Seven Hills Realty Trust 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q. OVERVIEW (dollars in thousands, except share data) We are a Maryland statutory trust. We were previously registered under the 1940 Act as a closed-end management investment company. Our investment objective while we operated as a registered investment company was investing in equity securities of real estate companies. On January 5, 2021, the SEC issued an order granting our request to deregister as an investment company under the 1940 Act. As a result, we changed our SEC registration to a reporting company under the Exchange Act. The issuance of the deregistration order enabled us to proceed with full implementation of our new business mandate to operate as a real estate investment trust that focuses primarily on originating and investing in first mortgage loans secured by middle market and transitional CRE. As a result of these changes to our business, we have not provided a comparison of our financial condition, any changes to financial conditions and results of operations to prior periods in which we were operating as a registered investment company because it would not be useful to our shareholders. The discussion herein is principally limited to our operations during the period following the SEC’s issuance of the deregistration order on January 5, 2021 to September 30, 2021. The results of operations from January 1, 2021 through January 4, 2021 were not material to our condensed consolidated financial statements and have not been presented or discussed separately, but they are included in our results of operations for the nine months ended September 30, 2021. Under our new business mandate of originating and investing in first mortgage loans secured by middle market and transitional CRE, we define middle market CRE as commercial properties that have values up to $100,000 and transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties. These assets are classified as loans held for investment in our condensed consolidated balance sheet. Loans held for investment are reported at cost, net of any unamortized loan fees and origination costs as applicable, unless the assets are deemed impaired. Our Manager is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended. We believe that our Manager provides us with significant experience and expertise in investing in middle market and transitional CRE. We operate our business in a manner consistent with our qualification for taxation as a REIT under the IRC. As such, we generally are not subject to U.S. federal income tax, provided that we meet certain distribution and other requirements. We also operate our business in a manner that permits us to maintain our exemption from registration under the 1940 Act. Merger with Tremont Mortgage Trust As noted earlier in this Quarterly Report on Form 10-Q, on April 26, 2021, we and TRMT entered into the Merger Agreement, pursuant to which, on the terms and subject to the satisfaction or waiver of the conditions thereof, TRMT agreed to merge with and into us, with us continuing as the surviving entity in the merger. The Merger was consummated and became effective at 4:01 p.m., Eastern Time, on September 30, 2021. At the Effective Time, the separate existence of TRMT ceased. Pursuant to the terms set forth in the Merger Agreement and the Letter Agreement, at the Effective Time, each one (1) issued and outstanding TRMT Common Shares was automatically converted into the right to receive 0.516 of one (1) of the SEVN Common Shares. No fractional shares of SEVN Common Shares were issued in the Merger, and holders of shares of TRMT Common Shares received cash in lieu of any such fractional shares. Pursuant to the Merger Agreement and the Letter Agreement, at the Effective Time, each outstanding unvested TRMT Common Share award under TRMT's equity compensation plan was converted into an award of SEVN Common Shares determined by multiplying the number of unvested TRMT Common Shares subject to such award by 0.516 (rounded down to the nearest whole number). Such award will continue to be subject to the same vesting and other terms and conditions as were in effect. 26 Table of Contents At the Effective Time, we changed our name to "Seven Hills Realty Trust”. The combined company continues to be managed by TRC, our Manager and TRMT’s manager (until TRMT ceased to exist), and our common shares continue to trade on Nasdaq under the new ticker symbol “SEVN.” Since the Merger was effective after the close of trading on September 30, 2021, assets acquired and liabilities assumed from TRMT in the Merger are included in our condensed consolidated balance sheet as of September 30, 2021; however, TRMT's results of operations are excluded from our condensed consolidated statement of operations for all periods presented. For further information regarding the Merger, see the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Our Investment and Financing Liquidity and Resources” of this Quarterly Report on Form 10-Q. COVID-19 Pandemic The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact have had a significant impact on the global economy, including the U.S. economy. Many of the restrictions that had been imposed in the United States during the pandemic have been lifted and commercial activity in the United States has increasingly returned to pre-pandemic practices and operations. To date, the COVID-19 pandemic has not had a significant impact on our business. There remains uncertainty as to the ultimate duration and severity of the COVID-19 pandemic, including risks that may arise from mutations or related strains of the virus, the ability to successfully administer vaccinations to a sufficient number of persons or attain immunity to the virus by natural or other means to achieve herd immunity, and the impact on the U.S. economy that may result from the inability of other countries to administer vaccinations to their citizens or their citizens’ ability to otherwise achieve immunity to the virus. As a result, we are unable to determine what the ultimate impact will be on our borrowers’ and other stakeholders’ businesses, operations, financial results and financial position. For further information and risks relating to the COVID-19 pandemic on us and our business, and the various actions our Manager has taken in response to the COVID-19 pandemic, see "Risk Factors" in the joint proxy statement/prospectus that is included in the registration statement on Form S-4, as subsequently amended and declared effective on July 26, 2021, and "Summary of Principal Risk Factors" included in our Current Report on Form 8-K filed on March 24, 2021. Reconciliation of Book Value per Common Share to Adjusted Book Value per Common Share The table below calculates our book value per common share and demonstrates how we calculate Adjusted Book Value per Common Share: September 30, 2021 Shareholders' equity $ 236,649 Total outstanding common shares 14,502 Book value per common share $ 16.32 Unaccreted purchase discount per common share 2.51 Adjusted Book Value per Common Share (1) $ 18.83 (1) Adjusted Book Value per Common Share is a non-GAAP financial measure that excludes the impact of the unaccreted purchase discount resulting from the excess fair value over the purchase price of the loans held for investment acquired in the Merger. The purchase discount of $36,443 was allocated to each acquired loan held for investment and will be accreted into income over the remaining term of the respective loan held for investment. See "Non-GAAP Financial Measures" included in the section captioned "Results of Operations" of this Quarterly Report on Form 10-Q for more information about Adjusted Book Value per Common Share. 27 Table of Contents Our Loan Portfolio The table below details overall statistics for our loan portfolio as of September 30, 2021 and December 31, 2020: As of September 30, 2021 (Successor Basis) As of December 31, 2020 (Predecessor Basis) Number of loans 22 5 Total loan commitments $ 525,885 $ 111,720 Unfunded loan commitments (1)(2) $ 53,963 $ 18,857 Principal balance (2) $ 472,018 $ 92,863 Carrying value $ 434,474 $ 91,879 Weighted average coupon rate 4.86 % 5.08 % Weighted average all in yield (3) 5.43 % 5.71 % Weighted average LIBOR floor 1.01 % 0.78 % Weighted average maximum maturity (years) (4) 3.7 4.2 Weighted average risk rating 3.0 3.0 Weighted average LTV (5) 68 % 68 % (1) Unfunded loan commitments are primarily used to finance property and building improvements and leasing capital and are generally funded over the term of the loan. (2) The principal balance at September 30, 2021 includes $96 of capitalized interest that does not reduce the amount of unfunded loan commitments and $204,692 of loans acquired in the Merger. (3) All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion. (4) Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions. (5) LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing. 28 Table of Contents Loan Portfolio Details The table below details our loan portfolio as of September 30, 2021: Location Property Type Origination Date Committed Principal Amount Principal Balance Coupon Rate All in Yield (1) Maximum Maturity (2) (date) LTV (3) Risk Rating First mortgage loans St. Louis, MO (4) Office 12/19/2018 $ 29,500 $ 27,763 L + 3.25% L + 3.74% 12/19/2023 72 % 2 Atlanta, GA (4) Hotel 12/21/2018 24,000 23,904 L + 3.25% L + 3.72% 12/21/2023 62 % 4 Coppell, TX (4) Retail 02/05/2019 19,865 19,615 L + 3.50% L + 3.72% 02/12/2022 73 % 4 Omaha, NE (4) Retail 06/14/2019 14,500 13,053 L + 3.65% L + 4.05% 06/14/2024 77 % 3 Yardley, PA (4) Office 12/19/2019 14,900 14,265 L + 3.75% L + 4.47% 12/19/2024 75 % 4 Allentown, PA (4) Industrial 01/24/2020 14,000 14,000 L + 3.50% L + 4.02% 01/24/2025 67 % 3 Dublin, OH (4) Office 02/18/2020 22,820 21,735 L + 3.75% L + 4.82% 02/18/2023 33 % 2 Downers Grove, IL Office 09/25/2020 30,000 29,500 L + 4.25% L + 4.69% 11/25/2024 67 % 3 Durham, NC Lab 12/17/2020 21,500 13,500 L + 4.35% L + 5.20% 12/17/2025 57 % 3 Los Angeles, CA Retail 12/17/2020 24,600 18,138 L + 4.25% L + 5.07% 12/17/2024 67 % 3 Aurora, IL Office / Industrial 12/18/2020 16,500 14,710 L + 4.35% L + 5.04% 12/18/2024 73 % 3 Miami, FL Office 01/19/2021 10,900 10,900 L + 4.50% L + 5.47% 01/19/2025 68 % 3 Olmstead Falls, OH Multifamily 01/28/2021 54,575 45,316 L + 4.00% L + 4.65% 01/28/2026 63 % 3 Colorado Springs, CO Office / Industrial 04/06/2021 34,275 29,404 L + 4.50% L + 5.03% 04/06/2025 73 % 3 Londonderry, NH Industrial 04/06/2021 39,240 34,323 L + 4.00% L + 4.62% 04/06/2026 73 % 3 Westminster, CO (4) Office 05/24/2021 15,250 13,506 L + 3.75% L + 4.25% 05/24/2026 66 % 3 Plano, TX Office 07/01/2021 27,384 24,827 L + 4.75% L + 5.18% 07/01/2026 78 % 3 Portland, OR Multifamily 07/09/2021 19,688 19,688 L + 3.57% L + 3.97% 07/09/2026 75 % 3 Portland, OR (4) Multifamily 07/30/2021 13,400 13,400 L + 3.57% L + 4.01% 07/30/2026 71 % 3 Seattle, WA Multifamily 08/16/2021 12,500 12,200 L + 3.55% L + 3.89% 08/16/2026 70 % 3 Dallas, TX (4) Office 08/25/2021 50,000 43,450 L + 3.25% L + 3.64% 08/25/2026 72 % 3 Sandy Springs, GA Retail 09/23/2021 16,488 14,821 L + 3.75% L + 4.11% 09/23/2026 72 % 3 Total/weighted average $ 525,885 $ 472,018 L + 3.86% L + 4.41% 68 % 3.0 (1) All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion. (2) Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions. (3) LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing. (4) These first mortgage loans were acquired in the Merger. As of September 30, 2021, we had $525,885 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 22 first mortgage loans. The impact from the COVID-19 pandemic has negatively impacted some of our borrowers’ business operations or tenants, particularly in the cases of our retail and hospitality collateral, which are some of the types of properties that have been most negatively impacted by the pandemic. We expect that those negative impacts may continue and may apply to other borrowers and/or their tenants. Further, although economic activity in the United States has improved significantly from the low points during the pandemic to date, certain industries have not recovered to their pre-pandemic positions. Therefore, certain of our borrowers’ business plans will likely take longer to execute than initially expected and certain of our borrowers may be unable to pay their debt service obligation owed and due to us as currently scheduled. As of September 30, 2021, we had three loans representing approximately 14% of the carrying value of our loan portfolio with a loan risk rating of “4” or “higher risk”. All of the loans in our portfolio are structured with risk mitigation mechanisms, such as cash flow sweeps or interest reserves, to help protect us against investment losses. In addition, we continue to actively engage with our borrowers regarding their execution of the business plans for the underlying collateral, among other things. As of October 29, 2021, all of our borrowers had paid all of their debt service obligations owed and due to us and none of the loans included in our investment portfolio were in default. 29 Table of Contents In October 2021, we originated a first mortgage loan of $24,750 to refinance a multi-tenant office building located in Carlsbad, CA. This loan requires the borrower to pay interest at the floating rate of LIBOR plus a premium of 325 basis points per annum. This floating rate loan includes an initial funding of $23,740 and a future funding allowance of $1,010 for tenant improvements, leasing commissions and capital expenditures and has a three-year initial term with two, one-year extension options, subject to the borrower meeting certain conditions. We did not have any impaired loans, non-accrual loans or loans in default as of September 30, 2021; thus, we did not record a reserve for loan loss as of that date. For further information regarding our risk rating policy, see Notes 3 and 6 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. However, depending on the duration and severity of the COVID-19 pandemic and any resulting economic downturn, our borrowers' businesses, operations and liquidity may be materially adversely impacted. As a result, they may become unable to pay their debt service obligations owed and due to us, which may result in the impairment of those loans, and our recording loan loss reserves with respect to those loans and recording of any income with respect to those loans on a nonaccrual basis. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in "Risk Factors" in the joint proxy statement/prospectus that is included in the registration statement on Form S-4, as subsequently amended and declared effective on July 26, 2021, and "Summary of Principal Risk Factors" included in our Current Report on Form 8-K filed on March 24, 2021. Financing Activities On February 18, 2021, one of our wholly owned subsidiaries entered into our UBS Master Repurchase Agreement with UBS, and on September 30, 2021, in conjunction with the Merger, we assumed the Citibank Master Repurchase Facility, and the Citibank Master Repurchase Agreement was amended to, among other things, change the guarantor under the Citibank Master Repurchase Facility from TRMT to SEVN. For further information regarding our Master Repurchase Facilities, see Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The table below is an overview of our Master Repurchase Facilities as of September 30, 2021: Agreement Maturity Date Principal Balance Unused Capacity Maximum Facility Size Collateral Principal Balance Citibank Master Repurchase Facility 11/06/2022 $ 128,962 $ 84,520 $ 213,482 $ 182,957 UBS Master Repurchase Facility 02/18/2024 87,383 104,617 192,000 134,749 $ 216,345 $ 189,137 $ 405,482 $ 317,706 The table below details our Master Repurchase Facilities activities during the three months ended September 30, 2021: Total Balance at June 30, 2021 $ 48,775 Borrowings 48,543 Repayments (10,332) Deferred fees (268) Amortization of deferred fees 55 Assumed in Merger 128,962 Balance at September 30, 2021 $ 215,735 30 Table of Contents The table below details our Master Repurchase Facilities activities during the nine months ended September 30, 2021: Total Balance at December 31, 2020 $ — Borrowings 97,715 Repayments (10,332) Deferred fees (698) Amortization of deferred fees 88 Assumed in Merger 128,962 Balance at September 30, 2021 $ 215,735 As of September 30, 2021, outstanding advancements under our Master Repurchase Facilities had a weighted average interest rate of LIBOR plus 198 basis points per annum, excluding associated fees and expenses. As of September 30, 2021 and October 29, 2021, we had a $216,345 and a $223,584, respectively, aggregate outstanding principal balance under our Master Repurchase Facilities. As of September 30, 2021, we were in compliance with all covenants and other terms under our Master Repurchase Agreements and our Guarantees. 31 Table of Contents RESULTS OF OPERATIONS (amounts in thousands, except per share data) As a result of the changes to our business, we have not provided a comparison of our financial statements to prior year periods in which we were operating as a registered investment company because it would not be useful to our shareholders. We have provided a 2021 third and second sequential quarter comparison which we believe may be useful to investors because we have operated as a mortgage REIT since January 5, 2021. The discussion herein is principally limited to our operations during the period following the SEC's issuance of the deregistration order on January 5, 2021 to September 30, 2021. Three Months Ended September 30, 2021 Compared to Three Months Ended June 30, 2021 Three Months Ended September 30, 2021 June 30, 2021 Change % Change INCOME FROM INVESTMENTS: Interest income from investments $ 4,510 $ 3,055 $ 1,455 47.6 % Less: interest and related expenses (488) (192) (296) 154.2 % Income from investments, net 4,022 2,863 1,159 40.5 % OTHER EXPENSES: Base management fees 731 721 10 1.4 % General and administrative expenses 433 714 (281) (39.4 %) Reimbursement of shared services expenses 349 275 74 26.9 % Total expenses 1,513 1,710 (197) (11.5 %) Income before income tax benefit (expense) 2,509 1,153 1,356 117.6 % Income tax benefit (expense) (25) 7 (32) n/m Net income $ 2,484 $ 1,160 $ 1,324 114.1 % Weighted average common shares outstanding - basic 10,263 10,208 55 0.5 % Weighted average common shares outstanding - diluted 10,264 10,208 56 0.5 % Net income per common share - basic and diluted $ 0.24 $ 0.11 $ 0.13 118.2 % n/m - not meaningful Interest income from investments . The increase in interest income from investments was primarily the result of a full quarter of interest income from investments on two loan investments that were originated during the three months ended June 30, 2021 and the interest income from the origination of four loan investments during the three months ended September 30, 2021. Interest and related expenses. The increase in interest and related expenses was primarily the result of advances made to us under our UBS Master Repurchase Facility during the three months ended September 30, 2021. General and administrative expenses . The decrease in general and administrative expenses was primarily due to share-based compensation recognized in the three months ended June 30, 2021 as a result of trustee share grants awarded in May and a decrease in professional services. Reimbursement of shared services expenses. Reimbursement of shared services expenses represents reimbursement of the costs for the services that our Manager arranges on our behalf from RMR LLC. The increase in reimbursement of shared services expenses was primarily the result of an increased usage of shared services from RMR LLC during the three months ended September 30, 2021. 32 Table of Contents Income tax benefit (expense). Income tax expense represents income taxes paid or payable by us in certain jurisdictions where we are subject to state income taxes. Net income . The increase in net income was due to the changes noted above. Non-GAAP Financial Measures We present Distributable Earnings and Adjusted Book Value per Common Share, which are considered “non-GAAP financial measures” within the meaning of the applicable SEC rules. Distributable Earnings does not represent net income or cash generated from operating activities and should not be considered as an alternative to net income determined in accordance with GAAP or an indication of our cash flows from operations determined in accordance with GAAP, a measure of our liquidity or operating performance or an indication of funds available for our cash needs. In addition, our methodology for calculating Distributable Earnings may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures; therefore, our reported Distributable Earnings may not be comparable to the distributable earnings as reported by other companies. We believe that Adjusted Book Value per Common Share is a more meaningful measure of our capital adequacy than book value per common share because it excludes the unaccreted purchase discount resulting from the Merger that will be accreted into income over the remaining term of the respective loans acquired in the Merger. Our methodology for calculating Adjusted Book Value per Common Share may differ from the methodologies employed by other companies to calculate the same or similar supplemental capital adequacy measures; therefore, our Adjusted Book Value per Common Share may not be comparable to the adjusted book value per common share reported by other companies. We elected to be taxed as a REIT under the IRC, effective for our 2020 taxable year. In order to maintain our qualification for taxation as a REIT, we are generally required to distribute substantially all of our taxable income, subject to certain adjustments, to our shareholders. We believe that one of the factors that investors consider important in deciding whether to buy or sell securities of a REIT is its distribution rate. Over time, Distributable Earnings may be a useful indicator of distributions to our shareholders and is a measure that is considered by our Board of Trustees when determining the amount of such distributions. We believe that Distributable Earnings provides meaningful information to consider in addition to net income and cash flows from operating activities determined in accordance with GAAP. This measure helps us to evaluate our performance excluding the effects of certain transactions, the variability of any management incentive fees that may be paid or payable and GAAP adjustments that we believe are not necessarily indicative of our current loan portfolio and operations. In addition, Distributable Earnings is used in determining the amount of base management and management incentive fees payable by us to our Manager under our management agreement. Distributable Earnings We calculate Distributable Earnings as net income, computed in accordance with GAAP, including realized losses not otherwise included in net income determined in accordance with GAAP, and excluding: (a) the management incentive fees earned by our Manager, if any; (b) depreciation and amortization, if any; (c) non-cash equity compensation expense; (d) unrealized gains, losses and other similar non-cash items that are included in net income for the period of the calculation (regardless of whether such items are included in or deducted from net income or in other comprehensive income under GAAP), if any; and (e) one-time events pursuant to changes in GAAP and certain non-cash items, if any. Distributable Earnings are reduced for realized losses on loan investments when amounts are deemed uncollectable. 33 Table of Contents Three Months Ended September 30, 2021 Nine Months Ended September 30, 2021 Reconciliation of net income to Distributable Earnings: Net income $ 2,484 $ 3,994 Non-cash equity compensation expense — 181 Distributable Earnings $ 2,484 $ 4,175 Weighted average common shares outstanding - basic 10,263 10,225 Weighted average common shares outstanding - diluted 10,264 10,225 Distributable Earnings per common share - basic and diluted $ 0.24 $ 0.41 Factors Affecting Operating Results Our results of operations are impacted by a number of factors and primarily depend on the interest income from our investments and the financing and other costs associated with our business. Our operating results are also impacted by general CRE market conditions and unanticipated defaults by our borrowers. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in "Risk Factors" in the joint proxy statement/prospectus that is included in the registration statement on Form S-4, as subsequently amended and declared effective on July 26, 2021, and "Summary of Principal Risk Factors" included in our Current Report on Form 8-K filed on March 24, 2021. Credit Risk . We are subject to the credit risk of our borrowers in connection with our investments. We seek to mitigate this risk by utilizing a comprehensive underwriting, diligence and investment selection process and by ongoing monitoring of our investments. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results. Changes in Fair Value of our Assets . We generally intend to hold our investments for their contractual terms, unless repaid earlier by the borrower. We evaluate our investments for impairment quarterly. Impairments occur when it is probable that we will not be able to collect all amounts due according to the applicable contractual terms. If we determine that a loan is impaired, we will record an allowance to reduce the carrying value of the loan to an amount that takes into account both the present value of expected future cash flows discounted at the loan's contractual effective interest rate and the fair value of any available collateral, net of any costs we expect to incur to realize that value. Although we intend to generally hold our investments for their contractual terms or until repaid earlier by the borrower, we may occasionally classify some of our investments as held for sale. Investments held for sale will be carried at the lower of their amortized cost or fair value within loans held for sale on our condensed consolidated balance sheet, with changes in fair value recorded through earnings. Fees received from our borrowers on any loans held for sale will be recognized as part of the gain or loss on sale. We do not currently expect to hold any of our investments for trading purposes. Availability of Leverage and Equity . We use leverage to make additional investments that may increase our returns. We may not be able to obtain the expected amount of leverage we desire or its cost may exceed our expectation and, consequently, the returns generated from our investments may be reduced. Our ability to further grow our loan portfolio over time will depend, to a significant degree, upon our ability to obtain additional capital. However, our access to additional capital depends on many factors including the price at which our common shares trade relative to their book value and market lending conditions. See "—Market Conditions" below. Market Conditions. After the initial market disruption resulting from the COVID-19 pandemic, the CRE debt markets began to rebound in the third quarter of 2020 and have since stabilized. Increased vaccination rates, strong consumer demand, significant increases in dedicated capital to alternative lenders, along with accommodating fiscal and monetary policies, have resulted in strong economic growth through the first half of 2021, supporting the growth in overall CRE transaction volume. Through the third quarter of 2021,CRE transaction volume is up over 50% compared to the same period in 2020 and is already on pace to exceed total 2019 volume. CRE values have also risen considerably, not only compared to 2020, but also in relation to values from the third quarter of 2019. This increase in CRE transaction activity and property values, combined with historically low interest rates have resulted in significant demand for CRE debt. CRE debt securities issuance of both fixed rate 34 Table of Contents commercial mortgage backed securities, or CMBS, and floating rate CRE collateralized loan obligations, or CLOs, is on pace to exceed the record 2019 volumes. Although debt and equity transaction volume has increased across all property types, the multifamily and industrial sectors remain the most coveted asset types amongst both lenders and investors. Multifamily is expected to continue to be a preferred asset class due to the stability of cash flows and the abundance of debt capital available from government sponsored enterprises, such as Fannie Mae and Freddie Mac. Multifamily properties comprise the majority of collateral for floating rate CRE CLO bond offerings and as a result, the competition among alternative lenders, like us, for loans secured by multifamily properties remains strong. Furthermore, this competition translates into low borrowing costs for buyers and owners of multifamily properties seeking to acquire or implement value added business plans. Investors’ interest in industrial properties, and in particular warehouse and distribution centers, continues to be strong as a result of the shift in consumers’ behavior to using increased levels of e-commerce, which has accelerated during the COVID-19 pandemic. The hospitality, office and retail sectors are among those that have been most negatively impacted by the economic downturn related to the COVID-19 pandemic. However, with the easing of government mandated restrictions and increased vaccination rates in the U.S., retail sales and leisure travel have experienced continued improvement during the third quarter of 2021, while business travel remains at levels significantly lower than prior to the onset of the pandemic. It is unclear how consumer and travel habits will be impacted over the long term due to the pandemic. These uncertainties may continue to burden these sectors, which would likely result in lenders with significant exposure to these property types continuing to face challenges. As it relates to the office sector, it is not yet known how the shift to flexible work-from-home schedules will impact the demand for office space going forward. As such, lenders will continue to face underwriting challenges with respect to assumptions related to new leasing, tenant renewal probabilities and occupancy rates for office properties, especially those assets located in urban core or central business district markets. Increased competition among lenders for multifamily and industrial properties has caused alternative lenders, like us, to expand their loan portfolios to include real estate sectors, such as data centers, manufactured housing communities, cold storage and self storage, in order to achieve favorable yields on high quality properties that have been less susceptible to the impact of the COVID-19 pandemic. Despite the strong performance of the debt capital markets in 2021, we believe challenges remain heading into 2022. The longer-term impact of the COVID-19 pandemic and potential for future variants of the virus is still uncertain. It is also unclear if recent signs of inflationary pressure are transitory in nature or not. Furthermore, it is unclear how the transition away from LIBOR as the preferred index for pricing floating rate debt will affect liquidity and performance of the floating rate debt markets. Despite these challenges, we believe that as the U.S. economy continues to grow, there will continue to be significant opportunities for alternative lenders like us to provide creative, flexible debt capital for a wide array of circumstances and business plans. Changes in Market Interest Rates . With respect to our business operations, increases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, if any, to increase; (b) the value of our fixed rate investments, if any, to decline; (c) the coupon rates on our variable rate investments, if any, to reset, perhaps on a delayed basis, to higher rates; and (d) it to become more difficult and costly for our borrowers, which may negatively impact their ability to repay our investments. See "—Market Conditions" above for a discussion of the current market including interest rates. Conversely, decreases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, if any, to decrease; (b) the value of our fixed rate investments, if any, to increase; (c) the coupon rates on our variable rate investments, if any, to reset, perhaps on a delayed basis, to lower rates; and (d) it to become easier and more affordable for our borrowers to refinance, and as a result repay, our loans, but may negatively impact our future returns if any such repayment proceeds were to be reinvested in lower yielding investments. The interest income on our loans and interest expense on our borrowings float with one month LIBOR. Because we generally intend to leverage approximately 75% of our investments, as LIBOR increases, our income from investments, net of interest and related expenses, will increase. LIBOR decreases are mitigated by interest rate floor provisions in our loan agreements with borrowers; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in LIBOR. Based on our loan portfolio at September 30, 2021, LIBOR was 0.08% and would have to exceed the floor established by any of our loans, which currently range from 0.25% to 2.50%, for us to realize an increase in interest income. 35 Table of Contents LIBOR is currently expected to be phased out for new contracts by December 31, 2021 and for pre-existing contracts by June 30, 2023. Our Master Repurchase Facilities provide that at such time as LIBOR shall no longer be made available or used for determining the interest rate of loans, the replacement base rate shall be an alternative benchmark rate (including any mathematical or other adjustments to the benchmark rate (if any) incorporated therein so that the resulting rate approximates LIBOR as close as reasonably possible) as determined by UBS and Citibank under similar facilities for the financing of similar assets and is consistent with the pricing index of similarly situated counterparties. We also currently expect that, as a result of any phase out of LIBOR, the interest rates under our loan agreements with borrowers would be amended to replace LIBOR for an alternative benchmark rate (which may include the secured overnight financing rate, or SOFR or another rate based on SOFR) that will approximate the existing interest rate as calculated in accordance with LIBOR. Size of Portfolio . The size of our loan portfolio, as measured both by the aggregate principal balance and the number of our CRE loans and our other investments, is also an important factor in determining our operating results. Generally, if the size of our loan portfolio grows, the amount of interest income we receive would increase and we may achieve certain economies of scale and diversify risk within our loan portfolio. A larger portfolio, however, may result in increased expenses; for example, we may incur additional interest expense or other costs to finance our investments. Also, if the aggregate principal balance of our loan portfolio grows but the number of our loans or the number of our borrowers does not grow, we could face increased risk by reason of the concentration of our investments. LIQUIDITY AND CAPITAL RESOURCES (dollars in thousands, except per share data) Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to fund our lending commitments, repay or meet margin calls resulting from our borrowings, if any, fund and maintain our assets and operations, make distributions to our shareholders and fund other business operating requirements. We require a significant amount of cash to originate, purchase and invest in our target investments, make additional unfunded loan commitment payments, repay principal and interest on our borrowings, make distributions to our shareholders and fund other business operating requirements. The long-term impact of the COVID-19 pandemic and its aftermath on financial markets is uncertain. To the extent that impact is significant, negative and sustained for an extended period, we expect that we may be challenged in accessing capital. Our sources of cash flows include cash on hand, payments of principal, interest and fees we receive on our investments, other cash we may generate from our business and operations and any unused borrowing capacity, including under our Master Repurchase Facilities or other repurchase agreements or financing arrangements, and may also include bank loans or public or private issuances of debt or equity securities. We believe that these sources of funds will be sufficient to meet our operating and capital expenses and pay our debt service obligations owed and make any distributions to our shareholders for the next 12 months and for the foreseeable future, subject to the duration and severity of the COVID-19 pandemic and economic impact on our borrowers and their ability to fund their debt service obligations owed to us. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in "Risk Factors" in the joint proxy statement/prospectus that is included in the registration statement on Form S-4, as subsequently amended and declared effective on July 26, 2021, and "Summary of Principal Risk Factors" included in our Current Report on Form 8-K filed on March 24, 2021. Pursuant to our Master Repurchase Facilities, we may sell to, and later repurchase from, UBS and Citibank the purchased assets. The initial purchase price paid by UBS or Citibank for each purchased asset is up to 75% of the lesser of the market value of the purchased asset or the unpaid principal balance of such purchased asset, subject to UBS’s and Citibank's approval. Upon the repurchase of a purchased asset, we are required to pay UBS or Citibank the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of UBS or Citibank relating to such purchased asset. The pricing rate (or interest rate) relating to a purchased asset is equal to one month LIBOR plus a customary premium within a fixed range, determined by the debt yield and property type of the purchased asset’s real estate collateral. UBS and Citibank each has the discretion under our respective Master Repurchase Agreement to make advancements at margins higher than 75%. For further information regarding our Master Repurchase Facilities, see Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I Item 1 of this Quarterly Report on Form 10-Q and "—Overview-Financing Activities" above. 36 Table of Contents The following is a summary of our sources and uses of cash flows for the period presented: Nine Months Ended September 30, 2021 Cash, cash equivalents and restricted cash at beginning of period $ 103,564 Net cash provided by (used in): Operating activities 1,297 Investing activities (167,104) Financing activities 82,090 Cash, cash equivalents and restricted cash at end of period $ 19,847 During the nine months ended September 30, 2021, our cash provided by operating activities consisted of our net income, partially offset by unfavorable changes in working capital. During the nine months ended September 30, 2021, our cash used in investing activities consisted of loan originations and additional fundings on our loans held for investment and payment of transaction costs related to the Merger, partially offset a loan repayment and cash assumed in the Merger during the third quarter of 2021. During the nine months ended September 30, 2021, our cash provided by financing activities consisted of proceeds from our UBS Master Repurchase Facility, partially offset by deferred financing cost payments related to our Master Repurchase Facility and distributions to our common shareholders. Distributions During the nine months ended September 30, 2021, we paid distributions to our common shareholders totaling $4,595 using cash on hand. We declared a cash distribution of $0.15 in lieu of our regular quarterly distribution to our common shareholders for the quarter ending September 30, 2021, and in anticipation of the closing of the Merger. No further dividends are expected to be declared in 2021 unless pursuant to applicable tax requirements. For further information regarding distributions we paid during the nine months ended September 30, 2021, see Note 8 to the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. Contractual Obligations and Commitments Our contractual obligations and commitments as of September 30, 2021 were as follows: Payment Due by Period Total Less than 1 Year 1 - 3 Years 3 - 5 Years More than 5 years Unfunded loan commitments (1) $ 53,963 $ 4,613 $ 49,350 $ — $ — Principal payments on Master Repurchase Facilities (2) 216,345 55,189 161,156 — — Interest payments (3) 6,315 3,810 2,505 — — $ 276,623 $ 63,612 $ 213,011 $ — $ — (1) The allocation of our unfunded loan commitments is based on the current loan maturity date to which the individuals commitments relate. (2) The allocation of outstanding advancements under our Master Repurchase Facilities is based on the current maturity date of each loan investment with respect to which the individual borrowing relates. (3) Projected interest payments are attributable only to our debt service obligations at existing rates as of September 30, 2021 and are not intended to estimate future interest costs which may result from debt prepayments, additional borrowings, new debt issuances or changes in interest rates. Off-Balance Sheet Arrangements As of September 30, 2021, we had no off-balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Debt Covenants Our principal debt obligations at September 30, 2021 were the outstanding balances under our Master Repurchase Facilities. Our Master Repurchase Agreements provide for acceleration of the date of repurchase of any then purchased assets 37 Table of Contents and UBS’s or Citibank's liquidation of the purchased assets upon the occurrence and continuation of certain events of default, including a change of control of us, which includes our Manager ceasing to act as our sole manager or to be a wholly owned subsidiary of RMR LLC. Our Master Repurchase Agreements also provide that upon the repurchase of any then purchased asset, we are required to pay UBS or Citibank the outstanding purchase price of such purchased asset and accrued interest and any and all accrued and unpaid expenses of UBS or Citibank relating to such purchased asset. In connection with our Master Repurchase Agreements, we entered into our Guarantees, which require us to guarantee 25% of the aggregate repurchase price, and 100% of losses in the event of certain bad acts as well as any costs and expenses of UBS and Citibank related to our Master Repurchase Agreements. The Guarantees also require us to comply with customary financial covenants, which include the maintenance of a minimum tangible net worth, minimum cash liquidity and a total indebtedness to stockholders' equity ratio and a minimum interest coverage ratio. As of September 30, 2021, we had a $216,345 aggregate outstanding principal balance under our Master Repurchase Facilities. Our Master Repurchase Agreements are structured with risk mitigation mechanisms, including a cash flow sweep, which would allow UBS or Citibank, as applicable, to control interest payments from our borrowers under our loans that are financed under our respective Master Repurchase Facilities, and the ability to accelerate dates of repurchase and institute margin calls, which may require us to pay down balances associated with one or more of our loans that are financed under our Master Repurchase Facilities. As of September 30, 2021, we were in compliance with all covenants and other terms under our Master Repurchase Agreements and, to date, UBS or Citibank has not utilized any such risk mitigation mechanisms under our Master Repurchase Agreements. Related Person Transactions We have relationships and historical and continuing transactions with our Manager, RMR LLC, RMR Inc. and others related to them. For example, as noted earlier in this Quarterly Report on Form 10-Q, TRMT merged with and into us effective September 30, 2021. For further information about these and other such relationships and related person transactions, see Notes 1, 10 and 11 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our Current Report on Form 8-K dated April 26, 2021, Proxy Statement for our 2021 Annual Meeting of Shareholders, Form S-4 and our other filings with the SEC. In addition, see the section captioned “Risk Factors” of this Quarterly Report on Form 10-Q and “Summary of Principal Risk Factors” included in our Current Report on Form 8-K filed on March 24, 2021 for a description of risks that may arise as a result of these and other related person transactions and relationships. We may engage in additional transactions with related persons, including businesses to which RMR LLC or its subsidiaries provide management services. 38 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.