UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2016

OR

For the transition period from                      to                     

Commission file number 001-36041

 

INDEPENDENCE REALTY TRUST, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

(215) 207-2100

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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 November 2, 2016 there were 68,996,070 shares of the Registrant’s common stock issued and outstanding.

 

 

 

 

 

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INDEPENDENCE REALTY TRUST, INC.

INDEX

 

 

 

 

 

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PART I—FINANCIAL INFORMATION

Independence Realty Trust, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited and dollars in thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited and dollars in thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited and dollars in thousands)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity

(Unaudited and dollars in thousands, except share information)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited and dollars in thousands)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

NOTE 1: Organization

Independence Realty Trust, Inc. was formed on March 26, 2009 as a Maryland corporation that has elected to be taxed as a real estate investment trust, or REIT, commencing with the taxable year ended December 31, 2011. We are currently externally managed by a subsidiary of RAIT Financial Trust, or RAIT, a publicly traded Maryland REIT whose common shares are listed on the New York Stock Exchange under the symbol “RAS.” As used herein, the terms “we,” “our” and “us” refer to Independence Realty Trust, Inc. and, as required by context, Independence Realty Operating Partnership, LP, which we refer to as IROP, and their subsidiaries. We own apartment properties in geographic submarkets that we believe support strong occupancy and have the potential for growth in rental rates. We seek to provide stockholders with attractive risk-adjusted returns, with an emphasis on distributions and capital appreciation. We own substantially all of our assets and conduct our operations through IROP, of which we are the sole general partner.

On September 27, 2016, we entered into an agreement, or the internalization agreement, with RAIT and RAIT affiliates providing for transactions which will change us from being externally managed to being internally managed and will separate us from RAIT.  We refer to the consummation of these transactions as the management internalization.  The management internalization consists of two parts: (i) our acquisition of our external advisor, which is a subsidiary of RAIT, and (ii) our acquisition of certain assets and the assumption of certain liabilities relating to the multifamily property management business of RAIT, including property management contracts relating to apartment properties owned by us, RAIT and third parties.  The purchase price for the management internalization is $43,000, subject to certain prorations at closing.  The internalization agreement provides that the closing of the management internalization will occur no earlier than December 20, 2016.  Pursuant to the internalization agreement, on October 5, 2016, we repurchased all of the 7,269,719 shares of our common stock owned by certain of RAIT’s subsidiaries and retired these shares.  See Note 11: Subsequent Events for further information.  

 

NOTE 2: Summary of Significant Accounting Policies

a. Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared by management in accordance with generally accepted accounting principles in the United States, or GAAP. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although we believe that the included disclosures are adequate to make the information presented not misleading. The unaudited interim consolidated financial statements should be read in conjunction with our audited financial statements as of and for the year ended December 31, 2015 included in our Annual Report on Form 10-K or the 2015 annual report. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our consolidated financial position and consolidated results of operations and cash flows are included. The results of operations for the interim periods presented are not necessarily indicative of the results for the full year.

b. Principles of Consolidation

The consolidated financial statements reflect our accounts and the accounts of IROP and other wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.  Pursuant to the accounting standard issued in February 2015 classified under Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 810, “Consolidation”, IROP is considered a variable interest entity.  As our significant asset is our investment in IROP, substantially all of our assets and liabilities represent the assets and liabilities of IROP.    

c. Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

d. Cash and Cash Equivalents

Cash and cash equivalents include cash held in banks and highly liquid investments with maturities of three months or less when purchased.  Cash, including amounts restricted, may at times exceed the Federal Deposit Insurance Corporation deposit insurance limit of $250 per institution.  We mitigate credit risk by placing cash and cash equivalents with major financial institutions.  To date, we have not experienced any losses on cash and cash equivalents.

e. Restricted Cash

Restricted cash includes tenant escrows and our funds held by lenders to fund certain expenditures or to be released at our discretion upon the occurrence of certain pre-specified events.  

f. Accounts Receivable and Allowance for Bad Debts

We make estimates of the collectability of our accounts receivable related to base rents, expense reimbursements and other revenue.  We analyze accounts receivable and historical bad debt levels, tenant credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.  In addition, tenants experiencing financial difficulties are analyzed and estimates are made in connection with expected uncollectible receivables.  Our reported operating results are affected by management’s estimate of the collectability of accounts receivable.

g. Investments in Real Estate

Allocation of Purchase Price of Acquired Assets

We account for acquisitions of properties that meet the definition of a business pursuant to FASB ASC Topic 805, “Business Combinations”. The fair value of the real estate acquired is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases for acquired in-place leases and the value of tenant relationships, based in each case on their fair values. Purchase accounting is applied to assets and liabilities associated with the real estate acquired. Transaction costs and fees incurred related to acquisitions are expensed as incurred. Transaction costs and fees incurred related to the financing of an acquisition are capitalized and amortized over the life of the related financing.

Upon the acquisition of properties, we estimate the fair value of acquired tangible assets (consisting of land, building and improvements) and identified intangible assets (consisting of in-place leases), and assumed debt at the date of acquisition, based on the evaluation of information and estimates available at that date.  Based on these estimates, we allocate the initial purchase price to the applicable assets and liabilities. As final information regarding fair value of the assets acquired and liabilities assumed is received and estimates are refined, appropriate adjustments will be made to the purchase price allocation, in no case later than twelve months of the acquisition date. During the nine months ended September 30, 2016, we made an adjustment related to the TSRE acquisition as described in NOTE 3: Investments in Real Estate.  

The aggregate value of in-place leases is determined by evaluating various factors, including the terms of the leases that are in place and assumed lease-up periods.  During the nine months ended September 30, 2016, we did not acquire any properties and, therefore, did not acquire any in-place leases. The value assigned to this intangible asset is amortized over the assumed lease up period, typically six months. For the three and nine months ended September 30, 2016 we recorded $0 and $3,735, respectively, of amortization expense for intangible assets. For the three and nine months ended September 30, 2015 we recorded $109 and $3,397, respectively, of amortization expense for intangible assets.  During the nine months ended September 30, 2016, $7,471 of intangible assets became fully amortized and were written off.  

Impairment of Long-Lived Assets

Management evaluates the recoverability of our investment in real estate assets, including related identifiable intangible assets, in accordance with FASB ASC Topic 360, “Property, Plant and Equipment”. This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that recoverability of the assets is not assured.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

Management reviews its long-lived assets on an ongoing basis and evaluates the recoverability of the carrying value when there is an indicator of impairment. An impairment charge is recorded when it is determined that the carrying value of the asset exceeds the fair value. The estimated cash flows used for the impairment analysis and the determination of estimated fair value are based on our plans for the respective assets and our views of market and economic conditions. The estimates consider matters such as current and historical rental rates, occupancies for the respective and/or comparable properties, and recent sales data for comparable properties. Changes in estimated future cash flows due to changes in our plans or views of market and economic conditions could result in recognition of impairment losses, which, under the applicable accounting guidance, could be substantial.

Depreciation Expense

Depreciation expense for real estate assets is computed using a straight-line method based on a life of 40 years for buildings and improvements and five to ten years for equipment and fixtures. For the three and nine months ended September 30, 2016 we recorded $7,765 and $23,192 of depreciation expense, respectively. For the three and nine months ended September 30, 2015 we recorded $4,594 and $13,064 of depreciation expense, respectively.

h. Revenue and Expenses

Minimum rents are recognized on an accrual basis, over the terms of the related leases on a straight-line basis. Any above market lease value and the capitalized below-market lease values are amortized as an adjustment to rental income over the lease term. Recoveries from residential tenants for utility costs are recognized as revenue in the period that the applicable costs are incurred.

For the three and nine months ended September 30, 2016, we recognized revenues of $38 and $151, respectively, related to recoveries of lost rental revenue due to natural disasters and other insurable events from our insurance providers.

For the three and nine months ended September 30, 2016, we incurred $435 and $1,325 of advertising expenses, respectively.  For the three and nine months ended September 30, 2015, we incurred $318 and $941 of advertising expenses, respectively.

i. Derivative Instruments

We may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with our borrowings.  

In accordance with FASB ASC Topic 815, “Derivatives and Hedging”, we measure each derivative instrument (including certain derivative instruments embedded in other contracts) at fair value and record such amounts in our consolidated balance sheet as either an asset or liability.  For derivatives designated as fair value hedges, derivatives not designated as hedges, or for derivatives designated as cash flow hedges associated with debt for which we elected the fair value option under FASB ASC Topic 825, “Financial Instruments”, the changes in fair value of the derivative instrument are recorded in earnings.  For derivatives designated as cash flow hedges, the changes in the fair value of the effective portions of the derivative are reported in other comprehensive income.  Changes in the ineffective portions of cash flow hedges, if any, are recognized in earnings.

j. Fair Value of Financial Instruments

In accordance with FASB ASC Topic 820, “Fair Value Measurements and Disclosures”, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity for disclosure purposes. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their value. Hierarchical levels, as defined in FASB ASC Topic 820, “Fair Value Measurements and Disclosures” and directly related to the amount of subjectivity associated with the inputs to fair valuations of these assets and liabilities, are as follows:

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

The availability of observable inputs can vary depending on the financial asset or liability and is affected by a wide variety of factors, including, for example, the type of investment, whether the investment is new, whether the investment is traded on an active exchange or in the secondary market, and the current market condition. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by us in determining fair value is greatest for instruments categorized in Level 3.

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that management believes market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that management believes are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be transferred from Level 1 to Level 2 or Level 2 to Level 3.

Fair value for certain of our Level 3 financial instruments is derived using internal valuation models. These internal valuation models include discounted cash flow analyses developed by management using current interest rates, estimates of the term of the particular instrument, specific issuer information and other market data for securities without an active market. In accordance with FASB ASC Topic 820, “Fair Value Measurements and Disclosures”, the impact of our own credit spreads is also considered when measuring the fair value of financial assets or liabilities, including derivative contracts. Where appropriate, valuation adjustments are made to account for various factors, including bid-ask spreads, credit quality and market liquidity. These adjustments are applied on a consistent basis and are based on observable inputs where available. Management’s estimate of fair value requires significant management judgment and is subject to a high degree of variability based upon market conditions, the availability of specific issuer information and management’s assumptions.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

FASB ASC Topic 825, “Financial Instruments” requires disclosure of the fair value of financial instruments for which it is practicable to estimate that value. The fair value of mortgage indebtedness is based on a discounted cash flows valuation technique. As this technique utilizes current credit spreads, which are generally unobservable, this is classified as a Level 3 fair value measurement within the fair value hierarchy.  We determine appropriate credit spreads based on the type of debt and its maturity. The fair value of our secured credit facility, term loan facility, cash and cash equivalents and restricted cash as of September 30, 2016 and December 31, 2015 approximated their respective unpaid principal balances due to the nature of these instruments. Given that cash and cash equivalents and restricted cash are short term in nature with limited fair value volatility, the carrying amount is deemed to be a reasonable approximation of fair value and the fair value input is classified as a Level 1 fair value measurement. The fair value input for the derivatives is classified as a Level 2 fair value measurement within the fair value hierarchy.  The fair value inputs for the secured credit facility and term loan facility are classified as Level 2 fair value measurements within the fair value hierarchy.  The following table summarizes the carrying amount and the fair value of our financial instruments as of the periods indicated:

 

 

k. Deferred Financing Costs

Costs incurred in connection with debt financing are deferred and classified within indebtedness and charged to interest expense over the terms of the related debt agreements, under the effective interest method.

l. Income Taxes

We have elected to be taxed as a REIT beginning with the taxable year ended December 31, 2011.  Accordingly, we recorded no income tax expense for the three and nine months ended September 30, 2016 and for the three and nine months ended September 30, 2015.

To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our ordinary taxable income to stockholders.  As a REIT, we generally are not subject to federal income tax on taxable income that we distribute to our stockholders.  If we fail to qualify as a REIT in any taxable year, we will be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions.  Such an event could materially adversely affect our 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 and maintain treatment as a REIT and intend to operate in such a manner so that we will remain qualified as a REIT for federal income tax purposes.  

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

m. Recent Accounting Pronouncements

Adopted Within these Financial Statements

In February 2015, the FASB issued an accounting standard classified under FASB ASC Topic 810, “Consolidation”. This accounting standard amends the consolidation analysis required under GAAP and requires management to reevaluate all previous consolidation conclusions. This standard considers limited partnerships to be VIEs, unless the limited partners have either substantive kick-out or participating rights. The presumption that a general partner should consolidate a limited partnership has also been eliminated. The standard amends the effect that fees paid to a decision maker or service provider have on the consolidation analysis, as well as amends how variable interests held by a reporting entity’s related parties affect the consolidation conclusion. This standard also clarifies how to determine whether equity holders as a group have power over an entity. This standard was effective for interim and annual reporting periods beginning after December 15, 2015, with an early adoption permitted. The adoption of this accounting standard did not have an impact on our consolidated financial statements as it did not change any of our existing consolidation conclusions.

In April 2015, the FASB issued an accounting standard classified under FASB ASC Topic 835, “Interest”. This accounting standard amends existing guidance to change reporting requirements for debt issuance costs by requiring debt issuance costs to be presented on the balance sheet as a direct deduction from the debt liability. This standard was effective for interim and annual reporting periods beginning after December 15, 2015, with an early adoption permitted. Retrospective application to prior periods is required. The adoption of this accounting standard resulted in the reclassification in our December 31, 2015 consolidated balance sheet of $9,226 of net deferred costs to total indebtedness on our consolidated balance sheet.

In September 2015, the FASB issued an accounting standard classified under FASB ASC Topic 805, “Business Combinations”.  This accounting standard amends existing guidance related to measurement period adjustments by requiring the adjustments to be recognized prospectively with disclosure of the impact of the adjustments had they been applied previously.  This standard was effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted.  As this standard only applied to measurement period adjustments that occur after the effective date, this standard did not have a material impact on our consolidated financial statements.  

Not Yet Adopted Within these Financial Statements

In May 2014, the FASB issued an accounting standard classified under FASB ASC Topic 606, “Revenue from Contracts with Customers”. This accounting standard generally replaces existing guidance by requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This accounting standard applies to all contracts with customers, except those that are within the scope of other Topics in the FASB ASC. During 2016, the FASB issued three amendments to this accounting standard which provide further clarification to this accounting standard. These standards amending FASB ASC Topic 606 are currently effective for annual reporting periods beginning after December 15, 2017. Management is currently evaluating the impact that these standards may have on our consolidated financial statements.

In January 2016, the FASB issued an accounting standard classified under FASB ASC Topic 825, “Financial Instruments”. This accounting standard addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.  Among other things, the amendment (i) eliminates certain disclosure requirements for financial instruments measured at amortized cost; (ii) requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) requires separate presentation, in other comprehensive income, of the change in fair value of a liability, when the fair value option has been elected, resulting from a change in the instrument-specific credit risk; and (iv) requires separate presentation of financial instruments by measurement category and form.  This standard is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years.  Early adoption is permitted for the separate presentation of changes in fair value due to changes in instrument-specific credit risk. Management is currently evaluating the impact that this standard may have on our consolidated financial statements.

In February 2016, the FASB issued an accounting standard classified under FASB ASC Topic 842, “Leases”.  This accounting standard amends lease accounting by requiring the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases on the balance sheet and disclosing key information about leasing arrangements.  This standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years.  Early application of the

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

amendments in this standard is permitted.  Management is currently evaluating the impact that this standard may have on our consolidated financial statements.

In March 2016, the FASB issued an accounting standard classified under FASB ASC Topic 815, “Derivatives and Hedging”.  This accounting standard clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met.  This standard is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period.  Management does not expect this standard to have a significant impact on our consolidated financial statements.

In March 2016, the FASB issued an accounting standard classified under FASB ASC Topic 815, “Derivatives and Hedging”. This accounting standard clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts.  This accounting standard clarifies what steps are required when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative.  Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks.  This standard is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period. Management does not expect this standard to have a significant impact on our consolidated financial statements.

In March 2016, the FASB issued an accounting standard classified under FASB ASC Topic 718, “Compensation – Stock Compensation”.  This accounting standard simplifies several aspects of the accounting for share-based payment award transactions, including: (i) income tax consequences; (ii) classification of awards as either equity or liabilities; and (iii) classification on the statement of cash flows.  This standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. Management is currently evaluating the impact that this standard may have on our consolidated financial statements.

In August 2016, the FASB issued an accounting standard classified under FASB ASC Topic 230, “Statement of Cash Flows”.  This accounting standard provides guidance on eight specific cash flow issues: (i) debt prepayment or debt extinguishment costs; (ii) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; (iii) contingent consideration payments made after a business combination; (iv) proceeds from the settlement of insurance claims; (v) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (vi) distributions received from equity method investees; (vii) beneficial interests in securitization transactions; and (viii) separately identifiable cash flows and application of the predominance principle.  The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period.  Management is currently evaluating the impact that this standard may have on our consolidated statement of cash flows.

In October 2016, the FASB issued an accounting standard classified under FASB ASC Topic 810, “Consolidation”.  The amendments in this accounting standard provide guidance on how a reporting entity that is the single decision maker of a VIE should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE.  The amendments in this accounting standard do not change the characteristics of a primary beneficiary in current GAAP.  A primary beneficiary of a VIE has both of the following characteristics: (i) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.  If a reporting entity satisfies the first characteristic of a primary beneficiary (such that it is the single decision maker of a VIE), the amendments in this accounting standard require that the reporting entity, in determining whether it satisfies the second characteristic of a primary beneficiary, to include all of its direct variable interest in a VIE and, on a proportionate basis, its indirect variable interest in a VIE held through related parties, including related parties that are under common control with the reporting entity.  If after performing that assessment, a reporting entity that is the single decision maker of a VIE concludes that it does not have the characteristics of a primary beneficiary, the amendments continue to require that the reporting entity to evaluate whether it and one or more of its related parties under common control, as a group, have the characteristics of a primary beneficiary.  The amendments in this accounting standard are effective for fiscal years beginning after December 15, 2016,

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

including interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period.  Management is currently evaluating the impact that this standard may have on our consolidated financial statements.

 

 

 

 

 

NOTE 3: Investments in Real Estate

As of September 30, 2016, our investments in real estate consisted of 46 apartment properties with 12,982 units (unaudited).  The table below summarizes our investments in real estate:

 

 

Acquisitions

During the first quarter of 2016, we received additional information regarding estimates we had made for certain accrued expenses related to our acquisition of Trade Street Residential Inc., or the TSRE acquisition, that was completed on September 17, 2015.  This information led to an increase in fair value of the net assets we acquired of $91, which we recognized during the nine months ended September 30, 2016.  During the third quarter of 2016, we finalized our purchase accounting process related to the TSRE acquisition.  As part of this process, we received additional information regarding estimates we had made for certain accrued expenses related to the TSRE acquisition which led to an increase in fair value of the net assets we acquired of $641, which we recognized during the three months ended September 30, 2016.

Dispositions

During the nine months ended September 30, 2016 we recognized a $9 loss related to the sale of a multifamily property which occurred in the prior year as we settled remaining amounts with buyers. The below table summarizes the dispositions for the nine months ended September 30, 2016 and also presents each property’s contribution to net income (loss) allocable to common shares, excluding the impact of the gain (loss) on sale:      

 

 

Related to the dispositions of Belle Creek and Tresa, we paid $211 and $275 of exit fees to RAIT, respectively, pursuant to the contractual terms of the mortgage indebtedness.  See Note 4: Indebtedness for further information.  These amounts were recognized in net gains (losses) on sale of assets.  

 

 

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

NOTE 4: Indebtedness

The following tables contain summary information concerning our indebtedness as of September 30, 2016:

 

 

 

  

As of September 30, 2016 we were in compliance with all financial covenants contained in our indebtedness.

The following table contains summary information concerning our indebtedness as of December 31, 2015:

 

 

 

As of September 30, 2016, the weighted average interest rate of our mortgage indebtedness was 3.8%. As of September 30, 2016 and December 31, 2015, RAIT held $0 and $38,075 of our mortgage indebtedness, respectively.  For the three and nine months ended September 30, 2016, we incurred approximately $0 and $361, respectively, of interest expense related to the RAIT indebtedness.  For the three and nine months ended September 30, 2015, we incurred approximately $243 and $722, respectively, of interest expense related to the RAIT indebtedness.

Secured Credit Facility

On September 17, 2015, IROP entered into a credit agreement with KeyBank with respect to a $325,000 senior secured credit facility, or the secured credit facility, which will mature on September 17, 2018. The secured credit facility is available for additional loans, may be increased to $450,000 and/or extended for two 12-month terms.  At September 30, 2016, amounts outstanding under the

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

secured credit facility bear interest at 245 basis points over 1-month LIBOR.  As of September 30, 2016, there was $77,665 of availability under the senior secured credit facility.  An unused fee of 0.25% is charged on this amount.

In March of 2016, IROP drew down $8,000 on the secured credit facility, which was used to repay $6,000 of the interim facility, discussed below.

In March of 2016, IROP drew down $45,476 on the secured credit facility, which was used to satisfy the existing mortgages and closing costs relating to the Oklahoma City portfolio of properties which were acquired in 2014.

In May of 2016, IROP repaid $77,665 on the secured credit facility with the proceeds received from entering into permanent financing relating to Aston, Avenues at Craig Ranch and Waterstone at Big Creek which were all acquired in 2015.  

In October of 2016, IROP paid down $107,335 on the secured credit facility with the proceeds received from a public offering.   See Note 11: Subsequent Events for further information.

Term Loan

On September 17, 2015, IROP entered into a credit agreement with respect to a $120,000 senior interim term loan facility, or the interim facility.  The interim facility was amended and restated to replace the interim facility with a $40,000 senior secured term loan, as described below.    

In January and February of 2016, IROP repaid $23,784 of the interim facility subsequent to two property dispositions.

In April and May of 2016, IROP repaid $30,000 of the interim facility subsequent to two property dispositions.

In May of 2016, IROP repaid $26,704 of the interim facility subsequent to the permanent financing of two properties with seven and ten year fixed-rate mortgages.

As noted above, the interim facility was amended and restated to provide for a $40,000 senior secured term loan, or the term loan, on June 24, 2016.  Upon entering into the term loan, IROP borrowed $40,000, using $416 to pay closing costs and $33,512 to repay the remaining balance under the interim facility. The maturity date of the term loan is September 17, 2018, subject to acceleration in the event of customary events of default.  The term loan requires monthly payments of interest only through June 30, 2017.  IROP is required to reduce the principal amount outstanding under the term loan by $100 per month beginning July 2017 and must apply 50% of all net proceeds from equity issuances, sales of assets, or refinancings of assets towards repaying the term loan.  At IROP’s option, borrowings under the term loan will bear interest at a rate equal to either (i) LIBOR plus a margin of 400 basis points, or (ii) a base rate plus a margin of 300 basis points.  IROP may prepay the term loan, in whole or in part, at any time without fee or penalty, except for breakage costs associated with LIBOR borrowings.  At September 30, 2016, the term loan bears interest at 400 basis points over 1-month LIBOR and the balance is $40,000.

 In October of 2016, IROP repaid the $40,000 term loan with the proceeds received from a public offering.   See Note 11: Subsequent Events for further information.

Mortgages-Fixed Rate

In February of 2016, we repaid $6,659 of mortgage indebtedness as part of a property disposition.

In March of 2016, we repaid $43,694 of mortgage indebtedness related to the Oklahoma City portfolio of properties we acquired in 2014 through a refinancing whereby IROP drew down on the secured credit facility.

On May 26, 2016, we entered into a loan agreement for a $25,050 loan secured by a first mortgage on our Aston property.  The loan bears interest at a rate of 3.4% per annum, provides for monthly payments of interest only through December 2019, when principal and interest payments will be due monthly based on a 30-year amortization schedule, and matures June 2023.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

On May 17, 2016, we entered into a loan agreement for a $31,250 loan secured by a first mortgage on our Avenues at Craig Ranch property. The loan bears interest at a rate of 3.3% per annum, provides for monthly payments of interest only through May 2019, when principal and interest payments will be due monthly based on a 30-year amortization schedule, and matures June 2023.

On May 20, 2016, we entered into a loan agreement for a $49,680 loan secured by a first mortgage on our Waterstone at Big Creek property.  The loan bears interest at a rate of 3.7% per annum, provides for monthly payments of interest only through June 2019, when principal and interest payments will be due monthly based on a 30-year amortization schedule, and matures June 2026.

Mortgages-Floating Rate

In April of 2016, we repaid $10,575 of mortgage indebtedness as part of a property disposition.  This indebtedness was held by RAIT.  During the nine months ended September 30, 2016, we paid $211 in exit fees pursuant to the contractual terms of the mortgage indebtedness to RAIT.

In May of 2016, we repaid $27,500 of mortgage indebtedness as part of a property disposition.  This indebtedness was held by RAIT. During the nine months ended September 30, 2016, we paid $275 in exit fees pursuant to the contractual terms of the mortgage indebtedness to RAIT.

 

 

NOTE 5: Derivative Financial Instruments

We may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with our borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with our operating and financial structure as well as to hedge specific anticipated transactions.  While these instruments may impact our periodic cash flows, they benefit us by minimizing the risks and/or costs previously described.  The counterparties to these contractual arrangements are major financial institutions with which we and our affiliates may also have other financial relationships. In the event of nonperformance by the counterparties, we are potentially exposed to credit loss. However, because of the high credit ratings of the counterparties, we do not anticipate that any of the counterparties will fail to meet their obligations.

Interest Rate Swaps and Caps

We have entered into an interest rate cap contract and an interest rate swap contract to hedge interest rate exposure on floating rate indebtedness.  

On September 30, 2015, we entered into an interest rate cap contract with a notional value of $200 million, a strike rate of 3.0% based on 1-month LIBOR and a maturity date of October 17, 2017.  Through June 23, 2016 this interest rate cap was designated as a cash flow hedge. Through that date, we concluded that this hedging relationship was highly effective in offsetting interest rate fluctuations associated with the identified indebtedness and, using the hypothetical derivative method, did not recognize any ineffectiveness.  On June 24, 2016, this interest rate cap was de-designated and, as of June 30, 2016, this interest rate cap was accounted for as a freestanding derivative.  The change in fair value of this interest cap was $1 for the nine months ended September 30, 2016.

On June 24, 2016, we entered into an interest rate swap contract with a notional value of $150 million, a strike rate of 1.145% and a maturity date of June 17, 2021.  We designated this interest rate swap as a cash flow hedge at inception and determined that the hedge is highly effective in offsetting interest rate fluctuations associated with the identified indebtedness. We concluded that this hedging relationship was and will continue to be highly effective, and using the hypothetical derivative method, did not recognize any ineffectiveness.  

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

The following table summarizes the aggregate notional amount and estimated net fair value of our derivative instruments as of September 30, 2016 and December 31, 2015:

 

 

Effective interest rate swaps and caps are reported in accumulated other comprehensive income and the fair value of these hedge agreements is included in other assets or other liabilities.

For interest rate swaps and caps that are considered effective hedges, we reclassified realized losses of $251 and $271, respectively, to earnings within interest expense for the three and nine months ended September 30, 2016. For interest rate swaps and caps that are considered effective hedges, we expect $721 to be reclassified out of accumulated other comprehensive income to earnings over the next 12 months.

 

 

NOTE 6: Shareholder Equity and Noncontrolling Interests

Stockholder Equity

Common Shares

Our board of directors has declared the following dividends:

 

 

During the three and nine months ended September 30, 2016, we also paid $0 and $42, respectively, of dividends on restricted common share awards that vested during the period.

On September 27, 2016 we announced a public offering of our common stock, which was completed on October 5, 2016. See Note 11: Subsequent Events for information regarding events that occurred in October of 2016 involving our equity including the completion of a public offering of our common stock and the repurchase of certain shares of our common stock.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

Noncontrolling Interest

On February 1, 2016, holders of IROP units exchanged 204,115 units for 204,113 shares of our common stock with fractional units being settled in cash. On August 1, 2016, holders of IROP units exchanged 35,808 units for 35,808 shares of our common stock. As of September 30, 2016, 2,915,008 IROP units held by unaffiliated third parties remain outstanding with a redemption value of $26,235, based on IRT’s stock price as of September 30, 2016.

Our board of directors has declared the following distributions on IROP’s LP units:

 

 

 

 

NOTE 7: Equity Compensation Plans

Long Term Incentive Plan

On April 5, 2011, our board of directors approved and adopted the Long Term Incentive Plan, or the incentive plan, and the Independent Directors Compensation Plan, or the director plan. Our incentive plan provides for the grant of awards to our directors, officers and full-time employees (in the event we ever have employees), full-time employees of our advisor and its affiliates, full-time employees of entities that provide services to our advisor, directors of our advisor or of entities that provide services to it, certain of our consultants and certain consultants to our advisor and its affiliates or to entities that provide services to our advisor. The incentive plan authorizes the grant of restricted or unrestricted shares of our common stock, non-qualified and incentive stock options, restricted stock units, stock appreciation rights, dividend equivalents and other stock- or cash-based awards. On July 29, 2013, our board of directors and stockholders approved the amendment and restatement of our incentive plan to reduce the number of shares of common stock issuable thereunder to 800,000 shares.  

Under the director plan, which operated as a sub-plan of our incentive plan, each of our independent directors has received 3,000 shares of common stock annually. In addition, our independent directors could elect to receive their annual cash fee in the form of our common shares or a combination of common shares and cash.

In March 2016, our board of directors adopted the 2016 Long Term Incentive Plan, or the 2016 LTIP, which was approved by stockholders at IRT’s Annual Meeting held on May 12, 2016.  The number of shares of common stock issuable thereunder is 4,300,000 shares of common stock.  The term of the 2016 LTIP was extended so that the 2016 LTIP will terminate on May 12, 2026. The director plan was terminated and future director awards will be made under the 2016 LTIP.

On February 12, 2016, our compensation committee awarded 210,000 restricted stock awards valued at $6.22 per share, or $1,306, in the aggregate.  The awards vest over a three-year period.

On May 12, 2016, our compensation committee made a stock grant under the 2016 LTIP so that our independent directors received 18,000 shares of our common stock, in the aggregate, valued at $137 using our closing stock price of $7.60.  These awards vested immediately.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

 

 

NOTE 8: Related Party Transactions and Arrangements

Fees and Expenses Paid to Our Advisor

As of September 25, 2015 we entered into the Second Amendment to the Second Amended and Restated Advisory Agreement.  The Second Amendment amends the advisory agreement to extend its term to October 1, 2020, and to provide for compensation to our Advisor for periods subsequent to October 1, 2015 as follows:

Prior to the Second Amendment, the Second Amended and Restated Advisory Agreement, which was effective as of May 7, 2013 through September 30, 2015, provided that our Advisor was compensated as follows:

For the three and nine months ended September 30, 2016, our Advisor earned $1,727 and $5,141 of asset management fees, respectively.  For the three and nine months ended September 30, 2015, our Advisor earned $1,259 and $3,306 of asset management fees, respectively.

For the three and nine months ended September 30, 2016, our Advisor earned $206 and $350 of incentive fees, respectively. For the three and nine months ended September 30, 2015, our Advisor earned $0 and $425 of incentive fees, respectively.  These fees are included within asset management fees in our consolidated statements of operations.

As of September 30, 2016 and December 31, 2015 we had liabilities payable to our Advisor for asset management fees and incentive fees of $3,726 and $1,854, respectively. These liabilities are presented within accounts payable and accrued expenses in the accompanying consolidated balance sheets.                

Property Management Fees Paid to Our Property Manager

We have entered into property management agreements with RAIT Residential, or our property manager, which is wholly owned by RAIT, with respect to each of our properties. Pursuant to the property management agreements, we pay our property manager property management and leasing fees on a monthly basis of an amount up to 4.0% of the gross revenues from the property for each month. Additionally, we may pay our property manager a separate fee for the one-time initial rent-up or leasing-up of newly constructed properties, in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area. Each management agreement has an initial one year term, subject to automatic one-year renewals unless either party gives prior notice of its desire to terminate the management agreement. For the three and nine months ended September 30, 2016 our property manager earned $1,219 and $3,710 of property management and construction management fees, respectively. For the three and nine months ended September 30, 2015 our property manager earned $861 and $2,381 of property management and construction management fees, respectively. As of September 30, 2016 and December 31, 2015, we had liabilities payable to our property manager for property

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

management and construction management fees of $0 and $440, respectively.  These liabilities are presented within accounts payable and accrued expenses in the accompanying consolidated balance sheets.

Dividends Paid to Affiliates of our Advisor

As of September 30, 2016 and December 31, 2015, RAIT owned 15.4% and 15.5% of the outstanding shares of our common stock, respectively.  For the three and nine months ended September 30, 2016, we declared and subsequently paid dividends of $1,309 and $3,927, respectively, related to shares of common stock owned by RAIT.  For the three and nine months ended September 30, 2015, we declared and subsequently paid dividends of $1,309 and $3,926 respectively, related to shares of common stock owned by RAIT.  As of September 30, 2016 and December 31, 2015, we had distributions payable to RAIT of $436 and $436, respectively.

 

 

RAIT Indebtedness

In the second quarter of 2016, we repaid $38,075 of mortgage indebtedness with proceeds from two property dispositions.  This indebtedness was held by RAIT.  During the three and nine months ended September 30, 2016, we paid $0 and $486, respectively, in exit fees pursuant to the contractual terms of the mortgage indebtedness to RAIT.

 

Management Internalization and Stock Repurchase

 

On September 27, 2016, we announced the management internalization, which involved the acquisition of our external advisor as well as the acquisition of certain assets and the assumption of certain liabilities relating to the multifamily property management business of RAIT, and the repurchase of up to all of the approximately 7,269,719 shares of our common stock owned by certain of RAIT’s subsidiaries.  See Note 1: The Company and Note 11: Subsequent Events for further information.

 

 

NOTE 9: Earnings (Loss) Per Share

The following table presents a reconciliation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2016 and 2015:

 

 

Certain IROP units, stock appreciation rights, or SARs, and unvested shares were excluded from the earnings (loss) per share computation because their effect would have been anti-dilutive, totaling 2,915,008 and 3,091,380 for the three and nine months ended September 30, 2016, respectively, and 3,278,935 and 3,184,326 for the three and nine months ended September 30, 2015, respectively.

 

 

NOTE 10: Other Disclosures

Litigation

We are subject to various other legal proceedings and claims that arise in the ordinary course of our business operations. Matters which arise out of allegations of bodily injury, property damage, and employment practices are generally covered by insurance. While the resolution of these other matters cannot be predicted with certainty, we currently believe the final outcome of such matters will not have a material adverse effect on our financial position, results of operations or cash flows.

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Independence Realty Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

As of September 30, 2016

(Unaudited and dollars in thousands, except share and per share data)

 

Other Matters

To the extent that a natural disaster or similar event occurs with more than a remote risk of having a material impact on the consolidated financial statements, we will disclose the estimated range of possible outcomes, and, if an outcome is probable, accrue an appropriate liability.

 

NOTE 11: Subsequent Events

On October 5, 2016, we completed the underwritten public offering that was announced on September 27, 2016.  We issued and sold 25,000,000 common shares, par value $0.01 per share, at a public offering price of $9.00 per common share. We received approximately $211,750 of net proceeds of the public offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.  

On October 5, 2016, we used these proceeds as follows: (i) $40,000 of the proceeds were used to prepay in full and terminate our $40,000 senior secured term loan facility; (ii) $62,156 of the proceeds were used to repurchase and retire 7,269,719 shares of our common stock from certain of RAIT’s subsidiaries at a purchase price of $8.55 per share; (iii) $47,335 of the proceeds were used to partially pay down the $325,000 senior secured credit facility; (iv) $43,000 of the proceeds were reserved to consummate the management internalization; and v) the remaining $19,259 was held for general corporate purposes.  

On October 11, 2016, we partially paid down an additional $30,000 on the $325,000 senior secured credit facility using proceeds received from the offering and cash on our balance sheet.  

As part of the offering, we granted the underwriters an option, exercisable for 30 days from the date of the underwriting agreement, to purchase up to an additional 3,750,000 common shares. On October 21 2016, the underwriters exercised their option to purchase an additional 3,750,000 common shares at a purchase price of $9.00 per common share.  We received $32,062 of net proceeds, after deducting underwriting discounts and commissions.

On October 24, 2016, we partially paid down an additional $30,000 on the $325,000 senior secured credit facility using the proceeds received from the exercise of the underwriters’ option.

 

 

 

 

 

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Forward-Looking Statements

The Securities and Exchange Commission, or SEC, encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This report contains or incorporates by reference such “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act.

Words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” “believes” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify forward-looking statements. As used herein, the terms “we,” “our” and “us” refer to Independence Realty Trust, Inc. and, as required by context, Independence Realty Operating Partnership, LP, which we refer to as IROP, and their subsidiaries.

We claim the protection of the safe harbor for forward-looking statements provided in the Private Securities Litigation Reform Act of 1995. These statements may be made directly in this report and they may also be incorporated by reference in this report to other documents filed with the SEC, and include, but are not limited to, statements about future financial and operating results and performance, statements about our plans, objectives, expectations and intentions with respect to future operations, products and services, and other statements that are not historical facts. These forward-looking statements are based upon the current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are difficult to predict and generally beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the anticipated results discussed in these forward-looking statements.

The risk factors discussed and identified in Item 1A of our 2015 Annual Report on Form 10-K, this Report and in other of our public filings with the SEC, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Except to the extent required by applicable law or regulation, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events.

Overview

We are a Maryland corporation that owns apartment properties in geographic submarkets that we believe support strong occupancy and have the potential for growth in rental rates. We seek to provide stockholders with attractive risk-adjusted returns, with an emphasis on distributions and capital appreciation. We are externally advised by a wholly-owned subsidiary of RAIT Financial Trust, or RAIT (NYSE: RAS), a multi-strategy commercial real estate company organized as an internally managed REIT with approximately $5.1 billion of assets under management as of September 30, 2016. RAIT invests primarily in commercial mortgage loans and, to a lesser extent, apartment properties. As of September 30, 2016, RAIT owned 7,269,719 shares of our common stock, representing approximately 15.4% of our outstanding shares of common stock.  As described below, on September 27, 2016, we entered into the internalization agreement to repurchase all of our outstanding common shares owned by RAIT at the first closing contemplated by the internalization agreement and to complete the management internalization at the second closing contemplated by the internalization agreement.  As described below, on October 5, 2016, we repurchased and retired these shares at the first closing.  The internalization agreement provides that this second closing will occur, subject to the terms and conditions contained therein, no earlier than December 20, 2016.  We expect that the management internalization will close during December of 2016.  We elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or the Code, commencing with our taxable year ended December 31, 2011.

We seek to acquire and operate apartment properties that:

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In the three and nine month period ended September 30, 2016, we continued to focus operationally on absorbing the growth we experienced during 2015 due primarily to our acquisition of TSRE in September 2015 and implementing our capital recycling strategy described below to reduce our leverage over time.  See “Operations Overview” below.  In addition, beginning in September 2016, we pursued the internalization of our management and entered into the internalization agreement with RAIT.  See “Management Internalization Overview” below.  With respect to our liquidity and capital resources, on September 27, 2016 we announced a public offering of our common stock, which was completed in October of 2016.  Pursuant to the October 2016 offering, we issued and sold, 28,750,000 shares of our common stock at a public offering price of $9.00 per share.  Total gross proceeds to IRT from the October 2016 offering, before deducting the underwriting discount and estimated offering expenses, were $258.8 million.  See “Liquidity and Capital Resources” below for a description of the October 2016 offering and the use of proceeds.

Operations Overview

We believe our operating results for the three-month period ended September 30, 2016 support our strategy of building a portfolio of apartment communities in primarily non-gateway markets, which continued to enjoy solid population and job growth while being relatively insulated from the effects of new construction. We continue to see the potential for rent increases and NOI growth within our markets.

During the three-month period ended September 30, 2016, revenue increased $12.9 million as compared to last year. This increase was primarily due to $14.8 million of revenue associated with properties we acquired in the TSRE acquisition offset by the impact of property sales. During the nine month period ended September 30, 2016, revenue increased $45.5 million as compared to last year.  This increase was primarily due to $48.6 million of revenue associated with properties we acquired in the TSRE acquisition offset by the impact of property sales.

On a same-store basis, rental revenue was up this quarter as compared to third quarter last year, as rental rates increased 3.4% on average across the same-store portfolio.  On a same-store basis, net operating income increased 6.0% for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015, and 4.6% for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.  See “Non-GAAP Financial Measures – Same Store Portfolio Net Operating Income” below for our definition of same store and definitions and reconciliations related to our net operating income margin.

As of September 30, 2016, we had $1.3 billion of gross investments in real estate comprised of 46 apartment properties containing an aggregate of 12,982 apartment units. We refer to these apartment properties as our “existing portfolio.” As of September 30, 2016, our existing portfolio had an average occupancy of 94.1% and an average monthly effective rent per occupied apartment unit of $977. 

As of September 30, 2016, we had $880.6 million of debt, with a weighted average effective interest cost of 3.5%.  Since we completed the TSRE acquisition in September 2015, we have been actively reducing our leverage through targeted asset sales and the use of proceeds of the October 2016 offering.  On October 5, 2016, we used $40.0 million of the net proceeds of the October 2016 offering to prepay in full and terminate our $40.0 million senior secured term loan facility.  On October 5, 2016, we used approximately $47.3 million of the net proceeds of the October 2016 offering to pay down the $325.0 million senior secured credit facility.  Later in October 2016, we paid down an additional $60.0 million on the $325.0 senior secured credit facility.  Including the October 2016 activity, we have reduced the principal amount of our indebtedness by $252.6 million since we completed the TSRE acquisition.  We also reduced amounts outstanding under the secured credit facility by refinancing three properties previously financed by the secured credit facility with longer term fixed rate mortgages. In the period from the TSRE acquisition through October 2016, we have reduced our leverage, which is calculated as total debt divided by total gross assets, from 68.0% to 53.4%. Under the terms of the $325.0 million senior secured credit facility, the contractual interest rate is reduced in periods when our leverage is at certain levels. We expect the contractual interest rate on this facility to be reduced in the first quarter of 2017 as a result of our lower leverage.

Management Internalization Overview

On September 27, 2016, we entered into an agreement to complete a management internalization, which includes property management functions. The management internalization provides management continuity as our existing management team will become full-time IRT employees. Additionally, we believe IRT will be afforded the related benefits of being an internalized, multifamily equity REIT, including expected cost savings and the elimination of any perceived conflicts that result from an external management structure. The management internalization consists of two parts: (i) our acquisition of our external advisor, which is a subsidiary of RAIT, and (ii) our acquisition of certain assets and the assumption of certain liabilities relating to the multifamily property management business of RAIT, including property management contracts relating to apartment properties owned by us, RAIT and third parties.  The purchase price for the management internalization is $43.0 million subject to certain prorations at

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closing.  As part of the same agreement, we also agreed to repurchase up to all of the approximately 7.3 million shares of our common stock owned by certain of RAIT’s subsidiaries, or the stock repurchase, subject to market conditions.

On October 5, 2016, the stock repurchase occurred and we used approximately $62.2 million of the proceeds from the October 2016 offering to repurchase the RAIT shares from certain of RAIT’s subsidiaries at a purchase price of $8.55 per share.  This price was equal to the price to the public in the October 2016 offering less underwriting discounts or commissions.  On October 5, 2016, we instructed our transfer agent to retire the RAIT shares and return them to the status of authorized but unissued shares.  As a result, on October 5, 2016 after giving effect to the shares issued in the October 2016 offering and the retirement of the RAIT shares, we had 65,243,345 shares of our common stock outstanding.

As required by the internalization agreement, IRT reserved $43.0 million in net proceeds from the October 2016 offering to consummate the management internalization as contemplated by the internalization agreement.

Upon closing of the management internalization, each of Scott F. Schaeffer, IRT’s Chief Executive Officer, Farrell Ender, IRT’s President, and James J. Sebra, IRT’s Chief Financial Officer (“CFO”), are expected to enter into employment agreements with IRT.  Messrs. Schaeffer and Ender are expected to terminate their employment with RAIT and become employees of IRT upon closing.  Mr. Sebra is expected to remain the CFO of RAIT until the later to occur of March 31, 2017 or the filing of RAIT’s Form 10-K for the fiscal year ending December 31, 2016 with the SEC.  In addition, more than 400 current employees of RAIT and the property manager are expected to become employees of IRT. Pursuant to the terms of the internalization agreement, IRT and RAIT will enter into a shared services agreement, pursuant to which RAIT and IRT will provide each other certain transitional services such as information technology, human resources, insurance, investor relations, legal, tax and accounting for a six-month transition period after the management internalization.

The management internalization will affect our future financial performance. We expect that, in the year following the closing of the management internalization, our ratio of net debt to gross assets and our ratio of net debt to EBITDA will both decline significantly, based on annualized results for the three month period ended September 30, 2016, due to the impact of the October 2016 offering, debt reductions, and expected cost savings from the management internalization. We also expect to record the purchase price we pay RAIT for the management internalization as an expense which will reduce our earnings in the period in which the management internalization occurs. In addition, due to the dilution resulting from our October 2016 offering, the expected length of time between the closing of the October 2016 offering and the management internalization, our earnings per share and core FFO will be reduced. We also believe we will reduce our general and administrative expenses from current levels after the management internalization occurs and the period covered by the shared services agreement ends.

The management internalization is conditioned upon, among other things, customary closing conditions, obtaining certain third party consents and the entry into employment agreements with the executives named above.  The internalization agreement provides that the management internalization will occur, subject to the terms and conditions contained therein, no earlier than December 20, 2016.  We expect the management internalization to occur by the end of December of 2016.  By its terms, the parties may terminate the internalization agreement if the other party breaches defined representations or covenants and such breach is not cured within 30 days, (ii) closing has not occurred by March 1, 2017 or (iii) a government authority has prohibited the transaction or denied a necessary approval.  If the internalization agreement is terminated due to a material breach, then the non-breaching party is entitled to a termination fee of up to $3.4 million, or the termination fee, for actual documented expenses incurred in conjunction with the internalization agreement.  

 

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Results of Operations

Three Months Ended September 30, 2016 Compared to the Three Months Ended September 30, 2015 (dollars in thousands)

 

See Non-GAAP Financial Measures – Same Store Portfolio Net Operating Income for a discussion about this metric.

Revenue

Rental income. Rental revenue increased $11.6 million to $34.3 million for the three months ended September 30, 2016 from $22.7 million for the three months September 30, 2015. The increase is attributable to $13.4 million of rental income from the acquisition of 19 properties in the three months ended September 30, 2015 present for a full quarter of operations in 2016 and $0.8 million from improved occupancy and rental rates in 2016 as compared to 2015 in our other properties. The increase was partially offset by a decrease of $2.6 million of rental income related to four properties that were disposed of after September 30, 2015.

Tenant reimbursement and other income. Tenant reimbursement and other income increased $1.3 million to $4.0 million for the three months ended September 30, 2016 from $2.7 million for the three months ended September 30, 2015. The increase is primarily attributable to $1.4 million of tenant reimbursement and other income from 19 new properties acquired in the three months ended September 30, 2015 present for a full quarter of operations in 2016. The increase was partially offset by a decrease of $0.3 million of tenant reimbursement and other income related to four properties that were disposed of after September 30, 2015.

Expenses

Real estate operating expenses. Real estate operating expenses increased $5.4 million to $17.3 million for the three months ended September 30, 2016 from $11.9 million for the three months ended September 30, 2015. The increase is attributable to $6.3 million of real estate operating expense from 19 new properties acquired in the three months ended September 30, 2015 present for a full quarter of operations in 2016 and an increase of $0.2 million of real estate operating expense in our same store portfolio. The increase was partially offset by a decrease of $1.2 million of real estate operating expense related to four properties that were disposed of after September 30, 2015.

General and administrative expenses. General and administrative expenses increased $0.2 million to $0.5 million for the three months ended September 30, 2016 from $0.3 million for the three months ended September 30, 2015 due to an increase in professional fees.

Stock compensation expense.  Compensation expense remained consistent for the three months ended September 30, 2016 and the three months ended September 30, 2015.

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Asset management fees. Asset management fees increased $0.6 million to $1.9 million for the three months ended September 30, 2016 from $1.3 million for the three months ended September 30, 2015. The increase is due to 19 new properties acquired in the three months ended September 30, 2015 present for a full quarter of operations in 2016.

Acquisition and integration expenses.  Acquisition and integration expenses decreased $12.8 million to nearly zero for the three months ended September 30, 2016 from $12.8 million for the three months ended September 30, 2015. The decrease is due to no property acquisitions during the three months ended September 30, 2016 as compared to 19 property acquisitions during the three months ended September 30, 2015.

Depreciation and amortization expense. Depreciation and amortization expense increased $3.1 million to $7.8 million for the three months ended September 30, 2016 from $4.7 million for the three months ended September 30, 2015. The increase is primarily attributable to $3.8 million of depreciation and amortization expense from 19 new properties acquired in the three months ended September 30, 2015 present for a full quarter of operations in 2016. The increase was partially offset by a decrease of $0.6 million of depreciation and amortization expense related to four properties that were disposed of after September 30, 2015.

Interest expense. Interest expense increased $3.7 million to $8.8 million for the three months ended September 30, 2016 from $5.1 million for the three months ended September 30, 2015. The increase is primarily attributable to $2.3 million of interest expense on the 19 new properties acquired in the three months ended September 30, 2015 present for a full quarter of operations in 2016 and $2.4 million of additional interest expense on debt obtained in connection with the TSRE merger that was present for a full quarter of operations in 2016. The increase was partially offset by a decrease of $0.5 million of interest expense related to four properties that were disposed of after September 30, 2015.

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Other

Gains (losses) on TSRE merger and property acquisitions. During the three months ended September 30, 2016, we recognized a $0.6 million gain as part of our completion of the purchase accounting process related to the TSRE merger.

Nine Months Ended September 30, 2016 Compared to the Nine Months Ended September 30, 2015 (dollars in thousands)

 

See Non-GAAP Financial Measures – Same Store Portfolio Net Operating Income for a discussion about this metric.

Revenue

Rental income. Rental revenue increased $40.8 million to $103.3 million for the nine months ended September 30, 2016 from $62.5 million for the nine months ended September 30, 2015. The increase is attributable to $44.7 million of rental income from the acquisition of 20 properties in the nine months ended September 30, 2015 present for a full nine months of operations in 2016 and $1.6 million from improved occupancy and rental rates in 2016 as compared to 2015 in our other properties. The increase was partially offset by a decrease of $5.5 million of rental income related to four properties that were disposed of after September 30, 2015.

Tenant reimbursement and other income. Tenant reimbursement and other income increased $4.7 million to $12.1 million for the nine months ended September 30, 2016 from $7.4 million for the nine months ended September 30, 2015. The increase is primarily attributable to $4.8 million of tenant reimbursement and other income from 20 new properties acquired in the nine months ended September 30, 2015 present for a full nine months of operations in 2016.

Expenses

Real estate operating expenses. Real estate operating expenses increased $18.7 million to $51.3 million for the nine months ended September 30, 2016 from $32.6 million for the nine months ended September 30, 2015. The increase is attributable to $20.7 million of real estate operating expense from 20 new properties acquired in the nine months ended September 30, 2015 present for a full nine months of operations in 2016 and an increase of $0.6 million of real estate operating expense in our same store portfolio. The increase was partially offset by a decrease of $2.6 million of real estate operating expense related to four properties that were disposed of after September 30, 2015.

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General and administrative expenses. General and administrative expenses increased $0.6 million to $1.8 million for the nine months ended September 30, 2016 from $1.2 million for the nine months ended September 30, 2015 primarily due to an increase in professional fees.

Stock compensation expense.  Compensation expense increased $0.5 million to $0.8 million for the nine months ended September 30, 2016 from $0.3 million for the nine months ended September 30, 2015 due to an increased number of awards that vested and an increase in our stock price for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.

Asset management fees. Asset management fees increased $1.8 million to $5.5 million for the nine months ended September 30, 2016 from $3.7 million for the nine months ended September 30, 2015. The increase is due to 20 new properties acquired in the nine months ended September 30, 2015 present for a full nine months of operations in 2016.

Depreciation and amortization expense. Depreciation and amortization expense increased $10.5 million to $26.9 million for the nine months ended September 30, 2016 from $16.4 million for the nine months ended September 30, 2015. The increase is attributable to $15.2 million of depreciation and amortization expense from 20 new properties acquired in the nine months ended September 30, 2015 present for a full nine months of operations in 2016. The increase was partially offset by a decrease of $1.5 million of depreciation and amortization expense related to four properties that were disposed of after September 30, 2015 and a decrease of $3.2 million of amortization expense in our same store portfolio.

Interest expense. Interest expense increased $14.4 million to $27.8 million for the nine months ended September 30, 2016 from $13.4 million for the nine months ended September 30, 2015. The increase is primarily attributable to $5.8 million of interest expense on the 20 new properties acquired in the nine months ended September 30, 2015 present for a full nine months of operations in 2016 and $10.3 million of interest expense on debt obtained in connection with the TSRE merger that was present for a full nine months of operations in 2016. The increase was partially offset by a $1.1 million decrease of interest expense related to four properties that were disposed of after September 30, 2015.

Other

Net gains (losses) on sale of assets. During the nine months ended September 30, 2016, three multi-family properties were sold resulting in gains of $31.8 million.

Gains (losses) on extinguishment of debt.  During the nine months ended September 30, 2016, we recognized a $0.6 million loss on the extinguishment of the debt related to the write-off of the unamortized deferred financing costs associated with debt that was extinguished.

Gains (losses) on TSRE merger and property acquisitions. During the three months ended September 30, 2016, we recognized a $0.6 million gain as part of our completion of the purchase accounting process related to the TSRE merger.

 

Non-GAAP Financial Measures

 

Funds from Operations and Core Funds from Operations

We believe that Funds from Operations, or FFO and Core Funds from Operations, or Core FFO, each of which is a non-GAAP financial measure, are additional appropriate measures of the operating performance of a REIT and us in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss allocated to common shares (computed in accordance with accounting principles generally accepted in the United States, or GAAP), excluding real estate-related depreciation and amortization expense, gains or losses on sales of real estate and the cumulative effect of changes in accounting principles.

Core FFO is a computation made by analysts and investors to measure a real estate company’s operating performance by removing the effect of items that do not reflect ongoing property operations, including acquisition and integration expenses, expensed costs related to the issuance of shares of our common stock, gains or losses on real estate transactions and equity-based compensation expenses, from the determination of FFO. We incur acquisition and integration expenses in connection with acquisitions of real estate properties and expense those costs when incurred in accordance with U.S. GAAP. As these expenses are one-time and reflective of investing activities rather than operating performance, we add back these costs to FFO in determining Core FFO.

Our calculation of Core FFO differs from the methodology used for calculating Core FFO by some other REITs and, accordingly, our Core FFO may not be comparable to Core FFO reported by other REITs. Our management utilizes FFO and Core FFO as measures of our operating performance, and believes they are also useful to investors, because they facilitate an understanding

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of our operating performance after adjustment for certain non-cash items, such as depreciation and amortization expenses, equity based compensation, amortization of deferred financing fees, TSRE financing extinguishment and employee separation costs, gains (losses) on TSRE merger and property acquisitions, and with respect to Core FFO, acquisition and integration expenses, pursuit costs and internalization costs that are required by GAAP to be expensed but may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Furthermore, although FFO, Core FFO and other supplemental performance measures are defined in various ways throughout the REIT industry, we also believe that FFO and Core FFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs. We also use Core FFO for purposes of determining the quarterly incentive fee, if any, payable to our advisor.

Neither FFO nor Core FFO is equivalent to net income or cash generated from operating activities determined in accordance with GAAP. Furthermore, FFO and Core FFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor Core FFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.

Set forth below is a reconciliation of net income (loss) to FFO and Core FFO for the three and nine months ended September 30, 2016 and 2015 (in thousands, except share and per share information):

 

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Same Store Portfolio Net Operating Income

We believe that Net Operating Income, or NOI, a non-GAAP measure, is a useful measure of our operating performance. We define NOI as total property revenues less total property operating expenses, excluding depreciation and amortization, asset management fees, acquisition and integration expenses and general administrative expenses. Other REITs may use different methodologies for calculating NOI, and accordingly, our NOI may not be comparable to other REITs. We believe that this measure provides an operating perspective not immediately apparent from GAAP operating income or net income. We use NOI to evaluate our performance on a same store and non-same store basis because NOI measures the core operations of property performance by excluding corporate level expenses and other items not related to property operating performance and captures trends in rental housing and property operating expenses. However, NOI should only be used as an alternative measure of our financial performance.

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We review our same store properties or portfolio at the beginning of each calendar year.  Properties are added into the same store portfolio if they were owned at the beginning of the previous year.  Properties that have been sold are excluded from the same store portfolio.

 

 

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay distributions and other general business needs.  We believe our available cash balances, financing arrangements and cash flows from operations will be sufficient to fund our liquidity requirements with respect to our existing portfolio for the next 12 months and the foreseeable future.

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Our primary cash requirements are to:

We intend to meet these liquidity requirements primarily through:

As previously disclosed in prior reports, we determined that the strategic long term benefits of the TSRE acquisition justified exceeding our historical leverage limits, defined as having total indebtedness of no more than approximately 65% of the combined initial purchase price of all of the properties in our portfolio.  Also, as previously disclosed, following the completion of the TSRE acquisition, we have instituted a strategy, which we refer to as our capital recycling strategy, seeking to reduce IRT’s leverage ratio over time by using the proceeds from sales of properties which are outside our core geographic footprint in the Southeastern United States or which we believe we have limited potential for further improvements to their operating results to repay a portion of our indebtedness.  We have successfully continued to implement our capital recycling strategy, which began in 2015, to reduce our leverage and reduce our exposure to short term indebtedness, particularly the interim facility:

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October 2016 Offering

Pursuant to the October 2016 offering, we issued and sold 28,750,000 shares of our common stock which generated total gross proceeds, before deducting the underwriting discount and estimated offering expenses, of $258.8 million.  On October 5, 2016, 25,000,000 of these shares were sold pursuant to the underwritten public offering and on October 21, 2016, 3,750,000 of these shares were sold pursuant to the exercise of the underwriters’ overallotment option.  We used approximately $243.8 million of net proceeds of the October 2016 offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, as follows:

Cash Flows

As of September 30, 2016 and 2015, we maintained cash and cash equivalents of approximately $29.2 million and $16.9 million, respectively. Our cash and cash equivalents were generated from the following activities (dollars in thousands):

 

 

Our cash inflow from operating activities during the nine months ended September 30, 2016 was related to the ongoing operations of our properties and increased as compared to the nine months ended September 30, 2016 as the number of properties we own has increased. Our cash inflow from operating activities during the nine months ended September 30, 2015 was impacted by $12.5 million of acquisition expenses and $4.3 million of employee separation expenses incurred during the nine-month period ended September 30, 2015 in connection with the TSRE transaction.

Our cash inflow from investing activities during the nine months ended September 30, 2016 is primarily due to the disposition of three properties.  Our cash outflow from investing activities during the nine months ended September 30, 2015 was primarily due to the TSRE transaction and our acquisition of one other property during the nine months ended September 30, 2015.

Our cash outflow from financing activities during the nine months ended September 30, 2016 was primarily due to repayments of mortgage indebtedness and the interim facility with proceeds from the three property dispositions. Our cash inflow from financing activities during the nine months ended September 30, 2015 was primarily due to financing obtained in connection with the TSRE transaction.

As a REIT, we evaluate our dividend coverage based on our cash flow from operating activities, excluding acquisition and integration expenses and changes in other assets and liabilities.  During the nine months ended September 30, 2016, we paid

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distributions to our common stockholders and noncontrolling interests of $27.1 million and generated cash flow from operating activities excluding acquisition and integration expenses and changes in other assets and liabilities of $31.2 million.

Off-Balance Sheet Arrangements

None.

Critical Accounting Estimates and Policies

Our 2015 Annual Report on Form 10-K contains a discussion of our critical accounting policies. On January 1, 2016 we adopted three new accounting pronouncements and revised our accounting policies as described in Note 2 to the Consolidated Financial Statements included in Part I, Item 1 of this report. Management discusses our critical accounting policies and management’s judgments and estimates with the audit committee of our board of trustees.

 

 

Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We may be exposed to interest rate changes primarily as a result of long-term debt used to maintain liquidity, fund capital expenditures and expand our real estate investment portfolio and operations. Market fluctuations in real estate financing may affect the availability and cost of funds needed to expand our investment portfolio. In addition, restrictions upon the availability of real estate financing or high interest rates for real estate loans could adversely affect our ability to dispose of real estate in the future. We seek to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. We may use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. With regard to variable rate financing, our advisor assesses our interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. Our advisor maintains risk management control systems to monitor interest rate cash flow risk attributable to both our outstanding and forecasted debt obligations as well as our potential offsetting hedge positions. While this hedging strategy is designed to minimize the impact on our net income and funds from operations of changes in interest rates, the overall returns on any investment in our securities may be reduced. We currently have limited exposure to financial market risks.

We may also be exposed to credit risk in derivative contracts we may use. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty will owe us, which creates credit risk for us. If the fair value of a derivative contract is negative, we will owe the counterparty and, therefore, do not have credit risk. We seek to minimize the credit risk in derivative instruments by entering into transactions with high-quality counterparties.

Interest Rate Risk and Sensitivity

Interest rates may be affected by economic, geo-political, monetary and fiscal policy, market supply and demand and other factors generally outside our control, and such factors may be highly volatile.  A change in market interest rates applicable to the fixed-rate portion our indebtedness affects the fair value, but it has no effect on interest incurred or cash flows.  A change in market interest rates applicable to the variable portion of our indebtedness affects the interest incurred and cash flows, but does not affect the fair value.

As of September 30, 2016, our only interest rate sensitive assets or liabilities related to our principal amount of $888.1 million of outstanding indebtedness, of which $137.3 is floating-rate and $750.8 million is fixed-rate indebtedness, an interest rate cap with a notional amount of $200.0 million and a float-to-fixed interest rate swap with a notional amount of $150.0 million. We monitor interest rate risk routinely and seek to minimize the possibility that a change in interest rates would impact the interest incurred and our cash flows.  To mitigate such risk, we may use interest rate derivative contracts.

As of September 30, 2016, the fair value of our fixed-rate indebtedness was $605.7 million.  The fair value of our fixed rate indebtedness was estimated using a discounted cash flow analysis utilizing rates that we believe a market participant would expect to pay for debt of a similar type and remaining maturity as if the debt were originated on September 30, 2016.  As we expect to remain obligated on our fixed rate instruments to maturity and the amounts due under such instruments would be limited to the outstanding principal balance and any accrued and unpaid interest, we do not expect that fluctuations in interest rates, and the resulting change in fair value of our fixed rate instruments, would have a significant impact on our operations.

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As of September 30, 2016, our interest rate cap had an insignificant asset fair value. The fair value of our interest rate cap was estimated using a discounted cash flow analysis based on forward interest rate curves and implied volatilities applicable to the individual caplets.  The interest rate cap has been excluded from the table below as its impact to our interest rate risk under the scenarios presented in the table yield are insignificant.  

As of September 30, 2016, our interest rate swap had a liability fair value of $0.7 million.  The fair value of our interest swap was estimated using a discounted cash flow analysis based on forward interest rate curves.  The impact of the interest rate swap has been included in the table below.  

 

The following table summarizes our indebtedness, and the impact to interest expense and the change in the net fair value of our indebtedness assuming an instantaneous increase or decrease of 100 basis points in the LIBOR interest rate curve (dollars in thousands).

 

 

 

After giving effect to the debt repayments as described in “Liquidity and Capital Resources” above, we have no effective exposure to variable-rate indebtedness.

 

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Under the supervision of our chief executive officer and chief financial officer and with the participation of our disclosure committee, we have carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting or in other factors during the quarter ended September 30, 2016, that have materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II—OTHER INFORMATION

We are subject to various other legal proceedings and claims that arise in the ordinary course of our business operations. Matters which arise out of allegations of bodily injury, property damage, and employment practices are generally covered by insurance. While the resolution of these other matters cannot be predicted with certainty, we currently believe the final outcome of such matters will not have a material adverse effect on our financial position, results of operations or cash flows.

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There have not been any material changes from the risk factors previously disclosed in Item 1A—“Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 other than what is listed below.

 

Risks Associated With the Management Internalization

 

We cannot assure you that we will be able to complete the Internalization, which could materially adversely affect our business, financial condition and results of operations.

 

We cannot assure you that we will be able to close on the management internalization. The management internalization is subject to the satisfaction of closing conditions, including obtaining third party consents. There can be no guarantee that the closing conditions will be satisfied and the transactions consummated. Failure to complete the transactions could materially adversely affect our business, financial condition and results of operations.

 

Upon the completion of the management internalization, we may not be able to retain all of the current employees who provide services to our Advisor or our executive officers. Our general and administrative expenses after the management internalization could be higher than our current expectations. Any of these foregoing risks could materially adversely affect our business, financial condition and results of operations.

 

We may not manage the management internalization effectively or realize its anticipated benefits.

 

We may not manage the management internalization effectively. The management internalization could be a time-consuming and costly process. The internalized company may encounter potential difficulties in the integration process which may result in the inability to successfully internalize corporate management or the property manager in a manner that permits us to achieve the cost savings anticipated to result from the management internalization. Following the management internalization, we expect to be reliant on RAIT for certain services such as information technology, human resources, insurance, investor relations, legal, tax and accounting for a period of time after the closing. If we are unable to internalize or find other providers for these services within a reasonable time period, we may not achieve all of the expected benefits of the management internalization. We also may not be able to retain all of the current properties of the property manager or the employees expected to transfer from RAIT to us upon the management internalization. The failure to manage the internalization effectively, including failure to smoothly transition services or retain employees, could result in the anticipated benefits of the management internalization not being realized in the timeframe currently anticipated or at all.

 

The management internalization was negotiated between a special committee of our Board of Directors, or the Special Committee, comprised solely of independent directors, and RAIT, which is affiliated with certain of our officers and directors.

 

The management internalization was negotiated with RAIT, which is affiliated with certain of our directors and officers. As a result, those officers and directors may have different interests than we do as a whole. This potential conflict would not exist in the case of a transaction negotiated with unaffiliated third parties. Moreover, if any of the RAIT-related parties to the transaction agreement breaches any of the representations, warranties or covenants made by it in the transaction agreement, we may choose not to enforce, or to enforce less vigorously, our rights because of our desire to maintain our ongoing relationship with RAIT and the interests of certain of our directors and officers. Moreover, the representations, warranties, covenants and indemnities in the transaction agreement are subject to limitations and qualifiers, which may also limit our ability to enforce any remedy under the agreement.

 

(a) We have previously disclosed four “UPREIT” transactions completed in May 2014, August 2014, November 2014 and December 2014 wherein IROP issued, in the aggregate, 1,282,449 common units, or units, to unaffiliated entities or persons in order to acquire properties. In addition, we have previously disclosed that in September 2015, IROP issued 1,925,419 units, plus cash in lieu of fractional TSR OP units, in a transaction related to the TSRE acquisition. All of such issuances were exempt from registration pursuant to Section 4(a)(2) of the Securities Act. As previously disclosed, these units are subject to exchange agreements containing the terms and conditions under which the units could be exchanged for cash in an amount equal to the value of an equivalent number of shares of our common stock as of the date IROP receives the holder’s notice of its desire to exchange the units for cash or, at IROP’s option, for the equivalent number of shares of our common stock. During the nine months ended September 30, 2016, IROP exchanged 239,923 units for 239,921 shares of our common stock (with fractional units being settled in cash). As a result of these exchanges, at September 30, 2016, there remained outstanding 2,915,008 units held by unaffiliated third parties.  The issuance of the

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shares of our common stock in these exchanges was exempt from registration pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D; all of the persons receiving such shares were accredited investors.

 

None.

 

None.

 

None.

 

The exhibits listed on the Exhibit Index (following the signatures section of this Quarterly Report on Form 10-Q) are included herewith.

 

 

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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.

 

 

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EXHIBIT INDEX

 

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