KBS REAL ESTATE INVESTMENT TRUST II, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)
The following discussion and analysis should be read in conjunction with our
accompanying consolidated financial statements and the notes thereto. Also see
“Forward-Looking Statements” and “Summary Risk Factors” preceding Part I and
Part I, Item 1A, “Risk Factors.”
Overview
We were formed on July 12, 2007 as a Maryland corporation that elected to be
taxed as a real estate investment trust (“REIT”) beginning with the taxable year
ended December 31, 2008 and we intend to continue to operate in such a manner.
We conduct our business primarily through our Operating Partnership, of which we
are the sole general partner. Subject to certain restrictions and limitations,
our business is managed by our advisor, KBS Capital Advisors LLC, pursuant to an
advisory agreement. KBS Capital Advisors conducts our operations and manages our
remaining real estate property. Our advisor owns 20,000 shares of our common
stock. We have no paid employees.
As of December 31, 2021, we owned one office property.
As of December 31, 2021, we had 183,346,918 shares of common stock issued and
outstanding.
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On November 13, 2019, in connection with a review of potential strategic
alternatives available to us, a special committee composed of all of our
independent directors (the “Special Committee”) and our board of directors
unanimously approved the sale of all of our assets and our dissolution pursuant
to the terms of the plan of complete liquidation and dissolution (the “Plan of
Liquidation”). The principal purpose of the Plan of Liquidation is to provide
liquidity to our stockholders by selling our assets, paying our debts and
distributing the net proceeds from liquidation to our stockholders. On March 5,
2020, our stockholders approved the Plan of Liquidation. The Plan of Liquidation
is included as an exhibit to this Annual Report on Form 10-K.
Plan of Liquidation
In accordance with the Plan of Liquidation, our objectives are to pursue an
orderly liquidation of our company by selling all of our assets, paying our
debts and our known liabilities, providing for the payment of unknown or
contingent liabilities, distributing the net proceeds from liquidation to our
stockholders and winding up our operations and dissolving our company.
Pursuant to the Plan of Liquidation, our board of directors has authorized the
following liquidating distributions:
Record Date Payment Date Liquidating Distribution Per Share
March 5, 2020 March 10, 2020 $ 0.75
August 3, 2020 August 7, 2020 $ 0.25
December 24, 2020 December 30, 2020 $ 0.40
October 1, 2021 October 5, 2021 $ 0.50
December 9, 2021 December 14, 2021 $ 0.20
We expect to distribute substantially all of the remaining proceeds from
liquidation after the completion of the sale of our remaining real estate
property.
Our expectations about the implementation of the Plan of Liquidation and the
amount of any additional liquidating distributions that we will pay to our
stockholders and when we will pay them are subject to risks and uncertainties
and are based on certain estimates and assumptions, one or more of which may
prove to be incorrect. As a result, the actual amount of any additional
liquidating distributions we pay to stockholders may be less than we estimate
and the liquidating distributions may be paid later than we predict. There are
many factors that may affect the amount of liquidating distributions we will
ultimately pay to our stockholders. If we underestimate our existing obligations
and liabilities or the amount of taxes, transaction fees and expenses relating
to the liquidation and dissolution, or if unanticipated or contingent
liabilities arise, the amount of liquidating distributions ultimately paid to
our stockholders could be less than estimated. Moreover, the liquidation value
will fluctuate over time in response to developments related to our remaining
real estate property, in response to the real estate and finance markets, based
on the actual liquidation timing and the amount of net proceeds received from
the disposition of our remaining asset and due to other factors. Given the
uncertainty and current business disruptions as a result of the outbreak of
COVID-19, our implementation of the Plan of Liquidation may be materially and
adversely impacted and this may have a material effect on the ultimate amount
and timing of liquidating distributions received by our stockholders. While we
have considered the impact from COVID-19 in our net assets in liquidation
presented on the Consolidated Statement of Net Assets as of December 31, 2021,
the extent to which our business may be affected by COVID-19 depends on future
developments with respect to the continued spread and treatment of the virus,
the actions taken to contain the pandemic or mitigate its impact, and the direct
and indirect economic effects of the pandemic and containment measures. See ” –
Market Outlook – Real Estate and Real Estate Finance Markets – COVID-19 Pandemic
and Portfolio Outlook” for a discussion of the impact of the outbreak of
COVID-19 on our business and our liquidation. We can give no assurance regarding
the timing of the disposition of our remaining asset, the sale price we will
receive for this asset, and the amount or timing of liquidating distributions to
be received by our stockholders.
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Market Outlook – Real Estate and Real Estate Finance Markets
Volatility in global financial markets and changing political environments can
cause fluctuations in the performance of the U.S. commercial real estate
markets. Possible future declines in rental rates, slower or potentially
negative net absorption of leased space and expectations of future rental
concessions, including free rent to renew tenants early, to retain tenants who
are up for renewal or to attract new tenants, may result in decreases in cash
flows from our remaining property. Further, revenues from our remaining property
could decrease due to a reduction in occupancy (caused by factors including, but
not limited to, tenant defaults, tenant insolvency, early termination of tenant
leases and non-renewal of existing tenant leases), rent deferrals or abatements,
tenants being unable to pay their rent and/or lower rental rates. Reductions in
revenues from our remaining property would adversely impact the timing of the
asset sale and/or the sales price we will receive for our property. Market
conditions can change quickly, potentially negatively impacting the value of
real estate investments. Most recently, the outbreak of COVID-19 has had a
negative impact on the real estate market as discussed below.
COVID-19 Pandemic and Portfolio Outlook
As of December 31, 2021, the novel coronavirus, or COVID-19, pandemic is
ongoing. The spread of COVID-19 in many countries, including the United States,
has significantly adversely impacted global economic activity and has
contributed to significant volatility in financial markets. The global impact of
the pandemic has been rapidly evolving and many countries, states and
localities, including states and localities in the United States, have reacted
by restricting many business and travel activities, mandating the partial or
complete closures of certain businesses and schools and taking other actions to
mitigate the spread of the virus, most of which have a disruptive effect on
economic activity, including the use of and demand for office space. Many
private businesses, including some of our tenants, continue to recommend or
mandate some or all of their employees work from home or are rotating employees
in and out of the office to encourage social distancing in the workplace. Due to
these events, during 2021, the usage of our assets remained lower than
pre-pandemic levels. In addition, we experienced a significant reduction in
leasing interest and activity when compared to pre-pandemic levels.
We cannot predict when, if and to what extent these restrictions and other
actions will end and when, if and to what extent economic activity, including
the use of and demand for office space, will return to pre-pandemic levels. Even
after the pandemic has ceased to be active, the prevalence of work-from-home
policies during the pandemic may alter tenant preferences in the long-term with
respect to the demand for leasing office space.
The outbreak of COVID-19 and its impact on the current financial, economic,
capital markets and real estate market environment, and future developments in
these and other areas present uncertainty and risk with respect to our business,
financial condition, results of operations, cash flows and liquidation. Although
a recovery is partially underway, it continues to be gradual, uneven and
characterized by meaningful dispersion across sectors and regions, and could be
hindered by persistent or resurgent infection rates. Issues with respect to the
distribution and acceptance of vaccines or the spread of new variants of the
virus could adversely impact the recovery. Overall, there remains significant
uncertainty regarding the timing and duration of the economic recovery, which
precludes any prediction as to the ultimate adverse impact COVID-19 may have on
our business and liquidation.
During the years ended December 31, 2021 and 2020, we did not experience a
significant impact to rental income collections from the COVID-19 pandemic. Rent
collections for the quarter ended December 31, 2021 were approximately 99%. Many
of our tenants have suffered reductions in revenue. As of December 31, 2021, we
had entered into lease amendments related to the effects of the COVID-19
pandemic, granting $0.2 million of rent deferrals for the period from March 2020
through December 31, 2021 and granting $0.2 million in rental abatements during
this period. From March 2020 through December 31, 2021, three tenants were
granted rental deferrals and five tenants were granted rental abatements as a
result of the pandemic. The three tenants granted deferrals were tenants at a
property sold in December 2021. We expect to collect the deferred rent from
these tenants from the purchaser of the property. We will continue to evaluate
any additional short-term rent relief requests from tenants on an individual
basis. Any future rent relief arrangements are expected to be structured as
temporary short-term deferrals of base rent that will be paid back over time.
Not all tenant requests will ultimately result in modified agreements, nor are
we forgoing our contractual rights under our lease agreements. In most cases, it
is in our best interest to help our tenants remain in business and reopen when
restrictions are lifted. Subsequent to December 31, 2021, we have not seen a
material impact on our rent collections. Current collections and rent relief
requests to date may not be indicative of collections or requests in any future
period.
Although we did not experience significant disruptions in rental income, during
the years ended December 31, 2021 and 2020, we reduced the estimated liquidation
value of our real estate portfolio by $78.1 million (or $54.6 million after
accounting for the decrease in estimated capital expenditures of $23.5 million
that was previously projected to be spent) and $90.2 million, respectively, due
to changes in leasing projections across our portfolio resulting in lower
projected cash flow and projected sales prices caused by the impact of the
COVID-19 pandemic. In future periods, we may need to recognize additional
decreases in the value of our remaining real estate property to the extent
leasing projections or the projected sales price declines.
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Our business, like all businesses, is being impacted by the uncertainty
regarding the COVID-19 pandemic, the effectiveness of policies introduced to
neutralize the disease, and the impact of those policies on economic activity.
Given the uncertainty and current business disruptions as a result of the
outbreak of COVID-19, our implementation of the Plan of Liquidation may be
materially and adversely impacted and this may have a material effect on the
ultimate amount and timing of liquidating distributions received by our
stockholders.
Liquidity and Capital Resources
As described above under “- Overview – Plan of Liquidation,” on March 5, 2020,
our stockholders approved the sale of all of our assets and our dissolution
pursuant to the terms of the Plan of Liquidation. We expect to sell all of our
assets, pay all of our known liabilities, provide for unknown liabilities and
distribute the net proceeds from liquidation to our stockholders. Our principal
demands for funds through the completion of our liquidation will be for: the
payment of operating expenses, capital expenditures and general and
administrative expenses, including expenses in connection with the Plan of
Liquidation; and payments of distributions to stockholders pursuant to the Plan
of Liquidation. During our liquidation, we intend to use our cash on hand and
proceeds from the sale of real estate properties as our primary sources of
liquidity. To the extent available, we also intend to use cash flow generated by
our remaining real estate property.
Our investment in real estate generates cash flow in the form of rental revenues
and tenant reimbursements, which are reduced by operating expenditures, the
payment of asset management fees and corporate general and administrative
expenses. Cash flow from operations from our real estate investment is primarily
dependent upon the occupancy level of the property, the net effective rental
rates on our leases, the collectibility of rent and operating recoveries from
our tenants and how well we manage our expenditures. As of December 31, 2021,
our remaining real estate property was 65% occupied.
For the year ended December 31, 2021, our cash needs for capital expenditures
and the payment of debt obligations were met with cash on hand and proceeds from
asset sales. With the proceeds from asset sales in 2021, we repaid a total of
$240.5 million of outstanding notes payable during the year ended December 31,
2021, and we did not have any outstanding notes payable as of December 31, 2021.
We do not intend to obtain additional debt financing in the future. Operating
cash needs during the same period were met with cash flow generated by our real
estate investments. We believe that our cash on hand, our cash flow from
operations to the extent available and proceeds from the sale of our remaining
real estate property will be sufficient to meet our liquidity needs during our
liquidation.
During the liquidating process, we intend to maintain adequate cash reserves for
liquidity, capital expenditures and other future capital needs. As of
December 31, 2021, the estimated capital expenditures through the anticipated
disposition date for our remaining real estate property were $19.4 million.
We expect to continue to pay liquidating distribution payments to our
stockholders through the completion of our liquidation process and to pay the
final liquidating distribution after we sell all of our assets, pay all of our
known liabilities and provide for unknown liabilities. At the time of adopting
the Plan of Liquidation, we had anticipated completing the orderly liquidation
of our company and paying substantially all of our liquidating distributions
from the net proceeds from liquidation within 24 months after stockholder
approval of the Plan of Liquidation, which occurred on March 5, 2020. Given the
uncertainty and business disruptions as a result of the outbreak of COVID-19,
our completion of the Plan of Liquidation has been delayed. We currently
anticipate that we will complete our liquidation by the third quarter of 2022.
Although we were not able to complete our liquidation within the 24-month period
described above, we do not anticipate any material unfavorable tax consequences
to our stockholders or to our status as a REIT. For U.S. federal income tax
purposes, (i) we did not have any current and accumulated earnings and profits
(including any gain) or taxable income or gain for the taxable years ended
December 31, 2020 and December 31, 2021 and (ii) we do not anticipate any
current and accumulated earnings and profits (including any gain) or taxable
income or gain in the future. Our expectations about the amount of future
liquidating distributions that we will pay and when we will pay them are based
on certain estimates and assumptions, one or more of which may prove to be
incorrect. As a result, the actual amount of liquidating distributions we pay to
our stockholders may be less than our estimate and the liquidating distributions
may be paid later than we predict. See “- Overview – Plan of Liquidation” and
“-Market Outlook – Real Estate and Real Estate Finance Markets – COVID-19
Pandemic and Portfolio Outlook” for a discussion of the impact of the outbreak
of COVID-19 on our business and our liquidation. We do not expect to pay regular
monthly distributions during the liquidating process.
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In addition to using our capital resources for capital expenditures and for
operating costs, we use our capital resources to make certain payments to our
advisor. We paid our advisor fees in connection with the acquisition and
origination of our assets and pay our advisor fees in connection with the
management and disposition of our assets and for certain costs incurred by our
advisor in providing services to us. Among the fees payable to our advisor is an
asset management fee. With respect to investments in real estate, we pay our
advisor a monthly asset management fee equal to one-twelfth of 0.75% of the
amount paid or allocated to acquire the investment, plus the cost of any
subsequent development, construction or improvements to the property. This
amount includes any portion of the investment that was debt financed and is
inclusive of acquisition fees and expenses related thereto. We also continue to
reimburse our advisor and our dealer manager for certain stockholder services.
During the year ended December 31, 2021, cash and cash equivalents increased by
$23.4 million primarily as a result of $178.0 million of net cash proceeds from
the dispositions of four office properties after debt repayments and net inflows
from investments in real estate of $19.4 million, offset by the payments of: the
$91.7 million Fourth Liquidating Distribution, the $36.7 million Fifth
Liquidating Distribution, $27.8 million of capital expenditures and $8.8 million
of corporate expenditures.
On November 1, 2021, in connection with our liquidation pursuant to the Plan of
Liquidation, our board of directors approved the termination of our share
redemption program effective as of November 22, 2021.
Pursuant to our stockholders’ approval of the Plan of Liquidation, we adopted
the liquidation basis of accounting as of February 1, 2020 (as the approval of
the Plan of Liquidation by our stockholders became imminent within the first
week of February 2020 based on the results of our solicitation of proxies from
our stockholders for their approval of the Plan of Liquidation) and for the
periods subsequent to February 1, 2020 in accordance with GAAP. Accordingly, on
February 1, 2020, assets were adjusted to their estimated net realizable value,
or liquidation value, which represents the estimated amount of cash that we will
collect through the disposal of our assets as we carry out our Plan of
Liquidation. The liquidation values of our operating properties are presented on
an undiscounted basis. Estimated costs to dispose of assets and estimated
capital expenditures through the anticipated disposition date of the properties
have been presented separately from the related assets. Liabilities are carried
at their contractual amounts due or estimated settlement amounts.
Changes in Net Assets in Liquidation
For the Year Ended December 31, 2021
Net assets in liquidation decreased by approximately $176.0 million from $381.5
million on December 31, 2020 to $205.5 million on December 31, 2021. Pursuant to
the Plan of Liquidation, on September 29, 2021, our board of directors
authorized the Fourth Liquidating Distribution in the amount of $0.50 per share
of common stock to our stockholders of record as of the close of business on
October 1, 2021, for an aggregate cash distribution of approximately
$91.7 million. The Fourth Liquidating Distribution was paid on October 5, 2021
and was funded with proceeds from the sales of Fountainhead Plaza and Granite
Tower. On December 9, 2021, our board of directors authorized the Fifth
Liquidating Distribution in the amount of $0.20 per share of common stock to our
stockholders of record as of the close of business on December 9, 2021, for an
aggregate cash distribution of approximately $36.7 million. The Fifth
Liquidating Distribution was paid on December 14, 2021 and was funded with
proceeds from the sales of Willow Oaks Corporate Center and an office building
in Corporate Technology Centre – 300 Holger. These liquidating distributions
were the largest component of the decline in net assets in liquidation.
The estimated net realizable value of real estate after estimated closing costs
and disposition fees decreased by $78.1 million during the year ended
December 31, 2021, which was primarily driven by our investments in an office
property located in Denver, Colorado (“Granite Tower”), an office property
located in Fairfax, Virginia (“Willow Oaks Corporate Center”) and an office
building located in Los Angeles, California (“Union Bank Plaza”), as follows:
•Granite Tower – The net proceeds from the sale of Granite Tower decreased by
approximately $24.1 million due to an increase in outstanding capital costs that
were previously projected to be spent prior to disposition of the property. The
decrease in the net realizable value of Granite Tower was offset by a decrease
in capital expenditures of $23.5 million primarily due to a reduction in tenant
improvement costs.
•Willow Oaks Corporate Center – The net proceeds from the sale of Willow Oaks
Corporate Center decreased by approximately $11.6 million to reflect the sales
price as the property was sold on December 8, 2021.
•Union Bank Plaza – The estimated net proceeds from the sale of Union Bank Plaza
decreased by approximately $45.4 million as the liquidation value was adjusted
based on information received from prospective buyers as the property is
currently being marketed for sale.
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Results of Operations
In light of the adoption of liquidation basis accounting as of February 1, 2020
and our liquidation pursuant to the Plan of Liquidation, the results of
operations for the current year period are not comparable to the prior year
period. The sale of assets under the Plan of Liquidation has a significant
impact on our operations. Changes in liquidation values of our assets are
discussed above under “- Changes in Net Assets in Liquidation.” See “- Overview
– Plan of Liquidation” and “- Market Outlook – Real Estate and Real Estate
Finance Markets – COVID-19 Pandemic and Portfolio Outlook” for a discussion of
the impact of the outbreak of COVID-19 on our business and our liquidation.
Due to the adoption of the Plan of Liquidation, we are no longer reporting funds
from operations and modified funds from operations as we no longer consider
these to be key performance measures.
Critical Accounting Policies and Estimates
Below is a discussion of the accounting policies that management considers
critical in that they involve significant management judgments and assumptions,
require estimates about matters that are inherently uncertain and because they
are important for understanding and evaluating our reported financial results.
These judgments affect the reported amounts of assets and liabilities and our
disclosure of contingent assets and liabilities as of the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods. With different estimates or assumptions, materially different amounts
could be reported in our financial statements. Additionally, other companies may
utilize different estimates that may impact the comparability of our results to
those of companies in similar businesses.
Subsequent to the adoption of the liquidation basis of accounting, we are
required to estimate all costs and income we expect to incur and earn through
the end of liquidation including the estimated amount of cash we expect to
collect through the disposal of our assets and the estimated costs to dispose of
our assets.
Pursuant to our stockholders’ approval of the Plan of Liquidation, we adopted
the liquidation basis of accounting as of and for the periods subsequent to
February 1, 2020 (as approval of the Plan of Liquidation became imminent within
the first week of February 2020 based on the results of our solicitation of
proxies from our stockholders for their approval of the Plan of Liquidation).
Accordingly, on February 1, 2020, assets were adjusted to their estimated net
realizable value, or liquidation value, which represents the estimated amount of
cash that we will collect through the disposal of our assets as we carry out our
Plan of Liquidation. The liquidation values of our real estate properties are
presented on an undiscounted basis. Estimated costs to dispose of our assets and
estimated capital expenditures through the anticipated disposition date of our
real estate properties have been presented separately from the related assets.
Liabilities are carried at their contractual amounts due or estimated settlement
amounts.
We accrue costs and income that we expect to incur and earn through the
completion of our liquidation, including the estimated amount of cash we expect
to collect through the disposal of our assets and the estimated costs to dispose
of our assets, to the extent we have a reasonable basis for estimation. These
amounts are classified as a liability for estimated costs in excess of estimated
receipts during liquidation on the Consolidated Statement of Net Assets. Actual
costs and income may differ from amounts reflected in the financial statements
because of the inherent uncertainty in estimating future events. These
differences may be material. See Note 2, “Plan of Liquidation” and Note 4,
“Liabilities for Estimated Costs in Excess of Estimated Receipts During
Liquidation” for further discussion. Actual costs incurred but unpaid as of
December 31, 2021 are included in accounts payable and accrued liabilities, due
to affiliate and other liabilities on the Consolidated Statement of Net Assets.
Revenue Recognition – Operating Leases
Under the liquidation basis of accounting, we have accrued all income that we
expect to earn through the completion of our liquidation to the extent we have a
reasonable basis for estimation. Revenue from tenants is estimated based on the
contractual in-place leases and projected leases through the anticipated
disposition date of the property. These amounts are classified in liabilities
for estimated costs in excess of estimated receipts during liquidation on the
Consolidated Statement of Net Assets.
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Real Estate
As of February 1, 2020, our investments in real estate were adjusted to their
estimated net realizable value, or liquidation value, to reflect the change to
the liquidation basis of accounting. The liquidation value represents the
estimated amount of cash that we will collect through the disposal of our
assets, including any residual value attributable to lease intangibles, as we
carry out the Plan of Liquidation. As of December 31, 2021, we estimated the
liquidation value of our remaining real estate property based on discounted cash
flow analyses. The liquidation values of our investments in real estate are
presented on an undiscounted basis and investments in real estate are no longer
depreciated. Estimated costs to dispose of these investments are carried at
their contractual amounts due or estimated settlement amounts and are presented
separately from the related assets. Subsequent to February 1, 2020, all changes
in the estimated liquidation value of the investments in real estate are
reflected as a change to our net assets in liquidation.
Rents and Other Receivables
In accordance with the liquidation basis of accounting, as of February 1, 2020,
rents and other receivables were adjusted to their net realizable value. We
periodically evaluate the collectibility of amounts due from tenants. Any
changes in the collectibility of the receivables are reflected as a change to
our net assets in liquidation.
Accrued Liquidation Costs
We accrue for certain estimated liquidation costs to the extent we have a
reasonable basis for estimation. These consist of legal fees, dissolution costs,
final audit/tax costs, insurance, and distribution processing costs.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code. To
continue to qualify as a REIT, we must meet certain organizational and
operational requirements, including a requirement to distribute at least 90% of
our annual REIT taxable income to stockholders (which is computed without regard
to the dividends-paid deduction or net capital gain and which does not
necessarily equal net income as calculated in accordance with GAAP). As a REIT,
we generally will not be subject to federal income tax on income that we
distribute as dividends to our stockholders. If we fail to qualify as a REIT in
any taxable year, we will be subject to federal income tax on our taxable income
at regular corporate income tax rates and generally will not be permitted to
qualify for treatment as a REIT for federal income tax purposes for the four
taxable years following the year during which qualification is lost, unless the
Internal Revenue Service grants us relief under certain statutory provisions.
Such an event could materially and adversely affect our net income and net cash
available for distribution to stockholders. However, we believe that we are
organized and operate in such a manner as to qualify for treatment as a REIT.
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