CENTERSPACE 10-Q

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements included in this report on Form 10-Q for the quarter ended June 30, 2021 (the “Report”), the audited financial 22 Table of Contents statements for the year ended December 31, 2020, which are included in Form 10-K filed with the SEC on February 22, 2021, and the risk factors in Item 1A, “Risk Factors,” of Form 10-K for the year ended December 31, 2020. This discussion and analysis, and other sections of this Report to contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to the expectations for future periods. Forward-looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions or other items related to the future. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “will,” “assumes,” “may,” “projects,” “outlook,” “future,” and variations of those words and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements to be materially different from the results of operations, financial condition, or plans expressed or implied by the forward-looking statements. Although Centerspace believes the expectations reflected in these forward-looking statements are based upon reasonable assumptions, the Company can give no assurance that our expectations will be achieved. Any statements contained herein that are not statements of historical fact should be deemed forward-looking statements. As a result, reliance should not be placed on these forward-looking statements, as these statements are subject to known and unknown risks, uncertainties, and other factors beyond the Company’s control and could differ materially from actual results and performance. The following factors, among others, could cause our future results to differ materially from those expressed in the forward-looking statements: • the COVID-19 pandemic and its ongoing effects on our employees, residents, and commercial tenants, third party vendors and suppliers, and apartment communities, as well as our cash flow, business, financial condition, and results of operation; • deteriorating economic conditions and rising unemployment rates in the markets where the Company owns apartment communities or in which it may invest in the future; • rental conditions in the Company’s markets, including occupancy levels and rental rates, potential inability to renew residents or obtain new residents upon expiration of existing leases, changes in tax and housing laws, or other factors, including the impact of the COVID-19-related governmental rules and regulations relating to rental rates, evictions, and other rental conditions; • changes in operating costs, including real estate taxes, utilities, insurance costs, and expenses related to complying with COVID-19 restrictions or otherwise responding to the COVID-19 pandemic; • timely access to material required to renovate apartment communities; • adverse changes in the Company’s markets, including future demand for apartment homes in those markets, barriers of entry into new markets, limitations on the ability to increase rental rates, inability to identify and consummate attractive acquisitions and dispositions on favorable terms, inability to reinvest sales proceeds successfully, and inability to accommodate any significant decline in the market value of real estate serving as collateral for mortgage obligations; • reliance on a single asset class (multifamily) and certain geographic areas of the U.S.; • inability to expand operations into new or existing markets successfully; • failure of new acquisitions to achieve anticipated results or be efficiently integrated; • inability to complete lease-up of projects on schedule and on budget; • inability to sell non-core properties on terms that are acceptable; • failure to reinvest proceeds from sales of properties into tax-deferred exchanges, which could necessitate special dividend and/or tax protection payments; • inability to fund capital expenditures out of cash flow; • inability to pay, or need to reduce, dividends on common shares; • financing risks, including the potential inability to meet existing covenants in existing credit facilities or to obtain new debt or equity financing on favorable terms, or at all; • level and volatility of interest or capitalization rates or capital market conditions; • loss contingencies and the availability and cost of casualty insurance for losses; • inability to continue to satisfy complex rules in order to maintain status as a REIT for federal income tax purposes, inability of the Operating Partnership to satisfy the rules to maintain its status as a partnership for federal income tax purposes, and the risk of changes in laws affecting REITs; • inability to attract and retain qualified personnel; • cyber liability or potential liability for breaches of privacy or information security systems; • inability to address catastrophic weather, natural events, and climate change; • inability to comply with laws and regulations applicable to the business and any related investigations or litigation; and 23 Table of Contents • other risks identified in this Report, in other SEC reports, or in other documents that the Company publicly disseminates. New factors may also arise from time to time that could have an adverse effect on the business and results of operations. Except as otherwise required by law, Centerspace undertakes no obligation to publicly update or revise these forward-looking statements to reflect events, circumstances, or changes in expectations after the date on which this Report is filed. Readers also should review the risks and uncertainties detailed from time to time in filings with the SEC, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2020. Executive Summary Centerspace owns, manages, acquires, redevelops, and develops apartment communities. The Company primarily focuses on investing in markets characterized by stable and growing economic conditions, strong employment, and an attractive quality of life that it believes, in combination, lead to higher demand for apartment homes and retention of residents. As of June 30, 2021, the Company owned interests in 62 apartment communities consisting of 11,579 apartment homes. Property owned, as presented in our Condensed Consolidated Balance Sheets, was $1.8 billion at June 30, 2021, compared to $1.8 billion at December 31, 2020. Renting apartment homes is the primary source of revenue, and the Company’s business objective is to provide great homes for its residents. Centerspace strives to maximize resident satisfaction and retention by investing in high-quality assets in desirable locations and creating vibrant apartment communities through service-oriented operations. Centerspace believes that delivering superior resident experiences will enhance resident satisfaction while also driving profitability for the business and shareholders. The Company has paid quarterly distributions continuously since its first distribution in 1971. COVID-19 Developments The COVID-19 pandemic has affected the business since March 2020, when it spread to many of the markets in which Centerspace owns properties. The Company’s first priority continues to be the health and well-being of its residents, team members, and the communities it serves. The Company enhanced cleaning protocols at its communities and offices, implemented physical distancing in communities common spaces, and instituted remote work guidelines for team members, all in accordance with state and local guidelines. The Company is utilizing technology to allow property teams to interact remotely with prospective residents through virtual leasing. Centerspace provided rent deferrals to residents and rent abatement to commercial tenants who were financially impacted by the COVID-19 pandemic. To support team members working on-site, additional COVID-19 paid time off and enhanced flextime arrangements was provided. Certain states and cities, including some of those in which the Company’s apartment communities are located, have reacted to the COVID-19 pandemic by instituting quarantines, restrictions on travel, shelter-in-place or stay-at-home directives, restrictions on types of businesses that may continue to operate, and restrictions on the types of construction projects that may continue. The availability of vaccines has led many states and cities to lift restrictions; however, due to new variants of the virus, Centerspace cannot predict whether restrictions will be reinstated or if additional restrictions will be imposed in the future. The Company implemented a plan to safely re-open common spaces in its communities while adhering to state and local guidelines, but recognizes that an increase in COVID-19 cases in these markets could cause the Company to close common spaces or take other preventive measures. Financial Impact of the COVID-19 Pandemic Many companies, especially in urban areas, have extended directives for employees to work from home during the COVID-19 pandemic. These extended directives have resulted in decreased traffic to businesses and, in some cases, closures of businesses in urban areas, which has resulted in lower demand and lower rent increases for the Company's five urban based apartment communities. The COVID-19 pandemic and these directives have affected operations and the conduct of business at apartment communities and offices, but did not have a material impact on Centerspace’s financial condition, operating results, or cash flows. The ongoing COVID-19 pandemic and the new variants of the virus could result in adverse financial and economic impacts that could include, but are not limited to, the following: • cause our residents or commercial tenants to defer or stop rental payments, and abandon or fail to renew leases, which would reduce the Company's primary source of net operating income and cash flows; 24 Table of Contents • cause the capital markets generally to become restricted or unavailable, thereby limiting our access to any needed debt or equity capital financing; • impact the business of, or cause the loss of, certain critical third-party suppliers or other service providers; • restrict our ability to continue to pay dividends on a quarterly basis at the current rate; • impair the value of tangible or intangible assets; • require us to record loss contingencies and incur additional expenses related to its COVID-19 response; or • cause the U.S. economy to suffer an extended economic slowdown, which could lead to a prolonged recession or even economic depression, which in turn would affect the demand for apartment communities and could have an adverse impact on our business and operating results. Centerspace has taken the following actions in order to protect its residents and employees, manage expenses and preserve cash flow during the COVID-19 pandemic: • reduced planned travel for team members through 2021; • left vacant positions unfilled; • used onsite team members to perform work normally contracted to third parties; and • moved the meetings of the Board of Trustees to virtual meetings, thereby limiting the expense associated with in-person meetings. Despite Centerspace ’ s efforts to manage its r esponse to the effects of the COVID-19 pandemic, the ultimate impact of the COVID-19 pandemic on rental revenue for 2021 and in future years cannot be determined at present. The situation surrounding the COVID-19 pandemic remains fluid, and the Company is actively managing its response in collaboration with residents, commercial tenants, government officials, and business partners and assessing potential impacts to financial position and operating results, as well as potential adverse impacts on our business. Our management remains committed to ensuring the safety of team members, residents, and communities, and to maintaining the financial stability of our business enterprise for the duration of the COVID-19 pandemic. Overview of the Three Months Ended June 30, 2021 For the three months ended June 30, 2021, revenue increased by $2.7 million to $46.7 million, compared to $43.9 million for the three months ended June 30, 2020, primarily due to same-store and non-same-store communities, offset by dispositions. Total expenses increased by $2.5 million to $43.9 million for the three months ended June 30, 2021, compared to $41.4 million for the three months ended June 30, 2020 primarily due to increased depreciation and amortization and general and administrative expenses. Funds from Operations (“FFO”) applicable to common shares and Units for the three months ended June 30, 2021 increased by $1.3 million to $13.7 million compared to $12.4 million for the three months ended June 30, 2020. This increase was primarily due to increased NOI from same-store and non-same-store communities, offset by decreased NOI from dispositions and increases in property management and general and administrative expenses. The drivers of these changes are discussed in more detail in the “Results of Operations” section below. In the Company ’ s ongoing efforts to improve the quality of its portfolio and balanc e sheet, during the second quarter of 2021, it disposed of five apartment communities in Rochester, Minnesota for a total sale price of $60.0 million, realizing an aggregate net gain on sale of $26.8 million. During the quarter, Centerspace entered into Contribution Agreements with entities managed by KMS. Upon closing, Centerspace will acquire a portfolio of 17 communities. Centerspace will fully fund the transaction through the issuance of up to $197.3 million, which will be paid in the form of Convertible Preferred Operating Partnership units that pay a 3.875% dividend and are convertible, at the holder's option, into common units at an exchange rate of 1.2048 common units per Convertible Preferred Operating Units representing a conversion price of $83.00 per unit. The KMS partners will have the ability to receive up to an aggregate of $16.2 million in cash in lieu of Convertible Preferred Operating Partnership Units. The Company will acquire real property assets subject to approximately $126.5 million in liabilities, a portion of which the company intends to refinance upon consummation of the transactions. The transaction is expected to close during the third quarter. See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing acquisitions and dispositions during the six months ended June 30, 2021 and 2020. 25 Table of Contents Results of Operations Reconciliation of Operating Income to Net Operating Income The following table provides a reconciliation of operating income to net operating income (“NOI”), which is defined below. (in thousands, except percentages) Three Months Ended June 30, Six Months Ended June 30, 2021 2020 $ Change % Change 2021 2020 $ Change % Change Operating income $ 2,733 $ 2,524 $ 209 8.3 % $ 4,374 $ 4,528 $ (154) (3.4) % Adjustments: Property management expenses 2,085 1,345 740 55.0 % 3,852 2,899 953 32.9 % Casualty (gain) loss (27) 913 (940) (103.0) % 74 1,240 (1,166) (94.0) % Depreciation and amortization 19,308 18,156 1,152 6.3 % 39,300 36,316 2,984 8.2 % General and administrative expenses 3,797 3,202 595 18.6 % 7,703 6,630 1,073 16.2 % Net operating income $ 27,896 $ 26,140 $ 1,756 6.7 % $ 55,303 $ 51,613 $ 3,690 7.1 % Consolidated Results of Operations The following consolidated results of operations cover the three and six months ended June 30, 2021 and 2020. (in thousands, except percentages) Three Months Ended June 30, Six Months Ended June 30, 2021 2020 $ Change % Change 2021 2020 $ Change % Change Revenue Same-store $ 40,521 $ 39,282 $ 1,239 3.2 % $ 80,521 $ 79,056 $ 1,465 1.9 % Non-same-store 4,436 931 3,505 376.5 % 8,677 1,202 7,475 621.9 % Other properties 646 402 244 60.7 % 1,296 1,375 (79) (5.7) % Dispositions 1,053 3,295 (2,242) (68.0) % 2,810 6,683 (3,873) (58.0) % Total 46,656 43,910 2,746 6.3 % 93,304 88,316 4,988 5.6 % Property operating expenses, including real estate taxes Same-store 16,528 15,567 961 6.2 % 32,906 32,222 684 2.1 % Non-same-store 1,439 385 1,054 273.8 % 2,935 504 2,431 482.3 % Other properties 268 252 16 6.3 % 557 530 27 5.1 % Dispositions 525 1,566 (1,041) (66.5) % 1,603 3,447 (1,844) (53.5) % Total 18,760 17,770 990 5.6 % 38,001 36,703 1,298 3.5 % Net operating income Same-store 23,993 23,715 278 1.2 % 47,615 46,834 781 1.7 % Non-same-store 2,997 546 2,451 448.9 % 5,742 698 5,044 722.6 % Other properties 378 150 228 152.0 % 739 845 (106) (12.5) % Dispositions 528 1,729 (1,201) (69.5) % 1,207 3,236 (2,029) (62.7) % Total $ 27,896 $ 26,140 $ 1,756 6.7 % $ 55,303 $ 51,613 $ 3,690 7.1 % Property management expenses (2,085) (1,345) 740 55.0 % (3,852) (2,899) 953 32.9 % Casualty gain (loss) 27 (913) (940) (103.0) % (74) (1,240) (1,166) (94.0) % Depreciation and amortization (19,308) (18,156) 1,152 6.3 % (39,300) (36,316) 2,984 8.2 % General and administrative expenses (3,797) (3,202) 595 18.6 % (7,703) (6,630) 1,073 16.2 % Interest expense (7,089) (6,940) 149 2.1 % (14,320) (13,851) 469 3.4 % Interest and other income (loss) 619 521 98 18.8 % 1,050 (2,256) 3,306 (146.5) % NET INCOME (LOSS) $ 23,103 $ (4,085) $ 27,188 (665.6) % $ 17,944 $ (11,769) $ 29,713 (252.5) % Dividends to preferred unitholders (160) (160) — — (320) (320) — — Net (income) loss attributable to noncontrolling interests – Operating Partnership (1,386) 447 (1,833) (410.1) % (917) 1,139 (2,056) (180.5) % Net (income) loss attributable to noncontrolling interests – consolidated real estate entities (19) (5) (14) 280.0 % (36) 140 (176) (125.7) % Net income (loss) attributable to controlling interests 21,538 (3,803) 25,341 (666.3) % 16,671 (10,810) 27,481 (254.2) % Dividends to preferred shareholders (1,607) (1,609) 2 (0.1) % (3,214) (3,314) 100 (3.0) % Redemption of Preferred Shares — 25 (25) (100.0) % — 298 (298) (100.0) % NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $ 19,931 $ (5,387) $ 25,318 (470.0) % $ 13,457 $ (13,826) $ 27,283 (197.3) % 26 Table of Contents Three Months Ended June 30, Six Months Ended June 30, Weighted Average Occupancy (1) 2021 2020 2021 2020 Same-store 94.9 % 94.5 % 94.9 % 94.9 % Non-same-store 94.2 % 95.3 % 93.0 % 94.0 % Total 94.8 % 94.5 % 94.7 % 94.8 % (1) Weighted average occupancy is defined as the percentage resulting from dividing actual rental revenue by scheduled rental revenue. Scheduled rental revenue represents the value of all apartment homes, with occupied homes valued at contractual rental rates pursuant to leases and vacant homes valued at estimated market rents. When calculating actual rents for occupied homes and market rents for vacant homes, delinquencies, and concessions are not taken into account. Market rates are determined using the currently offered effective rates on new leases at the community and are used as the starting point in determination of the market rates of vacant apartment homes. Centerspace believes that weighted average occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate. Weighted average occupancy may not completely reflect short-term trends in physical occupancy, and the calculation of weighted average occupancy may not be comparable to that disclosed by other REITs. Number of Apartment Homes June 30, 2021 June 30, 2020 Same-store 10,676 10,676 Non-same-store 903 182 Total 11,579 10,858 NOI is a non-GAAP financial measure, which the Company defines as total real estate revenues less property operating expenses, including real estate taxes. Centerspace believes that NOI is an important supplemental measure of operating performance for real estate because it provides a measure of operations that is unaffected by depreciation, amortization, financing, property management overhead, casualty losses, and general and administrative expenses. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders, or cash flow from operating activities as a measure of financial performance. Centerspace has provided certain information on a same-store and non-same-store basis. Same-store apartment communities are owned or in service for the entirety of the periods being compared, and, in the case of newly-constructed properties, have achieved a target level of physical occupancy of 90%. On the first day of each calendar year, the Company determines the composition of its same-store pool for that year as well as adjust the previous year, which allows it to evaluate full period-over-period operating comparisons for existing apartment communities and their contribution to net income. The company believes that measuring performance on a same-store basis is useful to investors because it enables evaluation of how a fixed pool of communities are performing year-over-year. The Company uses this measure to assess whether or not it has been successful in increasing NOI, raising average rental revenue, renewing the leases on existing residents, controlling operating costs, and making prudent capital improvements. The discussion below focuses on the main factors affecting real estate revenue and expenses from same-store apartment communities because changes from one year to another in real estate revenue and expenses from non-same-store apartment communities are generally due to the addition of those properties to the real estate portfolio, and accordingly provide less useful information for evaluating ongoing operational performance of the real estate portfolio. For the comparison of the six months ended June 30, 2021 and 2020, three apartment communities were non-same-store. Sold communities are included in “Dispositions,” while “Other” includes non-multifamily properties and the non-multifamily components of mixed-use properties. Revenue. Revenue increased by 6.3% to $46.7 million for the three months ended June 30, 2021, compared to $43.9 million in the three months ended June 30, 2020. Revenue from non-same-store communities and other properties increased by $3.5 million and $244,000, respectively, offset by a decrease of $2.2 million from dispositions. Revenue from same-store communities increased 3.2% or $1.2 million in the three months ended June 30, 2021, compared to the same period in the prior year. The increase was attributable to 2.8% growth in average rental revenue and a 0.4% growth in occupancy as weighted average occupancy increased to 94.9% from 94.5% for the three months ended June 30, 2021 and 2020, respectively. Revenue in our Minnesota markets has been affected by a reduction in collection rates for same-store communities to 96.4% from 99.0%, which has negatively impacted revenue by $699,000 as compared to $197,000 for the three months ended June 30, 2021 and 2020, respectively Revenue increased by 5.6% to $93.3 million for the six months ended June 30, 2021, compared to $88.3 million in the six months ended June 30, 2020. Revenue from non-same-store communities increased by $7.5 million, offset by decreases of $3.9 million and 79,000 from dispositions and other properties, respectively. Revenue from same-store communities increased 1.9% or $1.5 million in the six months ended June 30, 2021, compared to the same period in the prior year. The increase was attributable to 1.9% growth in average rental revenue for the six months ended June 30, 2021 and 2020, respectively. Property operating expenses, including real estate taxes . Property operating expenses, including real estate taxes, increased by 5.6% to $18.8 million in the three months ended June 30, 2021, compared to $17.8 million in the same period of the prior 27 Table of Contents year. An increase of $1.1 million at non-same-store communities was offset by a decrease $1.0 million from dispositions. Property operating expenses, including real estate taxes, at same-store communities increased by 6.2% or $961,000 in the three months ended June 30, 2021, compared to the same period in the prior year. At same-store communities, controllable expenses (which exclude insurance and real estate taxes) increased by $510,000, primarily due to increased compensation and utilities costs. Non-controllable expenses at same-store communities increased by $451,000, primarily due to insurance costs. Property operating expenses, including real estate taxes, increased by $1.3 million to $38.0 million in the six months ended June 30, 2021, compared to $36.7 million in the same period of the prior year. An increase of $2.4 million at non-same-store communities was offset by a decrease of $1.8 million from dispositions. Property operating expenses, including real estate taxes, at same-store communities increased by 2.1% or $684,000 in the six months ended June 30, 2021, compared to the same period of the prior year. At same-store communities, controllable expenses (which exclude insurance and real estate taxes), increased by $203,000, primarily due to increases in compensation and utilities costs. Non-controllable expenses at same-store communities increased by $481,000 primarily due to insurance costs. Property management expenses . Property management expense, consisting of property management overhead and property management fees paid to third parties increased by 55.0% to $2.1 million in the three months ended June 30, 2021, compared to $1.3 million in the same period of the prior year. The increase is primarily due to nonrecurring technology initiatives as well as compensation costs from an increase in headcount. Property management expense increased by 32.9% to $3.9 million in the six months ended June 30, 2021, compared to $2.9 million in the same period of the prior year. The increase is primarily due to technology initiatives and compensation costs. Casualty gain (loss). Casualty gain (loss) decreased by 103.0% to a gain of $27,000 in the three months ended June 30, 2021, compared to a loss of $913,000 in the same period of the prior year. The decrease is primarily due to weather-related losses that occurred in the prior year which did not occur in the current year. Casualty gain (loss) decreased by 94.0% to $74,000 in the six months ended June 30, 2021, compared to $1.2 million in the same period of the prior year. The decrease is primarily due to weather-related losses that occurred in the prior year which did not occur in the current year. Depreciation and amortization. Depreciation and amortization increased by 6.3% to $19.3 million in the three months ended June 30, 2021, compared to $18.2 million in the same period of the prior year, attributable to an increase of $2.2 million from non-same-store properties, offset by a decrease of $382,000 from same-store properties and $653,000 from sold properties. Depreciation and amortization increased by 8.2% to $39.3 million in the six months ended June 30, 2021, compared to $36.3 million in the same period of the prior year, attributable to an increase of $5.6 million from non-same-store properties, offset by decreases of $1.5 million and $1.1 million at same-store communities and sold properties, respectively. General and administrative expenses. General and administrative expenses increased by 18.6% to $3.8 million in the three months ended June 30, 2021, compared to $3.2 million in the same period of the prior year, primarily attributable to increases of $648,000 in incentive-based compensation costs related to company performance and share-based compensation arrangements due to the timing and form of grants and $279,000 in technology initiatives, offset by a decrease of $54,000 in consulting. General and administrative expenses increased by 16.2% to $7.7 million in the six months ended June 30, 2021, compared to $6.6 million in the same period of the prior year, primarily attributable to increases of $855,000 in incentive-based compensation costs related to company performance and share-based compensation arrangements due to the timing and form of grants, $523,000 for technology implementation initiatives, and $123,000 in legal costs, offset by a decrease in consulting costs. Interest expense. Interest expense increased by 2.1% to $7.1 million in the three months ended June 30, 2021, compared to $6.9 million in the same period of the prior year, primarily due to maintaining a larger average balance on the line of credit compared to the same period of the prior year and the addition of the Series C notes. Interest expense increased by 3.4% to $14.3 million in the six months ended June 30, 2021, compared to $13.9 million in the same period of the prior year, primarily due to maintaining a larger average balance on the line of credit compared to the same period of the prior year and the addition of the Series C notes. Interest and other income (loss). Interest and other income increased by 18.8% to $619,000 in the three months ended June 30, 2021, compared to $521,000 in the same period of the prior year. 28 Table of Contents Interest and other income increased to $1.1 million in the six months ended June 30, 2021, compared to a loss of $2.3 million in the same period of the prior year. The increase was primarily due to a $3.4 million loss in the value of marketable securities during the six months ended June 30, 2020 which did not occur in the current period. Net income (loss) available to common shareholders. Net income available to common shareholders increased by 470.0% to $19.9 million for the three months ended June 30, 2021, compared to a net loss of $5.4 million in the three months ended June 30, 2020. Net income available to common shareholders increased by 197.3% to $13.5 million for the six months ended June 30, 2021, compared to a net loss of $13.8 million in the same period of the prior year. Funds from Operations . Centerspace believes that Funds from Operations (“FFO”), which is a non-GAAP financial measures used as a standard supplemental measure for equity real estate investment trusts, is helpful to investors in understanding operating performance, primarily because its calculation does not assume the value of real estate assets diminishes predictably over time, as implied by the historical cost convention of GAAP and the recording of depreciation. The Company uses the definition of Funds from Operations FFO adopted by the National Association of Real Estate Investment Trusts, Inc. (“Nareit”). Nareit defines FFO as net income or loss calculated in accordance with GAAP, excluding: • depreciation and amortization related to real estate; • gains and losses from the sale of certain real estate assets; and • impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity. The exclusion in Nareit’s definition of FFO of impairment write-downs and gains and losses from the sale of real estate assets helps to identify the operating results of the long-term assets that form the base of investments, and assists management and investors in comparing those operating results between periods. Due to limitations of the Nareit FFO definition, Centerspace has made certain interpretations in applying this definition. The Company believes that all such interpretations not specifically provided for in the Nareit definition are consistent with this definition. Nareit's FFO White Paper 2018 Restatement clarified that impairment write-downs of land related to a REIT's main business are excluded from FFO and a REIT has the option to exclude impairment write-downs of assets that are incidental to the main business. While FFO is widely used by us as a primary performance metric, not all real estate companies use the same definition of FFO or calculate FFO the same way. Accordingly, FFO presented here is not necessarily comparable to FFO presented by other real estate companies. FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, but rather should be considered as an additional, supplemental measure. FFO also does not represent cash generated from operating activities in accordance with GAAP, nor is it indicative of funds available to fund all of the company’s needs, including its ability to service indebtedness or make distributions to shareholders. FFO applicable to common shares and Units for the three months ended June 30, 2021, increased to $13.7 million compared to $12.4 million for the comparable period ended June 30, 2020, an increase of 10.4%. This increase was primarily due to increased NOI from same-store and non-same-store communities, offset by decreased NOI from dispositions and increases in property management and general and administrative expenses. FFO applicable to common shares and Units for the six months ended June 30, 2021, increased to $26.6 million compared to $21.0 million for the same period of the prior year, an increase of 26.4%. The increase was primarily due to a prior year loss of $3.4 on marketable securities that did not occur in the current year, as well as increased NOI from same-store and non-same-store, offset by a decrease in NOI from dispositions. 29 Table of Contents Reconciliation of Net Income Available to Common Shareholders to Funds from Operations (in thousands, except per share and unit amounts) Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Net income (loss) available to common shareholders $ 19,931 $ (5,387) $ 13,457 $ (13,826) Adjustments: Noncontrolling interests – Operating Partnership 1,386 (447) 917 (1,139) Depreciation and amortization 19,308 18,156 39,300 36,316 Less depreciation – non real estate (87) (88) (185) (181) Less depreciation – partially owned entities (24) (33) (48) (315) (Gain) loss on sale of real estate (26,840) 190 (26,840) 190 Funds from operations applicable to common shares and Units $ 13,674 $ 12,391 $ 26,601 $ 21,045 Funds from operations applicable to common shares and Units $ 13,674 $ 12,391 $ 26,601 $ 21,045 Dividends to preferred unitholders 160 160 320 320 Funds from operations applicable to common shares and Units - diluted $ 13,834 $ 12,551 $ 26,921 $ 21,365 Per Share Data Earnings (loss) per common share - diluted $ 1.48 $ (0.44) $ 1.02 $ (1.13) FFO per share and Unit - diluted $ 0.95 $ 0.93 $ 1.87 $ 1.58 Weighted average shares and Units - diluted 14,514 13,558 14,402 13,482 Acquisitions and Dispositions During the second quarter of 2021, the Company disposed of five apartment communities compared to one parcel of unimproved land in the same period of the prior year. See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing acquisitions and dispositions during the six-month periods ended June 30, 2021 and 2020. Distributions Declared Distributions of $0.70 and $1.40 per common share and Unit were declared during the three and six months ended June 30, 2021 and 2020, respectively. Distributions of $0.4140625 and $0.828125 per Series C preferred share were declared during the three and six months ended June 30, 2021 and 2020, respectively. Distributions of $0.9655 and $1.931 per Series D preferred unit were declared during the three and six months ended June 30, 2021 and 2020, respectively. Liquidity and Capital Resources Overview Centerspace intends to maintain a strong balance sheet and preserve financial flexibility, which the Company believes should enhance its ability to capitalize on appropriate investment opportunities as they may arise. The Company intends to maintain its capital structure by continuing to focus on core fundamentals, which include generating positive cash flows from operations, maintaining appropriate debt levels and leverage ratios, and controlling overhead costs. The Company’s primary sources of liquidity are cash and cash equivalents on hand and cash flows generated from operations. Other sources include availability under the unsecured lines of credit, proceeds from property dispositions, including restricted cash related to net tax deferred proceeds, offerings of preferred and common shares under the shelf registration statement, and long-term unsecured debt and secured mortgages. The Company’s primary liquidity demands are normally-recurring operating and overhead expenses, debt service and repayments, capital improvements to communities, distributions to the holders of preferred shares, common shares, Series D preferred units, and Units, value-add redevelopment, common and preferred share buybacks and Unit redemptions, and acquisitions of additional communities. Although the Company believes that its financial condition and liquidity are sufficient to meet its reasonably anticipated liquidity demands, factors that could impact the Company’s future liquidity include, but are not limited to, volatility in capital and credit markets, the ability to access capital and credit markets, the effects of the COVID-19 pandemic, including its 30 Table of Contents potential impact on the Company’s ability to access the capital and credit markets on reasonable terms (or at all), the minimum REIT dividend requirements, and the Company’s ability to complete asset purchases, sales, or developments. As of June 30, 2021, the Company had total liquidity of approximately $168.2 million, which included $163.0 million available on the line of credit and $5.2 million of cash and cash equivalents. As of December 31, 2020, the Company had total liquidity of approximately $97.5 million, which included $97.1 million on the line of credit and $392,000 of cash and cash equivalents. COVID-19-Related Impacts on Liquidity Centerspace anticipates that its primary sources of liquidity will continue to be cash and cash equivalents on hand, cash flows generated from operations and availability under the unsecured lines of credit. Although cash flows may be reduced as a result of lower monthly collections of rent as well as the potential for lower occupancy or reduced rental rates during and after the COVID-19 pandemic, the Company has other available sources of liquidity such as proceeds from property dispositions; offerings of preferred and common shares under the shelf registration statement, ; and long term unsecured term loans and secured mortgages. The Company has the following contractual obligations over the next twelve months: • $12.8 million debt maturities remaining in 2021; • $7.3 million debt maturities in the first six months of 2022; and • approximately $7.8 million remaining to fund under a mezzanine loan the Company originated for the development of a multifamily community in Minneapolis, Minnesota. Potential Impact of COVID-19-Related Effects on Continuing Debt Availability Although the Company is in compliance with the covenants under all of its debt facilities and currently expects to continue to remain in compliance with these covenants, there can be no assurance that the Company will remain in compliance with those covenants or be able to access these funds depending on the length of the COVID-19 pandemic and the breadth of its impact on the U.S. economy generally and the credit markets in particular. Under the terms of the credit facility, the Company may be unable to obtain advances under the credit facility if: • the Company is unable to make certain representations and warranties, including a certification that, since April 30, 2018, there has been no adverse change in the business, financial condition, operations, performance or properties, taken as a whole, which would reasonably be expected to have a material adverse effect; • changes in the Company’s consolidated property NOI or capitalization rates applicable to the properties in the borrowing base reduce or eliminate availability under the credit facility; or • changes in the nature and composition (including occupancy rate) of the properties in the borrowing base cause these properties to become ineligible to be part of the borrowing base, and if the Company is not able to replace such properties with other qualifying properties, such ineligibility could reduce or eliminate the availability under the credit facility. Even if the Company remains in compliance with the foregoing representations, warranties, and covenants, it may be unable to access the full amount available under the credit facilities if its lenders fail to fund their commitments, which could occur if: • credit market deterioration or overall economic conditions affect the ability of one or more of the Company’s lenders to meet their funding commitments under the revolving credit facility. If a lender fails to fund its commitment under the revolving credit facility, that portion of the credit facility will be unavailable if the lender’s commitment is not replaced by a new commitment from an alternate lender; • distressed market conditions cause the Company’s lenders to transfer their commitments to other institutions, which could result in committed funds not being available, particularly if consolidation of the commitments under the credit facility or among its lenders were to occur; or • the Company is unable to obtain additional letters of credit due to a default by any lender in meeting its funding obligations. 31 Table of Contents As of the date of this filing, the Company has not experienced any restrictions or limitations on the availability of credit in its markets or with its lenders, although there can be no assurance that the Company will continue to be able to access the credit markets generally or the credit facility in the future. Debt The Company has an unsecured credit facility for $395.0 million, with the commitment allocated to a revolving line of credit for $250.0 million and the remaining $145.0 million allocated between two term loans: a $70.0 million unsecured term loan that matures on January 15, 2024 and a $75.0 million unsecured term loan that matures on August 31, 2025. As of June 30, 2021, the line of credit had total commitments and borrowing capacity of $250.0 million, based on the value of properties contained in an unencumbered asset pool (“UAP”). As of June 30, 2021, the additional borrowing availability was $163.0 million beyond the $87.0 million drawn, including the balance on the operating line of credit (discussed below). At December 31, 2020, the line of credit borrowing capacity was $250.0 million based on the UAP, of which $152.9 million was drawn on the line, including the balance on the operating line of credit. This credit facility matures on August 31, 2022, with one twelve-month option to extend the maturity date at the Company’s election. In January, the Company amended and expanded its private shelf agreement to increase the aggregate amount available for issuance of unsecured senior promissory notes to $225.0 million. In September 2019, the Company issued $75.0 million of Series A notes due September 13, 2029, bearing interest at a rate of 3.84% annually, and $50.0 million of Series B notes due September 30, 2028, bearing interest at a rate of 3.69% annually, under this facility. In January 2021, the Company issued $50.0 million of Series C notes due June 6, 2030, bearing interest at a rate of 2.70%. An additional $50.0 million remains available under this agreement. The Company also has a $6.0 million operating line of credit. This operating line of credit is designed to enhance treasury management activities and more effectively manage cash balances. This operating line matures on August 31, 2021, with pricing based on a market spread plus the one-month LIBOR index rate. Mortgage loan indebtedness was $288.4 million and $298.4 million on June 30, 2021 and December 31, 2020, respectively. All of the Company’s mortgage debt is at fixed rates of interest, with staggered maturities. This decreases the exposure to changes in interest rates, which reduces the effect of interest rate fluctuations on the Company’s results of operations and cash flows. As of June 30, 2021, the weighted average interest rate on mortgage debt was 3.90%, compared to 3.93% as of December 31, 2020. Equity Centerspace has an equity distribution agreement in connection with the 2019 ATM Program through which it may offer and sell common shares having an aggregate gross sales price of up to $150.0 million, in amounts and at times that the Company determines. The proceeds from the sale of common shares under the 2019 ATM program are intended to be used for general corporate purposes, which may include the funding of acquisitions and the repayment of indebtedness. During the six months ended June 30, 2021, the Company issued 896,000 common shares under the 2019 ATM program at an average price of $74.19 per share, net of commissions. Total consideration, net of commissions and issuance costs, was $66.5 million. As of June 30, 2021, common shares having an aggregate offering price of up to $0.1 million remained available under the 2019 ATM Program. Changes in Cash, Cash Equivalents, and Restricted Cash The following discussion relates to changes in consolidated cash, cash equivalents, and restricted cash which are presented in the Condensed Consolidated Statements of Cash Flows in Part I, Item 1 above. In addition to cash flow from operations, during the six months ended June 30, 2021, the Company generated capital from various activities, including: • Receiving $49.9 million, net of fees, from the issuance of Series C notes under the private placement agreement; • Receiving $59.2 million, net of transaction costs, from the sale of five apartment communities in Rochester, Minnesota; and • Receiving $66.4 million in net proceeds from the issuance of 896,000 common shares under the 2019 ATM Program. During the six months ended June 30, 2021, the Company used capital for various activities, including: • Acquiring Union Pointe, a 256-home apartment community located in Longmont, Colorado, for an aggregate purchase price of $76.9 million; 32 Table of Contents • Funding of mezzanine and construction loans of $12.8 million; • Repaying $10.1 million of mortgage principal; • Repaying $65.9 million on the line of credit; and • Funding capital improvements for apartment communities of approximately $9.0 million. Contractual Obligations and Other Commitments Contractual obligations and other commitments were disclosed in our Form 10-K for the year ended December 31, 2020. There have been no material changes to the Company’s contractual obligations and other commitments since that report was filed. Off-Balance Sheet Arrangements As of June 30, 2021, the Company had no significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Critical Accounting Policies In preparing the Condensed Consolidated Financial Statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. A summary of critical accounting policies is included in our Form 10-K for the year ended December 31, 2020, filed with the SEC on February 22, 2021 under the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Refer to Note 2 of the Notes to Condensed Consolidated Financial Statements in this report for additional information. There have been no other significant changes to the Company’s critical accounting policies during the six months ended June 30, 2021. 33 Table of Contents