Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion relates to our financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to materially differ from those projected. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, project development timing and investment amounts. Although the information is based on our current expectations, actual results could vary from expectations stated in this report. Numerous factors will affect our actual results, some of which are beyond our control. These include the timing and strength of national and regional economic growth, the strength of commercial and residential markets, competitive market conditions, and fluctuations in availability and cost of construction materials and labor resulting from the effects of worldwide demand, future interest rate levels and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and an investment in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information. See Item 1A for a discussion of material risks.
OVERVIEW
The Company operates as an internally managed diversified real estate investment trust, or REIT. The Company invests in a multi-tenant portfolio of commercial real estate assets comprised of office, industrial, and retail properties and model homes leased back to the homebuilder located primarily in the western United States. As of December 31, 2023, including properties held for sale, the Company owned or had an equity interest in:
•
Eight office buildings and one industrial building (“Office/Industrial Properties”) which total approximately 758,175 rentable square feet,
•
Three retail shopping centers (“Retail Properties”) which total approximately 65,242 rentable square feet, and
•
110 model homes owned by six affiliated limited partnerships and one corporation (“Model Home Properties”).
Presidio Property Trust’s office, industrial and retail properties are located California, Colorado, Maryland, North Dakota and Texas. Our Model Home Properties are located in five states, primarily in Texas. We acquire properties that are stabilized or that we anticipate will be stabilized within two or three years of acquisition. We consider a property to be stabilized once it has achieved an 80% occupancy rate for a full calendar year, or has been operating for three years. Our geographical clustering of assets enables us to reduce our operating costs through economies of scale by servicing a number of properties with less staff, but it also makes us more susceptible to changing market conditions in these discrete geographic areas.
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Most of our office and retail properties are leased to a variety of tenants ranging from small businesses to large public companies, many of which are not investment grade. We have in the past entered into, and intend in the future to enter into, purchase agreements for real estate having net leases that require the tenant to pay all of the operating expense (NNN Leases) or pay increases in operating expenses over specific base years. Most of our office leases are for terms of 3 to 5 years with annual rental increases. Our model homes are typically leased for 2 to 3 years to the homebuilder on a triple net lease. Under a triple net lease, the tenant is required to pay all operating, maintenance and insurance costs and real estate taxes with respect to the leased property.
We seek to diversify our portfolio by commercial real estate segments to reduce the adverse effect of a single under-performing segment, geographic market and/or tenant. We further supplement this at the tenant level through our credit review process, which varies by tenant class. For example, our commercial and industrial tenants tend to be corporations or individually owned businesses. In these cases, we typically obtain financial records, including financial statements and tax returns (depending on the circumstance), and run credit reports for any prospective tenant to support our decision to enter into a rental arrangement. We also typically obtain security deposits from these commercial tenants. Our Model Home business partners are substantial homebuilders with established credit histories. These tenants are subjected to financial review and analysis prior to us entering into a sale-leaseback transaction. Our ownership of the underlying property provides a further means to avoiding significant credit losses.
Significant Transactions in 2023 and 2022
Acquisitions during the year ended December 31, 2023:
•
We acquired 40 Model Home Properties and leased them back to the homebuilders under triple net leases during the year ended December 31, 2023. The purchase price for these properties was $21.9 million. The purchase price consisted of cash payments of $6.6 million and mortgage notes of $15.3 million.
Acquisitions during the year ended December 31, 2022:
•
We acquired 31 Model Home Properties and leased them back to the homebuilders under triple net leases during the year ended December 31, 2022. The purchase price for the properties was $15.6 million. The purchase price consisted of cash payments of $4.8 million and mortgage notes of $10.8 million.
We review our portfolio of investment properties for value appreciation potential on an ongoing basis, and dispose of any properties that no longer satisfy our requirements in this regard, taking into account tax and other considerations. The proceeds from any such property sale, after repayment of any associated mortgage or repayment of secured or unsecured indebtedness, are available for investing in properties that we believe will have a greater likelihood of future price appreciation.
Dispositions during the year ended December 31, 2023:
During year ended December 31, 2023, we disposed of the following properties:
•
22 model homes for approximately $11.7 million and the Company recognized a gain of approximately $3.2 million.
Dispositions during the year ended December 31, 2022:
During year ended December 31, 2022, we disposed of the following properties:
•
World Plaza, which was sold on March 11, 2022, for approximately $10.0 million and the Company recognized a loss of approximately $0.3 million.
•
31 model homes for approximately $17.5 million and the Company recognized a gain of approximately $5.4 million.
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Sponsorship of Special Purpose Acquisition Company
On January 7, 2022, we announced our sponsorship, through our wholly-owned subsidiary, Murphy Canyon Acquisition Sponsor, LLC (the “Sponsor”), of a special purpose acquisition company (“SPAC”) initial public offering. Murphy Canyon Acquisition Corp. (“Murphy Canyon” or the “SPAC”) raised $132,250,000 in capital investment to acquire an operating business. We, through our wholly-owned subsidiary, owned approximately 23.49% of the issued and outstanding stock in the entity upon the initial public offering being declared effective and consummated (excluding the private placement units described below), and following the completion of its initial business combination, the SPAC operates as a separately managed, publicly traded entity. The SPAC offered $132,250,000 units, with each unit consisting of one share of common stock and three-quarters of one redeemable warrant.
The Sponsor purchased an aggregate of 828,750 units (the “placement units”) of the SPAC at a price of $10.00 per unit, for an aggregate purchase price of $8,287,500. The placement units were sold in a private placement that closed simultaneously with the closing of the SPAC initial public offering. The Sponsor has agreed to transfer an aggregate of 45,000 placement units (15,000 each) to each of Murphy Canyon’s independent directors.
On November 8, 2022, the SPAC entered into an agreement and plan of merger with Conduit Pharmaceuticals Limited, a Cayman Islands exempted company (“Conduit Pharma”), and Conduit Merger Sub, Inc., a Cayman Islands exempted company and the SPAC’s wholly owned subsidiary. The merger agreement provided that the SPAC’s Cayman Island subsidiary will merge with and into Conduit Pharma, with Conduit Pharma surviving the merger as the SPAC’s wholly owned subsidiary and the public company renamed “Conduit Pharmaceuticals Inc.” (“Conduit”).
Initially, the SPAC was required to complete its initial business combination transaction by 12 months from the consummation of its initial public offering or up to 18 months if it extended the period of time to consummate a business combination in accordance with its certificate of incorporation. On January 26, 2023, at a special meeting of the stockholders, the stockholders approved a proposal to amend the SPAC’s certificate of incorporation to extend the date by which it has to consummate a business combination up to 12 times, each such extension for an additional one-month period, from February 7, 2023, to February 7, 2024. The stockholders also approved a related proposal to amend the trust agreement allowing the SPAC to deposit into the trust account, for each one-month extension, one-third of 1% of the funds remaining in the trust account following the redemptions made in connection with the approval of the extension proposal at the special meeting. Following redemptions made in connection with the special meeting, we owned approximately 65% of the issued and outstanding equity of the SPAC.
Throughout 2023, we loaned Murphy Canyon $1.0 million to fund its trust account and for operating expenses. The loan was non-interest bearing, unsecured and was repaid in full on the date of Murphy Canyon’s business combination with Conduit Pharma.
On September 22, 2023, Murphy Canyon completed its business combination with Conduit Pharma and changed its name to “Conduit Pharmaceuticals Inc.” Immediately prior to the business combination the Company owned approximately 65% of the SPAC’s outstanding common stock. Upon consummation of the business combination, the SPAC’s shares of Class B common stock were converted into shares of its Class A common stock and the shares of Class A common stock were then reclassified as a single class of Conduit common stock. As a result of the business combination, the Company was issued (i) 3,306,250 shares of Conduit’s common stock due to the conversion of the shares of the SPAC’s Class B common stock into shares of the SPAC’s Class A common stock and then reclassification into shares of Conduit common stock, (ii) 754,000 shares of Conduit common stock, which prior to the business combination were shares of the SPAC’s Class A common stock and (iii) private warrants to purchase 754,000 shares of Conduit common stock, which prior to the business combination were warrants to purchase 754,000 shares of the SPAC’s Class A common stock. Also in the business combination, shareholders and debtholders of Conduit Pharma were issued 65,000,000 shares of Conduit common stock. Immediately following the consummation of the business combination, the Company transferred 45,000 shares of Conduit common stock and warrants to purchase 45,000 shares of Conduit common stock to the SPAC’s independent directors as compensation for their services. As a result, the Company owned approximately 6.5% of Conduit’s common stock immediately following the business combination and currently owns approximately 6.3% of Conduit ’ s common stock. In connection with the business combination, the Company’s officers and directors who also served as officers and directors of the SPAC resigned from the SPAC, with the exception of the Company’s former Chief Financial Officer who resigned from the Company.
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ECONOMIC ENVIRONMENT
According to Nareit's, the National Association of Real Estate Investment Trusts, 2024 REIT Market Outlook, published on its website in December 2023, economic uncertainty, which began in 2022 and created a difficult environment for REIT share prices, will likely be an ongoing theme in 2024. For example, as the 10-year Treasury yield increased nearly 3% and REIT implied cap rates rose from 4.5% to nearly 6.5%, REIT share prices fell by 21.4% from the beginning of 2022 through December 1, 2023. As of the third quarter of 2023, the REIT implied and appraisal cap rate spread has remained wide as property appraisals have been slow to adjust to current market conditions. For example:
●
The REIT implied and private transaction-based cap rate spread was 170 bps.
●
The REIT implied and private appraisal-based cap rate spread was 216 bps.
According to Nareit, these great divides indicate serious disparities between today’s public and private real estate valuations. The potential valuation impacts associated with transaction and appraisal cap rates moving to the REIT implied cap rate are significant. All else equal, closing the REIT implied–transaction gap would require private value write-downs of more than 25%; the declines would need to exceed 30% to eliminate the REIT-implied appraisal spread. Though these valuation adjustments represent extreme scenarios, significant rises in transaction and appraisal cap rates are warranted and further material write-downs are likely on the horizon for the private real estate market. Nareit noted three hopeful signs for a meaningful REIT recovery in 2024 and beyond:
●
REITs have typically enjoyed strong absolute and relative total return performances after monetary policy tightening cycles end.
●
The valuation divergence between REITs and private real estate will likely converge in 2024, making REITs an attractive option for investors.
●
Solid balance sheets will enable REITs to navigate ongoing economic uncertainty while providing an advantage in terms of acquisitions and growth.
CREDIT MARKET ENV IRONMENT
Current market rates in February 2024 on fixed rate mortgages on homes range from 6.15% - 7.29%, depending on the term (1) . Current market rates for 5–10 year fixed rate loans for commercial properties range from 6.71% - 6.84%, depending on the type of building (retail/industrial/office) (2) . Interest rates increased in 2023 compared to 2022 due to the Federal Reserve raising interest rates 100 basis points, or 1%, in hopes of slowing down inflation going from 4.5% in December 2022 to 5.5% in July 2023. The Federal Reserve chose not to raise rates in September 2023, November 2023, December 2023, and January 2024, most recently noting “ Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated ” (3) . Although rates increased in 2023, it does not necessarily indicate that we would be unable to refinance or obtain mortgages on new homes or commercial properties at the same rate we have historically when they come due, as rates vary by property and are dependent upon factors including property cash flows, occupancy rates and lender credit.
(1) Source: https://www.bankrate.com/finance/mortgages/current-interest-rates.aspx
(2) Source: https://selectcommercial.com/commercial-mortgage-rates.php
(3) Source: https://www.federalreserve.gov/newsevents/pressreleases/monetary20240131a.htm
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As noted by Colliers Securities in its February 2024 Industry Notes: Going forward the Federal Reserve has put the REITs in a favorable position with rate cuts anticipated in the latter half of 2024. With the tightening cycle in effect for most of 2023, we anticipate the transaction market should return as interest rates stabilize or move lower. This should allow many REITs to re-accelerate their growth rates as acquisitions were few for many of the REITs in 2023. The other component for a healthy transaction market is sellers' need to adjust their price expectations. Borrowing at rates of approximately 3% are no longer realistic in the near future. With interest rates off their highs and REIT stock prices off their lows, opportunities for acquisitions may make sense for many REITs' cost of capital. The Collier Securities report further noted the following:
Industrial - The industrial sector, marked by its resilience, witnessed a steady increase in cap rates from March to September, reaching a peak at 6.39%. Subsequently, there was a gradual decline, and in January the trend reversed, and industrial cap rates surpassed those of other sectors, now being the sector with the highest cap rates at 6.24%, We view this more of the mix of assets transacting rather than a trend that investors are not attracted to the sector. In January, the industrial real estate sector exhibited a range of noteworthy changes in cap rates across cities. San Antonio emerged as the city with the highest cap rate at 8.72%, while Atlanta recorded the lowest rate at 4.57%. Notable increases were observed in Houston, with a significant rise from 7.08% in December to 7.50% in January. Similarly, San Antonio experienced a substantial surge from 6.19% to 8.72%, reflecting more a mix in assets. Conversely, Tampa saw a decrease from 5.42% to 3.95%, and Salt Lake City exhibited resilience with a drop from 6.40% to 6.10%. The diverse spread in cap rates highlights varied risk and return profiles across cities, emphasizing the need for investors to carefully assess local market dynamics. While the industrial sector, overall, demonstrates a broad upward trend in cap rates, with an average increase of 0.23% compared to December, we would not over read into this increase.
Retail - The retail sector underwent a series of fluctuations, showcasing the most significant variance among the sectors. Initially positioned with mid-range cap rates, retail surpassed office in December, reaching the highest cap rate at 6.48%. However in January, the retail sector experienced a decline in cap rates, which shows just how much these cap rates can move month-to-month given the low transaction volume. The highest cap rate is observed in Phoenix at 8.01% while Nashville experiences the lowest at 4.30%. Noteworthy changes from December to January include Houston's cap rate increasing from 5.54% to 5.93%. Los Angeles and Las Vegas both record a slight decrease from 5.20% in December to 4.76% in January and from 6.13% to 5.20%, respectively, reflecting nuanced adjustments in their respective markets. Phoenix maintains its position with notable cap rate expansions from 7.00% to 8.01%.
Office - In January, office cap rates decreased to an average of 6.03% from 6.27% in December. Notably, the office sector no longer holds the highest cap rates, with some cities exhibiting slight shifts in market dynamics. The office real estate market demonstrates city-specific dynamics, with wide-ranging cap rates. Columbus records the lowest cap rate of 4.65%, down from 6.00% in December, followed by San Jose at 4.80%. Indianapolis stands out with the highest cap rate at 9.62%, followed by Los Angeles with a cap rate of 7.74%, a significant increase from 5.00% in December. On the other hand, New York's cap rate increases from 6.00% to 6.83%. Cap rates can have a wider range as there is a large bifurcation between A & B assets.
MANAGEMENT EVALUATION OF RESULTS OF OPERATIONS
Management’s evaluation of operating results includes an assessment of our ability to generate cash flow necessary to pay operating expenses, general and administrative expenses, debt service and to fund distributions to our stockholders. As a result, management’s assessment of operating results gives less emphasis to the effects of unrealized gains and losses and other non-cash charges, such as depreciation and amortization and impairment charges, which may cause fluctuations in net income for comparable periods but have no impact on cash flows. Management’s evaluation of our potential for generating cash flow includes assessments of our recently acquired properties, our non-stabilized properties, long-term sustainability of our real estate portfolio, our future operating cash flow from anticipated acquisitions, and the proceeds from the sales of our real estate assets or other assets.
In addition, management evaluates the results of the operations of our portfolio and individual properties with a primary focus on increasing and enhancing the value, quality and quantity of properties in our real estate holdings. Management focuses its efforts on improving underperforming assets through re-leasing efforts, including negotiation of lease renewals and rental rates. Properties are regularly evaluated for potential added value appreciation and cash flow and, if lacking such potential, are sold with the equity reinvested in new acquisitions or otherwise allocated in a manner we believe is accretive to our stockholders. Our ability to increase assets under management is affected by our ability to raise borrowings and/or capital, coupled with our ability to identify appropriate investments.
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Our results of operations for the years ended December 31, 2023 and 2022 may not be indicative of those expected in future periods. Management does not expect the level of expenses and interest income, resulting from our investment in and consolidation of Murphy Canyon Acquisition Corp, to continue in the near future, since the de-SPAC and deconsolidation of that entity in September 2023. The de-SPAC resulted in the Company having an investment in Conduit Pharmaceuticals which totaled approximately $18.3 million as of December 31, 2023, with a cost basis of approximately $7.5 million. The Company entered into a lock-up agreement with Conduit regarding the common stock held by the Company, for 180 days from the closing of the business combination which ended March 20, 2024. Management is still considering the best course of action to monetize our investment. During 2023, elevated real estate prices in commercial real estate, increasing interest rates on lending, and compressing capitalization rates have made it challenging to acquire properties that fit our portfolio needs. As a result, we did not find any suitable commercial properties to acquire during 2023, but we were able to acquire 40 model home properties. Management will continue to evaluate potential acquisitions in an effort to increase our portfolio of commercial real estate and model homes.
CRITICAL ACCOUNTING POLICIES
As a company primarily involved in owning income generating real estate assets, management considers the following accounting policies critical as they reflect our more significant judgments and estimates used in the preparation of our financial statements and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses.
Real Estate Assets and Lease Intangibles . Land, buildings and improvements are recorded at cost, including tenant improvements and lease acquisition costs (including leasing commissions, space planning fees, and legal fees). We capitalize any expenditure that replaces, improves, or otherwise extends the economic life of an asset, while ordinary repairs and maintenance are expensed as incurred. We allocate the purchase price of acquired properties between the acquired tangible assets and liabilities (consisting of land, building, tenant improvements, land purchase options, and long-term debt) and identified intangible assets and liabilities (including the value of above-market and below-market leases, the value of in-place leases, unamortized lease origination costs and tenant relationships), based in each case on their respective fair values.
We allocate the purchase price to tangible assets of an acquired property based on the estimated fair values of those tangible assets assuming the building was vacant. Estimates of fair value for land, building and building improvements are based on many factors, including, but not limited to, comparisons to other properties sold in the same geographic area and independent third-party valuations. We also consider information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair values of the tangible and intangible assets and liabilities acquired.
The value allocated to acquired lease intangibles is based on management’s evaluation of the specific characteristics of each tenant’s lease. Characteristics considered by management in allocating these values include the nature and extent of the existing business relationships with the tenant, growth prospects for developing new business with the tenant, the remaining term of the lease and the tenant’s credit quality, among other factors.
The value allocable to the above-market or below-market market component of an acquired in-place lease is determined based upon the present value (using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of rents that would be paid using fair market rates over the remaining term of the lease.
The value of in-place leases and unamortized lease origination costs are amortized to expense over the remaining term of the respective leases, which range from less than a year to ten years. The amount allocated to acquire in-place leases is determined based on management’s assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. The amount allocated to unamortized lease origination costs is determined by what we would have paid to a third party to secure a new tenant reduced by the expired term of the respective lease.
Real Estate Held for Sale and Discontinued Operations. Real estate sold or to be sold during the current period is classified as “real estate held for sale” for all prior periods presented in the accompanying consolidated financial statements. Mortgage notes payable related to the real estate sold during the current period is classified as “notes payable related to real estate held for sale” for all prior periods presented in the accompanying consolidated financial statements. Additionally, we record the operating results related to real estate that has been disposed of as discontinued operations for all periods presented if the operations have been eliminated and represent a strategic shift and we will not have any significant continuing involvement in the operations of the property following the sale.
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Impairment of Real Estate Assets . We review the carrying value of each property to determine if circumstances that indicate impairment in the carrying value of the investment exist or that depreciation periods should be modified. If circumstances support the possibility of impairment, we prepare a projection of the undiscounted future cash flows, without interest charges, of the specific property and determine if the investment in such property is recoverable. If impairment is indicated, the carrying value of the property is written down to its estimated fair value based on our best estimate of the property’s discounted future cash flows.
Goodwill and Intangible Assets . Intangible assets, including goodwill and lease intangibles, are comprised of finite-lived and indefinite-lived assets. Lease intangibles represents the allocation of a portion of the purchase price of a property acquisition representing the estimated value of in-place leases, unamortized lease origination costs, tenant relationships and land purchase options. Intangible assets that are not deemed to have an indefinite useful life are amortized over their estimated useful lives. Indefinite-lived assets are not amortized.
We test for impairment of goodwill and other definite and indefinite lived assets at least annually, and more frequently as circumstances warrant. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset.
Sales of Real Estate Assets . Generally, our sales of real estate would be considered a sale of a nonfinancial asset as defined by ASC 610-20. If we determine we do not have a controlling financial interest in the entity that holds the asset and the arrangement meets the criteria to be accounted for as a contract, we would derecognize the asset and recognize a gain or loss on the sale of the real estate when control of the underlying asset transfers to the buyer.
Revenue Recognition . We recognize minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectability is reasonably assured and record amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, we determine whether the tenant improvements, for accounting purposes, are owned by the tenant or by us. When we are the owner of the tenant improvements, rental revenue begins when the tenant takes possession or has control of the physical use of the leased space and any tenant improvement allowance, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance (including amounts that the tenant can take in the form of cash or a credit against its rent) that is funded is treated as a lease incentive and amortized as a reduction of revenue over the lease term. Tenant improvement ownership is determined based on various factors, including, but not limited to:
•
whether the lease stipulates how a tenant improvement allowance may be spent;
•
whether the amount of a tenant improvement allowance is in excess of market rates;
•
whether the tenant or landlord retains legal title to the improvements at the end of the lease term;
•
whether the tenant improvements are unique to the tenant or general-purpose in nature; and
•
whether the tenant improvements are expected to have any residual value at the end of the lease.
We record property operating expense reimbursements due from tenants for common area maintenance, real estate taxes, and other recoverable costs in the period the related expenses are incurred.
We make estimates of the collectability of our tenant receivables related to base rents, including deferred rent receivable, expense reimbursements and other revenue or income. We specifically analyze accounts receivable, deferred rent receivable, historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, management makes estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectability of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. When a tenant is in bankruptcy, we will record a bad debt reserve for the tenant’s receivable balance and generally will not recognize subsequent rental revenue until cash is received or until the tenant is no longer in bankruptcy and has the ability to make rental payments.
Sales of real estate are recognized generally upon the transfer of control, which usually occurs when the real estate is legally sold. The application of these criteria can be complex and required us to make assumptions. We believe the relevant criteria were met for all real estate sold during the periods presented.
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Income Taxes. We have elected to be taxed as a REIT under Sections 856 through 860 of the Code, for federal income tax purposes. To maintain our qualification as a REIT, we are required to distribute at least 90% of our REIT taxable income to our stockholders and meet the various other requirements imposed by the Code relating to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we maintain our qualification for taxation as a REIT, we are generally not subject to corporate level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. If we fail to maintain our qualification as a REIT in any taxable year, and are unable to avail ourselves of certain savings provisions set forth in the Code, all of our taxable income would be subject to federal income tax at regular corporate rates, including any applicable alternative minimum tax. We are subject to certain state and local income taxes.
We, together with one of our entities, have elected to treat such subsidiaries as taxable REIT subsidiaries (a “TRS”) for federal income tax purposes. Certain activities that we undertake must be conducted by a TRS, such as non-customary services for our tenants, and holding assets that we cannot hold directly. A TRS is subject to federal and state income taxes.
Fair Value Measurements . Certain assets and liabilities are required to be carried at fair value, or if long-lived assets are deemed to be impaired, to be adjusted to reflect this condition. The guidance requires disclosure of fair values calculated under each level of inputs within the following hierarchy:
•
Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;
•
Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and
•
Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.
When available, we utilize quoted market prices from independent third-party sources to determine fair value and classify such items in Level 1 or Level 2 . In instances where the market for a financial instrument is not active, regardless of the availability of a nonbinding quoted market price, observable inputs might not be relevant and could require us to make a significant adjustment to derive a fair value measurement. Additionally, in an inactive market, a market price quoted from an independent third-party may rely more on models with inputs based on information available only to that independent third-party. When we determine the market for a financial instrument owned by us to be illiquid or when market transactions for similar instruments do not appear orderly, we use several valuation sources (including internal valuations, discounted cash flow analysis and quoted market prices) and establish a fair value by assigning weights to the various valuation sources.
As of December 31, 2023 and December 31, 2022, our marketable securities (excluding our investments in Conduit's common stock and common stock warrants), held at a third party broker, presented on the balance sheet were measured at fair value using Level 1 market prices and totaled approximately $45,149 and $0.8 million, respectively, with a cost basis of approximately $40,315 and $0.9 million, respectively. Additionally, the funds held in the Trust Account for the SPAC Class A common stockholders included a money market portfolio that was comprised of U.S. Treasury securities, considered cash equivalent, which were measured at fair value using Level 1 and totaled approximately $0 million and $136.9 million as of December 31, 2023 and December 31, 2022, respectively. Our investments in Conduit's common stock and common stock warrants presented on the consolidated balance sheets were measured at fair value using Level 1 market prices, which are currently held at Conduit's transfer agent, taking into account the adoption of ASU 2022-03 Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions , and totaled approximately $18.3 million as of December 31, 2023, with a cost basis of approximately $7.5 million. The Company entered into a lock-up agreement with Conduit regarding the common stock held by the Company, for 180 days from the closing of the business combination which ended March 20, 2024. There were no financial liabilities measured at fair value as of December 31, 2023 and December 31, 2022 .
The following table presents as of December 31, 2023 the Company’s assets subject to measurement at fair value on a nonrecurring basis (in thousands):
Fair Value Measurements as of December 31, 2023
Level 1
Level 2
Level 3
Total
Assets:
Goodwill for Dubose Model Homes
$
-
$
-
$
1,123,000
$
1,123,000
Goodwill for NTR Property Management
-
-
451,000
451,000
Total Assets
$
-
$
-
$
1,574,000
$
1,574,000
The following table presents as of December 31, 2022 the Company’s assets subject to measurement at fair value on a nonrecurring basis (in thousands):
Fair Value Measurements as of December 31, 2022
Level 1
Level 2
Level 3
Total
Assets:
Goodwill for Dubose Model Homes
$
-
$
-
$
1,123,000
$
1,123,000
Goodwill for NTR Property Management
-
-
1,300,000
1,300,000
Total Assets
$
-
$
-
$
2,423,000
$
2,423,000
Additionally, when determining the fair value of a liability in circumstances in which a quoted price in an active market for an identical liability is not available, we measure fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach. Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In this regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in an immediate settlement of the instrument.
Depreciation and Amortization . The Company records depreciation and amortization expense using the straight-line method over the useful lives of the respective assets. The cost of buildings are depreciated over estimated useful lives of 39 years, the costs of improvements are amortized over the shorter of the estimated life of the asset or term of the tenant lease (which range from 1 to 10 years), the costs associated with acquired tenant intangibles over the remaining lease term and the cost of furniture, fixtures and equipment are depreciated over 4 to 5 years.
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Earnings per share ( “ EPS ” ). The EPS on common stock has been computed pursuant to the guidance in FASB ASC Topic 260, Earnings Per Share. The guidance requires the classification of the Company’s unvested restricted stock, which contain rights to receive non-forfeitable dividends, as participating securities requiring the two-class method of computing net income per share of common stock. In accordance with the two-class method, earnings per share have been computed by dividing the net income less net income attributable to unvested restricted shares by the weighted average number of shares of common stock outstanding less unvested restricted shares. Diluted earnings per share is computed by dividing net income by the weighted average shares of common stock and potentially dilutive securities outstanding in accordance with the treasury stock method.
Dilutive common stock equivalents include the dilutive effect of in-the-money stock equivalents, which are calculated based on the average share price for each period using the treasury stock method, excluding any common stock equivalents if their effect would be anti-dilutive. In periods in which a net loss has been incurred, all potentially dilutive common stock shares are considered anti-dilutive and thus are excluded from the calculation. Securities that are excluded from the calculation of weighted average dilutive common stock, because their inclusion would have been antidilutive, are:
For the Year Ended December 31,
2023
2022
Common Stock Warrants
2,000,000
2,000,000
Placement Agent Warrants
80,000
80,000
Series A Warrants
14,450,069
14,450,069
Unvested Common Stock Grants
760,995
349,042
Total potentially dilutive shares
17,291,064
16,879,111
RESULTS FROM OPERATIONS FOR THE YEARS ENDED December 31, 2023 AND 2022
Our results from operations for 2023 and 2022 are not indicative of those expected in future periods as we expect that rental income, interest expense, rental operating expense, general and administrative expenses, and depreciation and amortization will significantly change in future periods as a result of the assets sold over the last two years.
Revenues. Total revenue was approximately $17.6 million for the year ended December 31, 2023, compared to approximately $17.8 million for the same period in 2022, a decrease of approximately $0.2 million or 1%. The decrease in rental income reported in 2023 compared to 2022 is directly related to the non-renewal of our largest tenant, in 2022, Halliburton, located in Shea Center II at December 31, 2022. This was offset by the increase in model home income, as our model home portfolio grew from 92 at December 31, 2022 to 110 at December 31, 2023.
Rental Operating Costs . Rental operating costs were approximately $6.0 million for the year ended December 31, 2023 compared to approximately $5.8 million for the same period in 2022, an increase of approximately $121,522 or 2%. Rental operating costs as a percentage of total revenue was 33.8% and 32.9% for the years ended December 31, 2023 and 2022, respectively, as office property expenses continue to increase, specifically insurance costs. As of December 31, 2023 our model home assets made up 35% of our total real estate assets, which is up from 28% as of December 31, 2022, and our gross revenue from model home assets represented approximately 23% of our total revenue. This percentage is expected to increase in 2024 as the percentage of our model home real estate assets has increased. There were no acquisitions or sales of retail, office or industrial properties during the year ended December 31, 2023, resulting in an expected decreases in the percent of gross revenues from those assets during 2024. Management does expect to see activity in sales in our commercial real estate assets in the near future. During the year ended December 31, 2023, the material impact to office property expense was an impairment as noted below.
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% of Gross Revenue for the year ended
Segment
12/31/2023
12/31/2022
Office/Industrial
65.9
%
71.2
%
Model Home
23.4
%
16.3
%
Retail
10.7
%
12.5
%
% of Total Real Estate Assets as of
Segment
12/31/2023
12/31/2022
Office/Industrial
53.5
%
60.3
%
Model Home
35.2
%
26.9
%
Retail
11.3
%
12.8
%
General and Administrative . General and administrative (“G&A”) expenses were approximately $6.8 million for the year ended December 31, 2023, compared to approximately $6.2 million for the same period in 2022, representing an increase of approximately $0.6 million or 10%. As a percentage of total revenue, our general and administrative costs was approximately 38.5% and 34.7% for the years ended December 31, 2023 and 2022, respectively. The G&A expense for the years ended December 31, 2022 was affected by a reduction in payroll costs totaling approximately $878,000, which included employee retention credits ("ERC") and decreased stock compensation, offset by the increase in D&O insurance for the SPAC totaling approximately $465,000 and higher accounting and consulting fees of approximately $412,000. There were no ERC payments to offset payroll costs in 2023 leading to higher overall payroll costs. Consolidated G&A expenses related to SPAC totaled approximately $1.0 million and $0.9 million for the years ended December 31, 2023 and 2022, respectively.
Depreciation and Amortization . Depreciation and amortization expenses were approximately $5.4 million for the year ended December 31, 2023, compared to approximately $5.5 million for the same period in 2022.
Asset Impairments . We review the carrying value of goodwill and each of our real estate properties annually to determine if circumstances indicate an impairment in the carrying value of these investments exists. During the year ended December 31, 2023, we recognized a non-cash impairment charge of approximately $3.2 million on goodwill and our real estate assets. Of the $3.2 million impairment for the year, approximately $2.0 million was related to our One Park Center property, approximately $0.4 million was related to eight model homes, and approximately $0.8 million was related to goodwill impairment. This impairment charge for One Park Center reflects management’s revised estimate of the fair market value based on sales comparable of like property in the same geographical area as well as an evaluation of future cash flows or an executed purchase sale agreement. The impairment charge for the eight model homes reflects the estimated sales prices for these specific model homes in 2024 as a result of an abnormally short hold period, less than two years, on model homes purchased in 2022, where the builder changed their product type in these neighborhoods after we had purchased the homes. We do not believe these losses are indicative of our overall model home portfolio. As noted above in the Overview section, during the year ended December 31, 2023, we sold 22 model homes for approximately $11.7 million and the Company recognized a gain of approximately $3.2 million. We expect to record a net gain on model home sales in the first quarter of 2024 as well. The impairment to goodwill was related to NTR Property Management and the fair market value adjustment based on future expected cash flows. The Company did not recognize a non-cash goodwill or real estate impairment during the year ended December 31, 2022.
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Interest Expense-mortgage notes. Interest expense, including amortization of deferred finance charges was approximately $5.0 million for the year ended December 31, 2023 compared to approximately $4.7 million for the same period in 2022, an increase of approximately $0.3 million, or 6%. The increase in mortgage interest expense relates to the increase mortgage debt on our commercial properties and model homes. During the year ended 2023 our total mortgage debt increased from $97.8 million at December 31, 2022 to $108.5 million at December 31, 2023 in connection with the acquisition of new model homes and our weighted average interest rate increased from 4.57% to 5.18% over the same time period.
Gain on Sale of Real Estate Assets. For the year ended December 31, 2023, the change in gain on sale relates to the mix and type of properties sold. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Significant Transactions in 2023 and 2022 above for further detail.
Income Tax Expense / Credit. For the year ended December 31, 2023, the Company recorded an expense of approximately ($0.3)million related to estimated refunds from federal and state taxes for capital gains from the sale of model homes held by the taxable REIT subsidiary compared to a recorded an income tax credit of approximately $1.2 million, for the year ended December 31, 2022. The reduction in taxes can be attributed to a lower gain on sale of model homes in 2023 as compared to 2022 as well as the deconsolidation of the SPAC, and the SPAC's income tax expense, in September 2023. Consolidated income tax expenses related to the SPAC totaled approximately $0.4 million and $0.6 million for the years ended December 31, 2023 and 2022, respectively.
Income allocated to non-controlling interests. Income allocated to non-controlling interests for the years ended December 31, 2023 and 2022 totaled approximately $3.0 million, and $3.6 million, and was directly impacted by the sale of 13 and 19 model homes during the years ended December 31, 2023 and 2022, respectively, held by our Model Home Partnerships.
Gain on deconsolidation of SPAC and remeasurement. Following the completion of the Murphy Canyon IPO in February 2022, we determined that Murphy Canyon is a Variable Interest Entity ("VIE") in which we had a variable interest because Murphy Canyon did not have enough equity at risk to finance its activities without additional subordinated financial support. Since the business combinations with Conduit on September 22, 2023, we have determined that Conduit’s (formally Murphy Canyon) public stockholders have substantive rights and we no longer have control of Conduit’s activity. Since we are no longer the controlling party, or have a majority of the issued and outstating common stock, the Company deconsolidated Conduit from our consolidated financial statements. In connection with the deconsolidation we recorded a gain of approximately $40.3 million. Of the total gain recognized on deconsolidation, approximately $34.1 million relates to the remeasurement of our retained investment in Murphy Canyon via the Sponsor shares which converted into shares of Conduit's common stock on September 22, 2023, and approximately $6.2 million relates to the deconsolidation of Murphy Canyon's assets and liabilities as of September 22, 2023.
Since deconsolidating Conduit, on September 22, 2023, our investments in Conduit's common stock and common stock warrants presented on the consolidated balance sheets were measured at fair value using Level 1 market prices, taking into account the adoption of ASU 2022-03
Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions , and totaled approximately
$18.3 million as of
December 31, 2023, with a cost basis of approximately $7.5 million. The Company entered into a lock-up agreement with Conduit regarding the common stock held by the Company, for 180 days from the closing of the business combination which ended on March 20, 2024.
Geographic Diversification Tables
The following table shows a list of commercial properties owned by the Company grouped by state and geographic region as of December 31, 2023:
State
No. of Properties
Aggregate Square Feet
Approximate % of Square Feet
Current Base Annual Rent
Approximate % of Aggregate Annual Rent
California
1
57,807
7.0
%
$
1,425,269
12.9
%
Colorado
5
324,245
39.4
%
4,883,335
44.2
%
Maryland
1
31,752
3.9
%
710,248
6.4
%
North Dakota (1)
4
399,113
48.4
%
3,687,043
33.5
%
Texas
1
10,500
1.3
%
335,973
3.0
%
Total
12
823,417
100.0
%
$
11,041,868
100.0
%
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The following table shows a list of our Model Home properties by geographic region as of December 31, 2023:
Geographic Region
No. of Properties
Aggregate Square Feet
Approximate % of Square Feet
Current Base Annual Rent
Approximate % of Aggregate Annual Rent
Midwest
4
12,307
3.7
%
$
182,748
4.3
%
Southeast
4
9,875
2.9
%
172,428
4.0
%
Southwest
102
312,174
93.4
%
3,926,124
91.7
%
Total
110
334,356
100.0
%
$
4,281,300
100.0
%
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our anticipated fut ure sources of liquidity may include existing cash and cash equivalents, cash flows from operations, refinancing of existing mortgages, future real estate sales, new borrowings from our model home lines of credit, the sale of our investment in Conduit Pharma, and the sale of our equity or issuance of debt securities or bonds. Our cash and restricted cash at December 31, 2023 was approximately $6.5 million . Our future capital needs include paying down existing borrowings, maintaining our existing properties, funding tenant improvements, paying lease commissions (to the extent they are not covered by le nder-held reserve deposits), and the payment of dividends to our stockholders. We also are actively seeking model home investments that are likely to produce income and achieve long-term gains in order to pay dividends to our stockholders. To ensure that we can effectively execute these objectives, we routinely review our liquidity requirements and continually evaluate all potential sources of liquidity.
Our short-term liquidity needs include paying our current operating costs, satisfying the debt service requirements of our existing mortgages, completing tenant improvements, paying leasing commissions, and funding dividends to stockholders. Future principal payments due on our mortgage notes payables during 2024, total appr oximately $23.5 million , of which $13.1 million is related to model home propertie s. During the next 12 months our four commercial property loans, Dakota Center, Research Parkway, Arapahoe Service Center and Union Town Center, have mortgage loans with maturity dates, totaling approximately $26.1 million. Management has begun discussions with various lenders to either restructure, extend or refinance these loans. Additionally, management may consider selling these properties if we are unsuccessful in extending the maturity dates or are unable to raise additional funds to pay these non-recourse loans in full. Only the loan on Research Parkway, for $1.6 million has recourse to the Company. Management expects certain model homes will be sold, and that the underlying mortgage notes will be paid off with sales proceeds, while other mortgage notes will be refinanced as the Company ha s done in the past. Additional principal payments will be made with cash flows from ongoing operations. On December 31, 2022, the lease for our largest tenant at that time, Halliburton, expired. Halliburton was located in our Shea Center II property in Colorado and did not renew the lease. We placed approximately $1.1 million in a reserve account with our lender to cover future mortgage payments, if necessary, in connection with Halliburton's vacant space, none of which has been used as of December 31, 2023. This reserve amount is included in "Cash, cash equivalents and restricted cash" on the balance sheet. Our management team is working to fill the 45,535 square foot space and has leased approximately 20% of the space to a tenant during 2023 and has reviewed various third party proposals for the remaining 80%. As of December 31, 2023, none of the third party proposals have fit into our long-term plans. We will continue to work on filling the space during 2024.
While we will continue to pursue value creating investments, the Board of Directors believes there is significant embedded value in our assets that is yet to be realized by the market. Therefore, returning capital to stockholders through a repurchase program is an attractive use of capital currently. On September 17, 2021, the Board of Directors authorized a stock repurchase program of up to $10 million of outstanding shares of our Series A Common Stock, which expired in September 2022. On September 15, 2022, the Board of Directors authorized a stock repurchase program of up to $6.0 million of outstanding shares of our Series A Common Stock and up to $4.0 million of our Series D Preferred Stock, which expired in September 2023. During the year ended December 31, 2022, the Company repurchased 196,631 shares of our Series A Common Stock at an average price of approximately $1.59 per share, including a commission of $0.035 per share, and 6,013 shares of our Series D Preferred Stock at an average price of approximately $20.31 per share, including a commission of $0.035 per share, for a total cost of $313,578 for the Series A Common Stock and $122,141 for the Series D Preferred Stock. In November 2023, the Board of Directors authorized a stock repurchase program of up to $6.0 million of outstanding shares of our Series A Common Stock and up to $4.0 million of our Series D Preferred Stock which shall expire in November 2024. During the year ended December 31, 2023, the Company repurchased 23,041 shares of our Series D Preferred Stock at an average price of approximately $ 15.97 per share, including a commission of $0.035 per share, and no shares of our Series A Common Stock, for a total cost of $0.2 million for the Series D Preferred Stock. The repurchased shares will be treated as authorized and unissued in accordance with Maryland law and shown as a reduction of stockholders’ equity at cost.
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There can be no assurance that the Company will refinance loans, take out additional financing or capital will be available to the Company on acceptable terms, if at all. If events or circumstances occur such that the Company does not obtain additional funding, it will most likely be required to reduce its plans, reduce certain discretionary spending or even sell properties, which could have a material adverse effect on the Company’s ability to achieve its intended business objectives. We believe that cash on hand, cash flow from our existing portfolio, distributions from joint ventures in Model Home Partnerships and property sales during 2024 will be sufficient to fund our operating costs, planned capital expenditures and required dividends for at least the next twelve months. If our cash flow from operating activities is n ot sufficient to fund our short-term liquidity needs, we plan to fund a portion of these needs from additional borrowings of secured or unsecured indebtedness, from real estate sales, issuance of debt instruments, additional investors, or we may reduce or suspend the rate of dividends to our stockholders.
Our long-term liquidity needs include proceeds necessary to grow and maintain our portfolio of investments. We believe that the potential financing capital available to us in the future is sufficient to fund our long-term liquidity needs. We are continually reviewing our existing portfolio to determine which properties have met our short- and long-term goals and reinvesting the proceeds in properties with better potential to increase performance. We expect to obtain additional cash in connection with refinancing of maturing mortgages and assumption of existing debt collateralized by some or all of our real property in the future to meet our long-term liquidity needs. If we are unable to arrange a line of credit, borrow on properties, privately place securities or sell securities to the public we may not be able to acquire additional properties to meet our long-term objectives.
The following is a summary of distributions declared per share of our Series A Common Stock and for our Series D Preferred Stock for the years ended December 31, 2023 and 2022 . The Company intends to continue to pay dividends to our common stockholders on a quarterly basis, and on a monthly basis for the Series D Preferred stockholders going forward, bu t there can be no guarantee the Board of Directors will approve any future dividends.
Quarter Ended
2023
2022
Distributions Declared
Distributions Declared
March 31
$
0.022
$
0.105
June 30
0.023
0.106
September 30
0.023
0.020
December 31
0.023
0.021
Total
$
0.091
$
0.252
Month
2023
2022
Distributions Declared
Distributions Declared
January
$
0.19531
$
0.19531
February
0.19531
0.19531
March
0.19531
0.19531
April
0.19531
0.19531
May
0.19531
0.19531
June
0.19531
0.19531
July
0.19531
0.19531
August
0.19531
0.19531
September
0.19531
0.19531
October
0.19531
0.19531
November
0.19531
0.19531
December 31
0.19531
0.19531
Total
$
2.34372
$
2.34372
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Cash, Cash Equivalents and Restricted Cash
At December 31, 2023 and December 31, 2022 , we had approximately $6.5 million and $16.5 million in cash equivalents, respectively, including $3.7 million and $4.4 million of restricted cash, respectively. Our cash equivalents and restricted cash consist of invested cash, cash in our operating accounts and cash held in bank accounts at third-party institutions. During the years ended December 31, 2023 and 2022 , we did not experience any loss or lack of access to our cash or cash equivale nts. Approximately $1.2 million of our cash and restricted cash balance is intended for capital expenditures on existing properties (including deposits held in reserve accounts by our lenders) over the next 12 months. We intend to use the remainder of our existing cash and cash equivalents for asset/property acquisitions, reduction of principal debt, general corporate purposes, common stock repurchases (if market conditions are met),or dividends to our stockholders.
Secured Debt
As of December 31, 2023 , all our commercial properties, except 300 NP which has no debt, had fixed-rate mortgage notes payable in the aggregate principal amount of $73.7 million , collater alized by a total of 11 commercial properties with loan terms at issuance ranging from 7 to 10 years. The weighted-average interest rate on these mortgage notes payable as of December 31, 2023 was approximately 4.87%, and our debt to estimated market value for our commercial properties was approximately 60.6%. During the next 12 months four of our commercial property loans, totaling approximately $26.1 million, will mature, with an estimated combined loan to value of approximately 59% as of December 31, 2023.
As of December 31, 2023 , the Company had fixed-rate mortgage notes payable related to model homes in the aggregate principal amount of $34.8 million, excluding loans eliminated through consolidation, collateralized by a total of 108 Model Homes. These loans generally have a term at issuance of three to five years. As of December 31, 2023 , the average loan balance per home outstanding and the weighted-average interest rate on these mortgage loans are ap proximately $322,368 and 5.81%, respectively. Our debt to estimated market value on all our model home properties is approximately 66.6%, excluding any loans eliminated through consolidation. We have been able to refinance maturing mortgages to extend maturity dates and we have not experienced any notable difficulties financing our acquisitions. The Company anticipates that any new mortgages used to acquire commercial properties or model homes in the near future will be at rates higher than our currently weighted average interest rate. As of December 31, 2023, we had issued two promissory notes to our majority owned subsidiaries, Dubose Model Home Investors 202 LP and Dubose Model Home Investors 204 LP, for the refinancing of two model home properties in Texas and Wisconsin, for approximately $0.5 million with interest rates ranging from 3.0% to 5.55% per annum and maturity dates between August 2024 and November 2025. These notes payable and notes receivable, including interest expense and interest income related to these promissory notes, are eliminated through consolidation on our financial statements.
Cash Flows for the years ended December 31, 2023 and December 31, 2022
Operating Activities: Net cash provided by operating activities for the years ended December 31, 2023 and 2022 increased by $0.6 million to approximately $1.5 million from $0.9 million. The change in net cash provided in operating activities is mainly due to changes in net income, including operating activities of the SPAC, which fluctuates based on timing of receipt and payment, as well as an increase in non-cash addbacks such as straight-line rent. Consolidated operating expenses related to the SPAC totaled approximately $1.45 million and $1.50 million for the years ended December 31, 2023 and 2022, respectively. There will be no operating expense related to the SPAC in future periods, since the deconsolidation in September 2023.
Investing Activities: Net cash from investing activities for the year ended December 31, 2023 was approximately $120.3 million compared to cash used in investing activities of approximately $126.4 million during the same period in 2022. The change from each period was primarily related to the gross cash distributed from the Trust Account for Murphy Canyon totaling approximately $137 million. Additionally, proceeds from sale of real estate, net, were down approximately $15 million in 2023, as compared to 2022, and proceeds used for real estate acquisition and building improvements were up approximately $10.5 million.
We currently project that we could spend up to $1.2 million (some of which is held in deposits reserve accounts by our lenders) on capital improvements, tenant improvements and leasing costs for properties within our portfolio during the rest of the year. Capital expenditures may fluctuate in any given period subject to the nature, extent, and timing of improvements required to the properties. We may spend more on capital expenditures in the future due to rising construction costs. Tenant improvements and leasing costs may also fluctuate in any given year depending upon factors such as the property, the term of the lease, the type of lease, the involvement of external leasing agents and overall market conditions.
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Table of Contents
Financing Activities: Net cash used in financing activities during the year ended December 31, 2023 was $131.8 million compared to $127.3 million provided by financing activities for the same period in 2022 and was primarily due to the following activities for the year ended December 31, 2023:
•
Payments on redemptions of approximately $137.2 million for Murphy Canyon common stock during the year ended December 31, 2023.
•
The payment of Series A Common Stock and Series D Preferred Stock dividends totaling approximately $1.2 million and $2.1 million, respectively during the year ended December 31, 2023.
•
Net repayment of mortgage notes payable and notes payable totaling approximately $10.1 million during the year ended December 31, 2023.
•
Distributions to noncontrolling interest of approximately $1.7 million.
•
The repurchase of Series D Preferred Stock totaling approximately $0.4 million.
These decreases to cash used in financing activities were offset by proceeds from mortgage notes payable, net of issuance costs of approximately $20.8 million.
Off-Balance Sheet Arrange ments
On July 12, 2021, the Company entered into a securities purchase agreement with a single U.S. institutional investor for the purchase and sale of 1,000,000 shares of its Series A Common Stock, Common Stock Warrants to purchase up to 2,000,000 shares of Series A Common Stock and Pre-Funded Warrants to purchase up to 1,000,000 shares of Series A Common Stock. Each share of Common Stock and accompanying Common Stock Warrants were sold together at a combined offering price of $5.00, and each share of Common Stock and accompanying Pre-Funded Warrant were sold together at a combined offering price of $4.99. The Pre-Funded Warrants were exercised in full during August 2021 at a nominal exercise price of $0.01 per share. The Common Stock Warrants have an exercise price of $5.50 per share, were exercisable upon issuance and will expire five years from the date of issuance.
In connection with this additional offering, we agreed to issue the Placement Agent Warrants to purchase up to 80,000 shares of Series A Common Stock, representing 4.0% of the Series A Common Stock and shares of Series A Common Stock issuable upon exercise of the Pre-Funded Warrants. The Placement Agent Warrants were issued in August 2021, post exercise of the Pre-Funded Warrants with an exercise price of $6.25 and will expire five years from the date of issuance.
Common Stock Warrants: If all the potential Common Stock Warrants outstanding at December 31, 2023, were exercised at the price of $5.00 per share, gross proceeds to us would be approximately $10 million and we would as a result issue an additional 2,000,000 shares of common stock.
Placement Agent Warrants: If all the potential Placement Agent Warrants outstanding at December 31, 2023, were exercised at the price of $6.25 per share, gross proceeds to us would be approximately $0.5 million and we would as a result issue an additional 80,000 shares of common stock.
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Table of Contents
January 14, 2022 was the record date with respect to the distribution of five-year listed warrants (the “Series A Warrants”). The Series A Warrants and the shares of common stock issuable upon the exercise of the Series A Warrants were registered on a registration statement that was filed with the SEC and was declared effective January 21, 2022. The Series A Warrants commenced trading on the Nasdaq Capital Market under the symbol “SQFTW” on January 24, 2022 and were distributed on that date to persons who held shares of common stock and existing outstanding warrants as of the January 14, 2022 record date, or who acquired shares of common stock in the market following the record date, and who continued to hold such shares at the close of trading on January 21, 2022. The Series A Warrants give the holder the right to purchase one share of common stock at $7.00 per share, for a period of five years. Should warrantholders not exercise the Series A Warrants during that holding period, the Series A Warrants will automatically convert to 1/10 of a common share at expiration, rounded down to the nearest number of whole shares.
Series A Warrants: If all the potential Series A Warrants outstanding at December 31, 2023, were exercised at the price of $7.00 per share, gross proceeds to us would be approximately $101.2 million and we would as a result issue an additional 14,450,069 shares of common stock.
Inflation
Leases generally provide for limited increases in rent as a result of fixed increases, increases in the consumer price index (typically subject to ceilings), or increases in the clients’ sales volumes. We expect that inflation will cause these lease provisions to result in rent increases over time. During times when inflation is greater than increases in rent, as provided for in the leases, rent increases may not keep up with the rate of inflation.
However, our use of net lease agreements tends to reduce our exposure to rising property expenses due to inflation because the client is responsible for property expenses. Inflation and increased costs may have an adverse impact on our clients if increases in their operating expenses exceed increases in revenue.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to provide disclosure pursuant to this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this item are filed with this report as described under Item 15.
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Table of Contents
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.