in the office building to the lender by deed-in-lieu of foreclosure and recognized a loss on disposal of real estate of $4.2 million. Accordingly, the Company no longer owns the multi-tenant office building.
Additionally, during the year ended December 31, 2023, the Company entered into the following investments:
| Property Location | Number of Properties | Date of Acquisition | Property Type | Total Capitalized Costs | ||||||||||||||||||||||
| Texas, United States | 3/24/2023 | Industrial | $ | |||||||||||||||||||||||
| Texas, United States | 5/25/2023 | Industrial | ||||||||||||||||||||||||
| $ | ||||||||||||||||||||||||||
These acquisitions were deemed to be real estate asset acquisitions, and therefore total transaction costs were capitalized to the cost basis of the assets. The following table presents an allocation of the total capitalized costs:
| Total Capitalized Costs: | ||||||||
| Cash and cash equivalents | $ | |||||||
| Loans held for investment | ||||||||
| Equity investment in unconsolidated investment | ||||||||
| Interest receivable | ||||||||
| Other assets | ||||||||
| $ | ||||||||
| Net Assets Acquired | ||||||||
| Cash and cash equivalents | $ | |||||||
| Other assets | ||||||||
| Land | ||||||||
| Buildings and Improvements | ||||||||
| Intangible assets and liabilities: | ||||||||
In-place lease (weighted-average expected life of | ||||||||
Below-market rent (weighted-average expected life of | ( | |||||||
| Accounts payable and accrued expenses | ( | |||||||
| $ | ||||||||
2022 — In June 2022, the Company sold the 4.9 acres of land it owned in Pennsylvania for net proceeds of $8.6 million and recognized a net loss on sale of $0.1 million, excluding impairment charges of $1.6 million and $3.4 million recognized in March 2022 and December 2021, respectively.
F-28
Notes to Consolidated Financial Statements
Real Estate Owned, Net
Real estate owned is comprised of eight industrial buildings located in Texas and a multi-tenant office building located in California, with lease intangible assets and liabilities. The following table presents the components of real estate owned, net as of:
| December 31, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| Cost | Accumulated Depreciation/Amortization | Net | Cost | Accumulated Depreciation/Amortization | Net | ||||||||||||||||||||||||||||||
| Real estate: | |||||||||||||||||||||||||||||||||||
| Land | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Building and building improvements | ( | ( | |||||||||||||||||||||||||||||||||
| Tenant improvements | ( | ( | |||||||||||||||||||||||||||||||||
| Furniture and fixtures | ( | ||||||||||||||||||||||||||||||||||
| Total real estate | ( | ( | |||||||||||||||||||||||||||||||||
| Lease intangible assets: | |||||||||||||||||||||||||||||||||||
| In-place lease | ( | ( | |||||||||||||||||||||||||||||||||
| Above-market rent | ( | ||||||||||||||||||||||||||||||||||
| Total intangible assets | ( | ( | |||||||||||||||||||||||||||||||||
| Lease intangible liabilities: | |||||||||||||||||||||||||||||||||||
| Below-market rent | ( | ( | ( | ( | |||||||||||||||||||||||||||||||
| Above-market ground lease | ( | ( | |||||||||||||||||||||||||||||||||
| Total intangible liabilities | ( | ( | ( | ( | |||||||||||||||||||||||||||||||
| Total real estate | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
Real Estate Operating Revenues and Expenses
The following table presents the components of real estate operating revenues and expenses that are included in the consolidated statements of operations:
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Real estate operating revenues: | |||||||||||
| Lease revenue | $ | $ | |||||||||
| Other operating income | |||||||||||
| Total | $ | $ | |||||||||
| Real estate operating expenses: | |||||||||||
| Utilities | $ | $ | |||||||||
| Real estate taxes | |||||||||||
| Repairs and maintenances | |||||||||||
| Management fees | |||||||||||
| Lease expense, including amortization of above-market ground lease | |||||||||||
| Other operating expenses | |||||||||||
| Total | $ | $ | |||||||||
Leases
As of December 31, 2023, the Company owned eight industrial buildings that were leased to ten tenants. As of December 31, 2022, the Company owned a multi-tenant office building that was leased to three tenants. In addition, the office building was subject to a ground lease whereby the Company was the lessee (or a tenant) to the ground lease. The ground lease provided for a new base rent every 5 years based on the greater of the annual base rent for the prior lease year or 9 % of the fair market value of the land. The next rent reset on the ground lease is scheduled for November 1, 2025. The Company was litigating with
F-29
Notes to Consolidated Financial Statements
the landlord with respect to the appropriate method for determining the fair value of the land for purposes of setting the ground rent – Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217. On October 19, 2023, the Company conveyed its interest in the property to a subsidiary of Centennial Bank by deed in lieu of foreclosure. Accordingly, the Company is no longer a party to the ground lease and has taken the necessary steps to terminate the associated litigation.
Scheduled Future Minimum Rent Income
| Years Ending December 31, | Total | |||||||
| 2024 | $ | |||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| 2028 | ||||||||
| Thereafter | ||||||||
| Total | $ | |||||||
Scheduled Annual Net Amortization of Intangibles
| Years Ending December 31, | Net Decrease in Real Estate Operating Revenue (1) | Increase in Depreciation and Amortization (1) | Total | |||||||||||||||||
| 2024 | $ | ( | $ | $ | ||||||||||||||||
| 2025 | ( | |||||||||||||||||||
| 2026 | ( | |||||||||||||||||||
| 2027 | ( | |||||||||||||||||||
| 2028 | ( | |||||||||||||||||||
| Thereafter | ( | |||||||||||||||||||
| Total | $ | ( | $ | $ | ||||||||||||||||
_______________
(1)Amortization of below-market rent and above-market rent intangibles is recorded as an adjustment to lease revenues; and amortization of in-place lease intangibles is included in depreciation and amortization.
Supplemental Ground Lease Disclosures
As discussed in “Leases” above, on October 19, 2023, the Company conveyed its interest in the property to a subsidiary of Centennial Bank by deed in lieu of foreclosure. Accordingly, the Company is no longer a party to the ground lease.
Supplemental balance sheet information related to the ground lease was as follows as of:
| December 31, 2022 | |||||||||||
| Operating lease | |||||||||||
| Operating lease right-of-use asset | $ | ||||||||||
| Operating lease liability | $ | ||||||||||
| Weighted average remaining lease term — operating lease (years) | |||||||||||
| Weighted average discount rate — operating lease | % | ||||||||||
F-30
Notes to Consolidated Financial Statements
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Operating lease cost | $ | $ | |||||||||
Supplemental non-cash information related to the ground lease was as follows:
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Amounts included in the measurement of lease liability: | |||||||||||
| Operating cash flows from an operating lease | $ | $ | |||||||||
| Right-of-use asset obtained in exchange for lease obligations: | |||||||||||
| Operating lease | $ | $ | |||||||||
Note 7. Fair Value Measurements
Level 1 — Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access.
Level 2 — Pricing inputs are other than quoted prices in active markets, including, but not limited to, quoted prices for similar assets and liabilities in markets that are active, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities (such as interest rates, yield curves, volatilities, rate of prepayment, loss severities, credit risks and default rates) or other market corroborated inputs.
Level 3 — Significant unobservable inputs are based on the best information available in the circumstances, to the extent observable inputs are not available, including the Company’s own assumptions used in determining the fair value of investments. Fair value for these investments is determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance, and financing transactions subsequent to the acquisition of the investment. The inputs into the determination of fair value require significant management judgment.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.
As of December 31, 2023 and 2022, the Company had not elected the fair value option for its financial instruments, including loans held for investment, loans held for investment acquired through participation, held-to-maturity debt securities, obligations under participation agreements, term loan payable, repurchase agreement payable, mortgage loan payable and revolving line of credit. Such financial instruments are carried at cost, less impairment or less net deferred costs, where applicable. Marketable securities and derivatives are financial instruments that are reported at fair value.
F-31
Notes to Consolidated Financial Statements
Financial Instruments Carried at Fair Value on a Recurring Basis
From time to time, the Company may invest in short-term debt and equity securities which are classified as available-for-sale securities, which are presented at fair value and included in Other assets in the consolidated balance sheet. Changes in the fair value of equity securities are recognized in earnings. Changes in the fair value of debt securities are reported in other comprehensive income until the securities are realized.
As discussed in Note 9, in March 2023, the Company entered into a loan agreement with a lender to provide financing for the acquisition of real estate properties (Note 6). In connection with the financing, the Company purchased an interest rate cap for $258,500 to effectively cap the related index rate at 5.0 %. The interest rate cap met all the criteria of a derivative under ASC 815, but it did not meet the criteria under ASC 815-20-25 to qualify for hedging accounting. As such, the interest rate cap is reported at fair value and is included in other assets in the consolidated balance sheet, and the change in the fair value of the interest rate cap is reported in the consolidated statements of operations.
The following tables present fair value measurements of marketable securities and derivatives, by major class according to the fair value hierarchy as of:
| December 31, 2023 | ||||||||||||||||||||||||||
| Fair Value Measurements | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
Money market fund (1) | $ | $ | $ | $ | ||||||||||||||||||||||
| Marketable securities - debt securities | ||||||||||||||||||||||||||
| Marketable securities - equity securities | ||||||||||||||||||||||||||
Derivative - interest rate cap (2) | ||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
(1) Amount is included in cash and cash equivalents on the consolidated balance sheets.
(2) Amount is included in other assets on the consolidated balance sheets.
| December 31, 2022 | ||||||||||||||||||||||||||
| Fair Value Measurements | ||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||
| Marketable Securities: | ||||||||||||||||||||||||||
| Debt securities | $ | $ | $ | $ | ||||||||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||||||||||||
The following table presents the activities of the marketable securities and derivatives:
| Years Ended December 31, | ||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||
| Marketable Securities | Derivatives | Marketable Securities | ||||||||||||||||||
| Beginning balance | $ | $ | $ | |||||||||||||||||
Purchases (1) | ||||||||||||||||||||
Proceeds from sale (2) | ( | ( | ||||||||||||||||||
| Reclassification of net realized (losses) gains on marketable securities into earnings | ( | |||||||||||||||||||
| Unrealized losses on marketable securities and derivatives | ( | ( | ( | |||||||||||||||||
| Ending balance | $ | $ | $ | |||||||||||||||||
(1)On July 25, 2023, the Company disclosed that it acquired approximately 5.2 % of the outstanding shares of common stock of MITT as of July 24, 2023.
F-32
Notes to Consolidated Financial Statements
Financial Instruments Not Carried at Fair Value
In the first quarter of 2023, the Company purchased $20.0 million of corporate bonds with a coupon rate of 6.125 % with a maturity date of May 15, 2023. The Company classified these bonds as held-to-maturity debt securities, as it had the intent and ability to hold these securities until maturity. These securities were recorded at amortized cost and were fully redeemed at par on May 15, 2023.
The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value on the consolidated balance sheets as of:
| December 31, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||||||||
| Level | Principal Amount | Carrying Value | Fair Value | Principal Amount | Carrying Value | Fair Value | |||||||||||||||||||||||||||||||||||
| Loans: | |||||||||||||||||||||||||||||||||||||||||
| Loans held for investment | 3 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Loans held for investment acquired through participation | 3 | ||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses | — | ( | — | — | ( | — | |||||||||||||||||||||||||||||||||||
| Total loans | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||
| Liabilities: | |||||||||||||||||||||||||||||||||||||||||
| Unsecured notes payable | 1 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||
| Secured financing agreements | 3 | ||||||||||||||||||||||||||||||||||||||||
| Obligations under participation agreements | 3 | ||||||||||||||||||||||||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||
The Company estimated that its other financial assets and liabilities, not included in the tables above, had fair values that approximated their carrying values at both December 31, 2023 and 2022 due to their short-term nature.
Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charge)
The Company periodically assesses whether there are any indicators that the value of its real estate investments may be impaired or that their carrying value may not be recoverable (Note 2).
The following table presents information about assets for which the Company recorded impairment charge and that were measured at fair value on a non-recurring basis for the year ended December 31, 2023 and 2022:
| Year Ended December 31, | ||||||||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||||||||
| Fair Value | Impairment Charge | Fair Value | Impairment Charge | |||||||||||||||||||||||
| Impairment Charge | ||||||||||||||||||||||||||
| Real estate and intangibles | $ | $ | $ | $ | ||||||||||||||||||||||
| $ | $ | |||||||||||||||||||||||||
Impairment charge, and their related triggering events and fair value measurements were as follows:
Real Estate and Intangibles
The impairment charge described below are reflected within Impairment charge in the consolidated statements of operations.
For the year ended December 31, 2023, the Company recorded an impairment charge of $11.8 million on the multi-tenant office building located in California in order to reduce the carrying value of the building to its estimated fair value. The fair value measurement was determined by estimating discounted cash flows using two significant unobservable inputs, which were the cash flow discount rate (8.50 %) and terminal capitalization rate (7.50 %). In October 2023, the Company conveyed its
F-33
Notes to Consolidated Financial Statements
interest in the office building to the lender by deed in lieu of foreclosure. Accordingly, the Company no longer owns the multi-tenant office building.
For the year ended December 31, 2022, the Company recorded an impairment charge of $1.6 million on the 4.9 acres of land located in Pennsylvania to reduce the carrying value of the land to its estimated fair value, which was based on the selling price in the purchase and sale agreement. The land was sold in June 2022.
Valuation Process for Fair Value Measurement
The fair value of the Company’s investment in equity securities, held-to-maturity debt securities and its unsecured notes payable is determined based on quoted prices in an active market and is classified as Level 1 of the fair value hierarchy.
Market quotations are not readily available for the Company’s real estate-related loan investments, all of which are included in Level 3 of the fair value hierarchy, and therefore these investments are valued utilizing a yield approach, i.e., a discounted cash flow methodology to arrive at an estimate of the fair value of each respective investment in the portfolio using an estimated market yield. In following this methodology, investments are evaluated individually, and management takes into account, in determining the risk-adjusted discount rate for each of the Company’s investments, relevant factors, which may include available current market data on applicable yields of comparable debt/preferred equity instruments; market credit spreads and yield curves; the investment’s yield; covenants of the investment, including prepayment provisions; the ability of our borrowers and investees to make payments and their net operating income and debt-service coverage ratio; construction progress reports and construction budget analysis; the nature, quality and realizable value of any collateral (and loan-to-value ratio); the forces that influence the local markets in which the asset (the collateral) is purchased and sold, such as capitalization rates, occupancy rates, rental rates and replacement costs; and the anticipated duration of each real estate-related loan investment.
The Manager designates a valuation committee to oversee the entire valuation process of the Company’s Level 3 loans. The valuation committee is comprised of members of the Manager’s senior management, deal and portfolio management teams, who meet on a quarterly basis, or more frequently as needed, to review the Company investments being valued as well as the inputs used in the proprietary valuation model. Valuations determined by the valuation committee are supported by pertinent data and, in addition to a proprietary valuation model, are based on market data, industry accepted third-party valuation models and discount rates or other methods the valuation committee deems to be appropriate. Because there is no readily available market for these investments, the fair values of these investments are approved in good faith by the Company’s board of directors (which is made up exclusively of independent directors).
The fair values of the Company’s mortgage loan payable, secured borrowing, term loan payable and revolving line of credit are determined by discounting the contractual cash flows at the interest rate the Company estimates such arrangements would bear if executed in the current market.
The following tables summarize the valuation techniques and significant unobservable inputs used by the Company to value the Level 3 loans as of December 31, 2023 and 2022. The tables are not intended to be all-inclusive, but instead identify the significant unobservable inputs relevant to the determination of fair values.
Fair Value at December 31, 2023 | Primary Valuation Technique | Unobservable Inputs | December 31, 2023 | |||||||||||||||||||||||||||||
| Asset Category | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
Loans held for investment, net (1) | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Loans held for investment acquired through participation, net | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Secured financing agreements | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Total Level 3 Liabilities | $ | |||||||||||||||||||||||||||||||
(1)Amount includes $154.6 million of non-performing loans (Note 4). The fair market value estimates were determined primarily using discounted cash flow models and Level 3 inputs, which include estimates of property-specific cash flows over a specific holding period, a discount rate range of 6.75 % to 7.00 % and a terminal capitalization rate range of 5.75 % to 6.00 %. These inputs are based on the location, type and nature of the property, current sales and lease comparable,
F-34
Notes to Consolidated Financial Statements
anticipated real estate and capital market conditions, and managements knowledge, experience and judgment. Additionally, the Company may use sales comparables, purchase price and appraisals to corroborate the estimated value of a loan’s collateral or may use sponsor’s guarantee to estimate the value of a non-performing loan.
| Fair Value at December 31, 2022 | Primary Valuation Technique | Unobservable Inputs | December 31, 2022 | |||||||||||||||||||||||||||||
| Asset Category | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
| Loans held for investment, net | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Loans held for investment acquired through participation, net | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Assets | $ | |||||||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Obligations under participation agreements | $ | Discounted cash flow | Discount rate | % | % | % | ||||||||||||||||||||||||||
| Secured financing agreements | Discounted cash flow | Discount rate | % | % | % | |||||||||||||||||||||||||||
| Total Level 3 Liabilities | $ | |||||||||||||||||||||||||||||||
Note 8. Related Party Transactions
Management Agreement
The Company entered into the Management Agreement with the Manager whereby the Manager is responsible for its day-to-day operations. The following table presents a summary of fees paid and costs reimbursed to the Manager in connection with providing services to the Company that are included on the consolidated statements of operations:
| Years Ended December 31, | |||||||||||
| 2023 | 2022 | ||||||||||
Origination and extension fee expense (1) | $ | $ | |||||||||
| Asset management fee | |||||||||||
| Asset servicing fee | |||||||||||
| Operating expenses reimbursed to Manager | |||||||||||
Disposition fee (2) | |||||||||||
| Total | $ | $ | |||||||||
_______________
(1)Origination and extension fee expense is generally offset with origination and extension fee income. Any excess is deferred and amortized to interest income over the term of the loan.
Origination and Extension Fee Expense
Pursuant to the Management Agreement, the Manager or its affiliates receives an origination fee in the amount of 1 % of the amount used to originate, fund, acquire or structure real estate-related investments, including any third-party expenses related to such loans. In the event that the term of any real estate-related loan held by the Company is extended, the Manager also receives an extension fee equal to the lesser of (i) 1 % of the principal amount of the loan being extended or (ii) the amount of fee paid to the Company by the borrower in connection with such extension.
Asset Management Fee
Under the terms of the Management Agreement, the Manager or its affiliates provides the Company with certain investment management services in return for a management fee. The Company pays a monthly asset management fee at an annual rate of 1 % of the aggregate funds under management, which includes the loan origination price or aggregate gross acquisition price, as defined in the Management Agreement, for each real estate related loan and cash held by the Company.
F-35
Notes to Consolidated Financial Statements
Asset Servicing Fee
The Manager or its affiliates receives from the Company a monthly servicing fee at an annual rate of 0.25 % of the aggregate gross origination price or acquisition price, as defined in the Management Agreement, for each real estate-related loan held by the Company.
Transaction Breakup Fee
In the event that the Company receives any “breakup fees,” “busted-deal fees,” termination fees, or similar fees or liquidated damages from a third-party in connection with the termination or non-consummation of any loan or disposition transaction, the Manager will be entitled to receive one-half of such amounts, in addition to the reimbursement of all out-of-pocket fees and expenses incurred by the Manager with respect to its evaluation and pursuit of such transactions. As of December 31, 2023 and 2022, the Company had not
Operating Expenses
The Company reimburses the Manager for operating expenses incurred in connection with services provided to the operations of the Company, including the Company’s allocable share of the Manager’s overhead, such as rent, employee costs, utilities, and technology costs.
Disposition Fee
Pursuant to the Management Agreement, the Manager or its affiliates receives a disposition fee in the amount of 1 % of the gross sale price received by the Company from the disposition of any real estate-related loan, or any portion of, or interest in, any real estate-related loan. The disposition fee is paid concurrently with the closing of any such disposition of all or any portion of any real estate-related loan or any interest therein, which is the lesser of (i) 1 % of the principal amount of the loan or debt-related loan prior to such transaction or (ii) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of a loan, the Company will pay a disposition fee upon the sale of such property equal to 1 % of the sales price.
Management Agreement Amendment
On March 11, 2024, the Company and the Manager entered into an amendment to the Management Agreement, effective as of January 1, 2024 (the “Amendment”), in order to extend the term of the Management Agreement and modify the terms upon which the Management Agreement may be terminated. Except as discussed below, the terms of the Management Agreement remain unchanged by the Amendment. Except where the context requires otherwise, all references herein to the “Management Agreement” are to the Management Agreement as modified by the Amendment.
The term of the Management Agreement will expire on December 31, 2027 (the “Initial Term”) and will automatically renew for an unlimited number of additional one-year terms upon each anniversary date of the last day of the Initial Term (each, a “Renewal Term”), unless terminated by the Company or the Manager during the Initial Term or a Renewal Term in accordance with the terms of the Management Agreement (as described below).
The Management Agreement may be terminated by the Company during the Initial Term or any Renewal Term upon a finding by either (i) at least two-thirds of the independent directors on the Board or (ii) the holders of a majority of the outstanding shares of the Company’s common stock (other than those shares held by members of the Company’s senior management team or affiliates of the Manager) that either (a) there has been unsatisfactory performance by the Manager that is materially detrimental to the Company, or (b) the compensation payable to the Manager pursuant to the Management Agreement is unfair; provided, however, that the Company will not have the right to terminate the Management Agreement on the basis of unfair compensation to the Manager if the Manager agrees to continue to provide its services under the Management Agreement in exchange for reduced fees that at least two-thirds of the independent directors on the Board determine to be fair pursuant to the procedures set forth in the Management Agreement. The Company must deliver prior written notice of any such termination to the Manager at least 180 days prior to the last calendar day of the Initial Term or the then-current Renewal Term, as applicable, and the Management Agreement will terminate effective as of the last calendar day of the Initial Term or the then-current Renewal Term, as applicable.
Upon any termination of the Management Agreement by the Company as discussed above, the Company will pay the Manager, on the date on which such termination is effective, a termination fee in an amount equal to three times the average annual fees of all types and expense reimbursements received by or owed to the Manager pursuant to the Management
F-36
Notes to Consolidated Financial Statements
Agreement during the 24-month period immediately preceding such termination (the “Termination Fee”), calculated as of the end of the most recently completed monthly prior to the date of such termination.
The Company may also terminate the Management Agreement, effective upon 30 calendar days’ prior written notice from the Board to the Manager, without payment of any Termination Fees or other penalties, upon (i) the material breach of the Management Agreement by the Manager or its affiliates that continues for 30 days after written notice thereof to the Manager (or 45 days after delivery of written notice thereof if the Manager takes diligent steps to cure such breach within 30 days of delivery of the written notice), (ii) any fraud or other criminal conduct, gross negligence or breach of fiduciary duty by the Manager or its affiliates in connection with the Management Agreement, as determined by a final, non-appealable judgment of a court of competent jurisdiction, (iii) the Manager’s bankruptcy, insolvency or dissolution, or (iv) an Internalization Event (as defined in the Management Agreement). No Termination Fee or other penalty is payable upon such a termination by the Company.
The Manager may terminate the Management Agreement, effective upon 60 days’ prior written from the Manager to the Company, if the Company breaches the Management Agreement and such breach continues for 30 days after written notice thereof. The Company will pay the Manager the Termination Fee upon such termination by the Manager.
Due From Affiliate
On December 1, 2022, the Company entered into a revolving promissory note receivable with Mavik Special Opps Co-Investments, LP, an affiliate of the Company. The promissory note receivable bears interest at the Prime Rate, as such Prime Rate is published in the Wall Street Journal, computed on the basis of the actual number of days elapsed and a year of 365 days. The promissory note was scheduled to mature on December 1, 2023. In December 2023, the promissory note was amended to extend the maturity date to June 30, 2024. During the year ended December 31, 2023 and 2022, the Company provided funding under the promissory note receivable of $3.8 million and $0.4 million, respectively. As of December 31, 2023 and 2022, amount outstanding under the promissory note receivable was $3.8 million and none , respectively, which is included in Other assets on the consolidated balance sheet.
Cost Sharing and Reimbursement Agreement
The Company and Terra LLC have entered into a cost sharing and reimbursement agreement effective October 1, 2022, pursuant to which Terra LLC is responsible for its allocable share of the Company’s expenses, including fees paid by the Company to the Manager based on relative assets under management. These fees are eliminated in consolidation and therefore have no impact on the Company’s consolidated financial statements.
Distributions Paid
For the years ended December 31, 2023 and 2022, the Company made distributions to investors totaling $18.6 million and $16.0 million, respectively, of which $18.6 million and $6.5 million were returns of capital, respectively (Note 11).
Due to Manager
As of December 31, 2023 and 2022, approximately $4.2 million and $3.9 million, respectively, was due to the Manager, as reflected on the consolidated balance sheets, primarily related to the present value of the disposition fees on individual loans due to the Manager.
Mavik Real Estate Special Opportunities Fund, LP
On August 3, 2020, the Company entered into a subscription agreement with RESOF whereby the Company committed to fund up to $50.0 million to purchase limited partnership interests in RESOF. For more information on this investment, please see Note 5.
Participation Agreements
In the normal course of business, the Company may enter into participation agreements with related parties, primarily other affiliated funds managed by the Manager, and to a lesser extent, unrelated parties (the “Participants”). The purpose of the participation agreements is to allow the Company and an affiliate to originate a specified loan when, individually, the Company
F-37
Notes to Consolidated Financial Statements
does not have the liquidity to do so or to achieve a certain level of portfolio diversification. The Company may transfer portions of its investments to other Participants or it may be a Participant to a loan held by another entity.
ASC 860, Transfers and Servicing (“ASC 860”), establishes accounting and reporting standards for transfers of financial assets. ASC 860-10 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Company has determined that the participation agreements it enters into are accounted for as secured borrowings under ASC 860 (see “Participation Interests” in Note 2 and “Obligations Under Participation Agreements” in Note 9).
Participation Interests Purchased by the Company
From time to time, the Company may purchase investments from affiliates pursuant to participation agreements. In accordance with the terms of each participation agreement, each Participant’s rights and obligations, as well as the proceeds received from the related borrower/issuer of the loan, are based upon their respective pro rata participation interest in the loan.
The table below lists the participation interests purchased by the Company pursuant to participation agreements as of:
| December 31, 2023 | ||||||||||||||||||||
| Participating Interests | Principal Balance | Carrying Value | ||||||||||||||||||
Mesa AZ Industrial Owner, LLC (1) | $ | $ | ||||||||||||||||||
UNJ Sole Member, LLC (1) | ||||||||||||||||||||
| Allowance for credit losses | — | ( | ||||||||||||||||||
| $ | $ | |||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||
| Participating Interests | Principal Balance | Carrying Value | ||||||||||||||||||
Havemeyer TSM LLC (1)(2) | $ | $ | ||||||||||||||||||
Mesa AZ Industrial Owner, LLC (1) | ||||||||||||||||||||
UNJ Sole Member, LLC (1) | ||||||||||||||||||||
| $ | $ | |||||||||||||||||||
________________
(1)The loan is held in the name of Mavik Real Estate Special Opportunities Fund REIT, LLC, a related-party REIT managed by the Manager.
(2)This loan was repaid in February 2023.
Transfers of Participation Interest by the Company
| Transfers Treated as Obligations Under Participation Agreements as of December 31, 2022 | |||||||||||||||||||||||||||||
| Principal Balance | Carrying Value | % Transferred | Principal Balance | Carrying Value | |||||||||||||||||||||||||
610 Walnut Investors LLC (1) | $ | $ | % | $ | $ | ||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||
________________
These investments are held in the name of the Company, but each of the Participant’s rights and obligations, including interest income and other income (e.g., exit fee, prepayment income) and related fees/expenses (e.g., disposition fees, asset
F-38
Notes to Consolidated Financial Statements
Note 9. Debt
Unsecured Notes Payable
The following table is a summary of the Company’s unsecured notes payable outstanding as of:
| December 31, | ||||||||||||||||||||||||||||||||
| Coupon Rate | Effective Rate (1) | Maturity Date | 2023 | 2022 | ||||||||||||||||||||||||||||
| % | % | 6/30/2026 | $ | $ | ||||||||||||||||||||||||||||
| % | % | 3/31/2026 | ||||||||||||||||||||||||||||||
| Total principal amount | ||||||||||||||||||||||||||||||||
| Unamortized issue discount | ( | ( | ||||||||||||||||||||||||||||||
Unamortized purchase discount (2) | ( | ( | ||||||||||||||||||||||||||||||
| Unamortized deferred financing costs | ( | ( | ||||||||||||||||||||||||||||||
| Unsecured notes payable, net | $ | $ | ||||||||||||||||||||||||||||||
_______________
(1)Includes issue discount, purchase discount and deferred financing costs that are amortized to interest expense over the life of the notes.
(2)In connection with the BDC Merger, Terra LLC assumed all the obligations under the 7.00 % Senior Notes (Note 3) and recorded a purchase discount of $4.6 million, representing the difference between the carrying value and the fair value of the notes on the date of the merger.
The 6.00 % Senior Notes Due 2026
On June 10, 2021, the Company issued $78.5 million in aggregate principal amount of its 6.00 % notes due 2026, and on June 25, 2021, the underwriters partially exercised their option to purchase an additional $6.6 million of the notes (collectively the “6.00 % Senior Notes Due 2026”). The 6.00 % Senior Notes Due 2026 may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after June 10, 2023, at a redemption price equal to 100 % of the outstanding principal amount thereof, plus accrued and unpaid interest.
The 7.00 % Senior Notes Due 2026
On February 10, 2021, Terra BDC issued $34.8 million in aggregate principal amount of 7.00 % fixed-rate notes due 2026, and on February 26, 2021, the underwriters exercised the option to purchase an additional $3.6 million of the notes (collectively the “7.00 % Senior Notes Due 2026”). The 7.00 % Senior Notes Due 2026 may be redeemed in whole or in part at any time or from time to time at Terra BDC’s option on or after February 10, 2023, at a redemption price equal to 100 % of the outstanding principal amount thereof, plus accrued and unpaid interest. In connection with the BDC Merger, Terra LLC agreed to take all necessary action to assume the payment of the principal of and interest on all of the outstanding 7.00 % Senior Notes Due 2026.
Covenant Compliance
The Company’s unsecured notes payable contain certain financial covenants. As of December 31, 2023, the Company was in compliance with such covenants.
F-39
Notes to Consolidated Financial Statements
Secured Financing Arrangements
The following table is a summary of the Company’s secured financing agreements in place as of:
| December 31, 2023 | December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||
| Current Maturity | Extended Maturity | Weighted Average Interest Rate (1) | Pledged Asset Carrying Value | Maximum Facility Size | Principal Amount | Principal Amount | ||||||||||||||||||||||||||||||||||||||
| Repurchase Agreements: | ||||||||||||||||||||||||||||||||||||||||||||
Goldman Sachs Bank facility (2)(3) | February 2024 | February 2025 | % | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
UBS AG facility (2)(4) | November 2024 | (5) | % | |||||||||||||||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||||||||||||||||||
| Non-Recourse Financing: | ||||||||||||||||||||||||||||||||||||||||||||
Promissory notes payable (2)(6) | March 2025 - March 2026 | March 2026 - March 2027 | % | N/A | ||||||||||||||||||||||||||||||||||||||||
| Property mortgages - fixed rate | June 2028 | June 2028 | % | N/A | ||||||||||||||||||||||||||||||||||||||||
Property mortgages - variable rate (7) | April 2027 | April 2028 | % | |||||||||||||||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||||||||||||||||||
| Other Secured Financing: | ||||||||||||||||||||||||||||||||||||||||||||
Revolving line of credit (2)(8) | March 2024 | March 2025 | % | |||||||||||||||||||||||||||||||||||||||||
Term loan (9) | March 2024 | March 2024 | % | |||||||||||||||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||||||||||||||||||
| Unamortized deferred financing costs and other | ( | ( | ||||||||||||||||||||||||||||||||||||||||||
| Secured financing agreements, net | $ | $ | ||||||||||||||||||||||||||||||||||||||||||
(1)Amount is calculated using the applicable index rate as of December 31, 2023.
(2)These facilities were used to finance the Company’s senior loan investments.
(3)Interest rate is based on Term SOFR (subject to underlying loan floors on a case-by-case basis) plus a spread ranging from 2.0 % to 5.00 %. In March 2024, the Company amended the Goldman Sachs Bank facility agreement to extend the maturity date to February 18, 2025 and to reduce the minimum interest coverage ratio covenant.
(4)Interest rate is based on Term SOFR plus a spread of 1.965 %. In February 2024, the outstanding balance was repaid. In March 2024, the Company amended the side letter to the UBS AG facility agreement to reduce the maximum amount available under this facility to zero. In connection with this amendment, UBS AG waived the payment of any fees and the meeting of any representations, warranties or covenants for the period commencing on December 31, 2023 until such time as there are amounts outstanding under the UBS AG facility agreement.
(5)The maturity of this facility can be extended annually on mutually agreeable terms.
(6)Interest rate is based on Term SOFR plus a spread ranging from 4.75 % to 5.6 % with a combined floor rate ranging from 9.0 % to 10.9 %.
(7)Interest rate is based on Term SOFR plus a spread of 3.5 % with a Term SOFR floor of 3.75 %.
(8)Prior to March 31, 2023 borrowings under this facility bore interest at an annual rate of LIBOR + 3.25 % with a combined floor of 4.0 %. In connection with the transition of LIBOR, on March 31, 2023, the facility was amended and the interest rate was changed to Term SOFR + 3.35 % with a combined floor of 6.0 %. In March 2024, the Company amended the facility agreement to waive the quarterly minimum net worth covenant for the purposes of the December 31, 2023 measurement date and to decrease the minimum net worth covenant for future quarterly measurement dates. The amendment includes certain additional changes, including, but not limited to, extending the maturity date to September 12, 2024 with an option to extend the facility term for an additional 12 -month period, reducing the credit limit to $75.0 million, increasing the coupon rate and revising the minimum profitability covenant.
In the normal course of business, the Company is in discussions with its lenders to extend, amend, or replace any financing facilities which contain near term expirations.
F-40
Notes to Consolidated Financial Statements
For the years ended December 31, 2023 and 2022, approximately $2.5 million and $2.0 million, respectively, of amortization of deferred financing costs and other from secured financing agreements was included in interest expense on the consolidated statements of operations. Additionally, for the years ended December 31, 2023 and 2022, the Company received proceeds from secured financing of $211.0 million and $286.6 million, respectively, and made repayments on secured financing of $205.3 million and $239.7 million, respectively.
Repurchase Agreements
The Company seeks to mitigate risks associated with its repurchase agreements by managing risk related to the credit quality of its assets, interest rates, liquidity, the rate of prepayment and market value. The margin call provisions under the repurchase facilities provide the lender with certain rights in the event of a decline in the credit of the underlying assets purchased. To monitor credit risk associated with the performance and value of its loans and investments, the Company’s asset management team regularly reviews its investment portfolios and is in regular contact with its borrowers, monitoring performance of the collateral and enforcing its rights as necessary. The Company further seeks to manage risks associated with the repurchase agreements by matching the maturities and interest rate characteristics of its loans with the related repurchase agreement.
Financing Activities
During the year ended December 31, 2023, the Company entered into the following financing arrangements:
•Two property mortgages for a total of $73.5 million for the acquisition of eight industrial buildings; and
•Three promissory notes for a total of $63.5 million to finance three senior loan investments.
Additionally, in October 2023, the Company conveyed its interest in an office building to the lender by deed-in-lieu of foreclosure and the related $27.6 million mortgage payable is effectively extinguished.
Covenant Compliance
The Company’s secured financing agreements contain certain financial tests and covenants. In the event of a default or any breach of covenant of a related agreement, the lender has the right to accelerate all amounts due, charge interest at a default rate, retain all cash flow from the loans originated and/or sell such loans in a private sale on terms possibly unfavorable to the Company. As of December 31, 2023, the Company was in compliance with all such covenants, as amended or waived (see footnotes to "Secured Financing Arrangements" table above).
Scheduled Debt Principal Payments
| Years Ending December 31, | Total | |||||||
2024 (1) | $ | |||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| 2028 | ||||||||
| Thereafter | ||||||||
| Unamortized deferred financing costs and other | ( | |||||||
| Total | $ | |||||||
_______________
(1)Amount includes $75.5 million of borrowings under a repurchase agreement for which the maturity was extended to 2025 subsequent to December 31, 2023. Amount also includes $47.5 million of borrowings under a revolving line of credit for which the maturity was extended to September 2024 plus an option to extend the maturity for an additional 12-month period.
F-41
Notes to Consolidated Financial Statements
Obligations Under Participation Agreements
Note 10. Commitments and Contingencies
Unfunded Commitments on Loans Held for Investment
Certain of the Company’s loans contain provisions for future fundings, which are subject to the borrower meeting certain performance-related metrics that are monitored by the Company. These fundings amounted to approximately $35.7 million and $47.3 million as of December 31, 2023 and 2022, respectively. The Company expects to maintain sufficient cash on hand to fund such commitments through matching these commitments with principal repayments on outstanding loans or draw downs on credit facilities.
Unfunded Investment Commitment
As discussed in Note 5, on August 3, 2020, the Company entered into a subscription agreement with RESOF whereby the Company committed to fund up to $50.0 million to purchase limited partnership interests in RESOF. As of December 31, 2023 and 2022, the unfunded investment commitment was $37.4 million and $22.4 million, respectively.
Other
The Company enters into contracts that contain a variety of indemnification provisions. The Company’s maximum exposure under these arrangements is unknown; however, the Company has not had prior claims or losses pursuant to these contracts. The Manager has reviewed the Company’s existing contracts and expects the risk of loss to the Company to be remote.
As described above in Note 6 “Real Estate Operating Revenue and Expenses”, the Company previously owned a multi-tenant office building that is subject to a ground lease. The ground lease provides for a new base rent every 5 years based on the greater of the annual base rent for the prior lease year or 9 % of the fair market value of the land. The next rent reset on the ground lease is scheduled for November 1, 2025. The Company was litigating with the landlord with respect to the appropriate method for determining the fair value of the land for purposes of setting the ground rent. On October 19, 2023, the Company conveyed its interest in the property to a subsidiary of Centennial Bank by deed-in-lieu of foreclosure. Accordingly, the Company is no longer a party to the ground lease, and has taken the necessary steps to terminate the associated litigation (styled Terra Ocean Ave., LLC v. Ocean Avenue Santa Monica Realty LLC, Superior Court of California, Los Angeles County, Case No. 20STCV34217).
Additionally, from time to time, we and individuals employed by us and our Manager may be a party to certain legal proceedings in the ordinary course of business, including proceedings relating to the enforcement of our rights under contracts with our borrowers and investees. While the outcome of these legal proceedings cannot be predicted with certainty, we do not expect that such proceedings will have a material effect upon our financial condition or results of operations.
F-42
Notes to Consolidated Financial Statements
Note 11. Equity
Earnings Per Share
The following table presents earnings per share:
| Years Ended December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Net loss | $ | ( | $ | ( | ||||||||||
| Series A preferred stock dividend declared | ( | ( | ||||||||||||
| Net loss allocable to common stock | $ | ( | $ | ( | ||||||||||
| Weighted-average shares outstanding - basic and diluted | ||||||||||||||
| Loss per share - basic and diluted | $ | ( | $ | ( | ||||||||||
Preferred Stock Classes
Preferred Stock
The Company’s charter gives it authority to issue 50,000,000 0.01 no 125
Series A Preferred Stock
On November 30, 2016, the Board classified and designated 125 shares of Preferred Stock as a separate class of Preferred Stock to be known as the 12.5 % Series A Redeemable Cumulative Preferred Stock, $1,000 liquidation value per share (“Series A Preferred Stock”). In December 2016, the Company sold 125 shares of the Series A Preferred Stock for $125,000 . The Series A Preferred Stock paid dividends at an annual rate of 12.5 % of the liquidation preference. These dividends were cumulative and payable semi-annually in arrears on June 30 and December 31 of each year.
The Series A Preferred Stock, with respect to dividend rights and rights upon liquidation, dissolution or winding up of the Company, ranked senior to common stock. The Company, at its option, may redeem the shares, with written notice, at a redemption price of $1,000 per share, plus any accrued unpaid distribution through the date of the redemption. The Series A Preferred Stock carried a redemption premium of $50 per share if redeemed prior to January 1, 2019. The Series A Preferred Stock generally had no voting rights. However, the Series A Preferred Stockholders’ voting was required if (i) authorization or issuance of any securities senior to the Series A Preferred Stock; (ii) an amendment to the Company’s charter that has a material adverse effect on the rights and preference of the Series A Preferred Stock; and (iii) any reclassification of the Series A Preferred Stock.
In March 2023, the Series A Preferred Stock was fully redeemed at par for a total of $125,000 plus accrued dividends.
Common Stock
On October 1, 2022, in connection with the BDC Merger, the Company amended its charter to increase the shares authorized from 500,000,000 to 950,000,000 , consisting of 450,000,000 shares of Class A Common Stock, $0.01 par value per share (“Class A Common Stock”), 450,000,000 shares of Class B Common Stock, and 50,000,000 shares of Preferred Stock. Concurrently, 4,847,910 shares of Class B Common Stock were issued to former Terra BDC stockholders and each share of the Company’s common stock issued and outstanding immediately prior to the effective time of the BDC Merger was automatically changed into one issued and outstanding share of Class B Common Stock. As of December 31, 2023, Terra Fund 7 and Terra Offshore REIT held 8.7 % and 10.1 %, respectively, of the issued and outstanding shares of the Company’s common stock.
The Class B Common Stock rank equally with and have identical preferences, rights, voting powers, restrictions, limitations as to dividends and other distributions, qualifications, and terms and conditions of redemption as each other share of the Company’s common stock, except as set forth below with respect to conversion.
F-43
Notes to Consolidated Financial Statements
In connection with the potential liquidity transactions discussed in Note 1, on December 1, 2023, the Company amended its articles of amendment and restatement (the “A&R Articles”) to provide the Board with greater flexibility to pursue a direct listing. In connection with a listing of shares of Class A Common Stock on a national securities exchange, the outstanding shares of Class B Common Stock will be convertible on a one -for-one basis into listed shares of Class A Common Stock, subject to certain conversion terms and holding periods. Currently, there are no outstanding shares of Class A Common Stock.
The A&R Articles also incorporate the provisions generally required by state regulators in order to become a non-traded REIT and publicly sell shares of the Company’s stock not listed on an exchange. These non-traded REIT provisions will spring into effect and become operative if the Company ultimately decides to register and sell shares in a non-traded REIT format.
Distributions
The Company generally intends to distribute substantially all of its taxable income, which does not necessarily equal net income as calculated in accordance with U.S. GAAP, to its stockholders each year to comply with the REIT provisions of the Internal Revenue Code. All distributions will be made at the discretion of the Board and will depend upon its taxable income, financial condition, maintenance of REIT status, applicable law, and other factors as the Board deems relevant.
For the years ended December 31, 2023 and 2022, the Company made distributions to investors totaling $18.6 million and $16.0 million, respectively, of which $18.6 million and $6.5 million were returns of capital, respectively. Additionally, for the years ended December 31, 2023 and 2022, the Company made distributions to preferred stockholders of $3,907 and $15,624 , respectively.
Distributions paid to stockholders consist of ordinary income, capital gains, return of capital or a combination thereof for income tax purposes. The following table presents distributions per share, declared and paid during the years ended December 31, 2023 and 2022, reported for federal tax purposes and serves as a designation of capital gain distributions, if applicable, pursuant to Section 857(b)(3)(C) of the Internal Revenue Code and Treasury Regulation § 1.857-6(e):
| Years Ended December 31, | ||||||||||||||
| 2023 | 2022 | |||||||||||||
| Ordinary income | $ | $ | ||||||||||||
| Capital gain | ||||||||||||||
| Return of capital | ||||||||||||||
| $ | $ | |||||||||||||
Dividend Reinvestment Plan
On January 20, 2023, the Board adopted a distribution reinvestment plan (the “Plan”), pursuant to which the Company’s stockholders may elect to reinvest cash distributions payable by the Company in additional shares of Class A Common Stock and Class B Common Stock, at the price per share determined pursuant to the Plan. For the year ended December 31, 2023, the Company issued 663 shares of Class B Common Stock for a total of $8,399 pursuant to the Plan.
Note 12. Subsequent Events
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Terra Property Trust, Inc.
Schedule III – Real Estate and Accumulated Depreciation
As of December 31, 2023
| Initial Costs | Cost Capitalized Subsequent to Acquisition | Increase (Decrease) in Net Investment | Gross Amount at Period End | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Description | Encumbrance | Land | Building and Building Improvements | Land | Building and Building Improvements | Total | Accumulated Depreciation | Date of Construction | Date Acquired | Life Used for Depreciation | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Industrial buildings in Dallas, TX | $ | $ | $ | $ | $ | $ | $ | $ | $ | 1970; 1978; 1980 | May 2023 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Industrial buildings in Dallas, TX | 1975; 1977; 1988 | March 2023 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
At December 31, 2023, the aggregate cost of real estate for federal income tax purposes was $109.2 million.
The changes in total real estate assets and accumulated depreciation are as follows:
| Reconciliation of Real Estate Asset | Reconciliation of Accumulated Depreciation | |||||||||||||||||||
| Year Ended December 31, 2023 | Year Ended December 31, 2023 | |||||||||||||||||||
| Balance, beginning of year | $ | Balance, beginning of year | $ | |||||||||||||||||
| Additions during the year: | Additions during the year: | |||||||||||||||||||
| Acquisitions | Depreciation for the year | |||||||||||||||||||
| Capital improvements | Deductions during the year: | |||||||||||||||||||
| Deductions during the year: | Disposition (1) | ( | ||||||||||||||||||
Dispositions (1) | ( | Balance, end of year | $ | |||||||||||||||||
Impairment charge (1) | ( | |||||||||||||||||||
| Balance, end of year | $ | |||||||||||||||||||
___________________________
F-45
Terra Property Trust, Inc.
Schedule IV – Mortgage Loans on Real Estate
As of December 31, 2023
Description (1) | Number of Loans | Property Type/Location | Contractual Interest Rate (2) | Maximum Maturity Date (3) | Periodic Payment Terms | Prior Liens | Face Amount | Carrying Amount | Principal Amount of Mortgages Subject to Delinquent Principal or Interest | |||||||||||||||||||||||||||||||||||||||||||||||
| Mezzanine loans individually < 3% of carrying amount of total loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Mezzanine loan | 1 | Student housing/California | % | May 2027 | Interest Only | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||
| Mezzanine loan | 1 | Industrial/Massachusetts | % | September 2027 | Interest Only | |||||||||||||||||||||||||||||||||||||||||||||||||||
Mezzanine loan (4)(5) | 1 | Mixed-use/California | % | June 2027 | Interest Only | |||||||||||||||||||||||||||||||||||||||||||||||||||
| First mortgages individually > 3% of carrying amount of total loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan A (6) | Office/Georgia | % | August 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan B | Hotel/California | % | January 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan C (7)(8) | Industrial/New Jersey | % | August 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan D | Land/New Jersey | % | March 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan E | Office/California | % | December 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan F | Infrastructure/Utah | % | August 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan G | Mixed-use/North Carolina | % | November 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan H (4)(5) | Land/Arizona | % | September 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan I | Student housing/Utah | % | March 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan J | Multifamily/Washington | % | April 2026 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan K | Multifamily/California | % | October 2024 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| First mortgages individually < 3% of carrying amount of total loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| First mortgages | 2 | Multifamily/California & Washington | April 2024 March 2027 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Preferred equity investments individually > 3% of carrying amount of total loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan L (9) | Office/New York | % | July 2022 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan M | Multifamily/Georgia | % | June 2026 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Loan N | Mixed use/California | % | August 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan O (10) | Mixed use/New York | % | March 2025 | Interest Only | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Preferred equity investments individually < 3% if carrying amount of total loans: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Preferred equity investment (11) | 1 | Multifamily/New York | % | August 2021 | Interest Only | |||||||||||||||||||||||||||||||||||||||||||||||||||
F-46
Total loans (12) | $ | $ | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Allowance for credit losses (13) | ( | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Carrying value, net | $ | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
___________________________
(1)All of the Company’s loans have a prepayment provision.
(2)For all floating rate loans, contractual interest rate was determined using the applicable benchmark rate as of December 31, 2023.
(3)Maximum maturity date assumes all extension options are exercised.
(4)Participation interest is with Mavik Real Estate Special Opportunities Fund REIT, LLC, a related-party REIT managed by the Manager.
(5)The Company acquired these investments through participation agreements. See “Participation Agreements” in Note 8 in the accompanying notes to the consolidated financial statements.
(6)This loan is current in maturity default. The Company recorded an allowance of credit losses of $11.8 million on this loan as a result of a decline in the fair value of the underlying collateral.
(7)Amount included $4.0 million of incremental borrowing that bears interest at an annual rate of 20.0 % until certain conditions are met, at which time the interest rate will be the same as the original loan.
(8)The interest payment on this loan is past due; however, the Company expects to be able to collect all amounts due for both principal and interest according to the contractual terms of the loan.
(9)This loan is current in maturity default. The Company recorded an allowance of credit losses of $26.4 million on this loan as a result of a decline in the fair value of the underlying collateral.
(10)This loan is current in maturity default. The Company recorded an allowance of credit losses of $15.1 million on this loan and expects the sponsor to pay the remaining balance.
(11)This loan is current in maturity default. The Company initiated a litigation to seek full repayment of the loan from the sponsor.
(12)The aggregate cost for U.S. federal income tax purposes was $575.9 million.
(13)Excludes $0.3 million of allowance for credit losses related to unfunded commitments.
F-47
Terra Property Trust, Inc.
Notes to Schedule IV - Mortgage Loans on Real Estate
December 31, 2023
| Reconciliation of Mortgage Loans on Real Estate | ||||||||
| Year Ended December 31, 2023 | ||||||||
| Balance, beginning of year | $ | |||||||
| Additions during the period: | ||||||||
| New mortgage loans | ||||||||
| Deductions during the period: | ||||||||
| Collections of principal | ( | |||||||
| ( | ||||||||
| Amortization of premium | ( | |||||||
| Accrual, payment and accretion of investment-related fees and other, net | ( | |||||||
| Provision for loan losses | ( | |||||||
| ( | ||||||||
| Balance, end of year | $ | |||||||
F-48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 15, 2024
| TERRA PROPERTY TRUST, INC. | ||||||||
| By: | /s/ Vikram S. Uppal | |||||||
| Vikram S. Uppal | ||||||||
| Chief Executive Officer and Chief Investment Officer | ||||||||
| (Principal Executive Officer) | ||||||||
| By: | /s/ Gregory M. Pinkus | |||||||
| Gregory M. Pinkus | ||||||||
| Chief Financial Officer, Treasurer and Secretary | ||||||||
| (Principal Financial and Accounting Officer) | ||||||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | Title | Date | ||||||||||||
| /s/ Vikram S. Uppal | Chairman of the Board, Chief Executive Officer and Chief Investment Officer | March 15, 2024 | ||||||||||||
| Vikram S. Uppal | (Principal Executive Officer) | |||||||||||||
| /s/ Gregory M. Pinkus | Chief Financial Officer, Treasurer and Secretary | March 15, 2024 | ||||||||||||
| Gregory M. Pinkus | (Principal Financial and Accounting Officer) | |||||||||||||
| /s/ Roger H. Beless | Director | March 15, 2024 | ||||||||||||
| Roger H. Beless | ||||||||||||||
| /s/ Michael L. Evans | Director | March 15, 2024 | ||||||||||||
| Michael L. Evans | ||||||||||||||
| /s/ Adrienne M. Everett | Director | March 15, 2024 | ||||||||||||
| Adrienne M. Everett | ||||||||||||||
| /s/ Spencer E. Goldenberg | Director | March 15, 2024 | ||||||||||||
| Spencer E. Goldenberg | ||||||||||||||
| /s/ Gaurav Misra | Director | March 15, 2024 | ||||||||||||
| Gaurav Misra | ||||||||||||||
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