NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
for the three months ended March 31, 2022 and 2021
NOTE 1 • ORGANIZATION
Centerspace, collectively with its consolidated subsidiaries (“Centerspace,” “the Company,” “we,” “us,” or “our”), is a North Dakota real estate investment trust (“REIT”) focused on the ownership, management, acquisition, redevelopment, and development of apartment communities. As of March 31, 2022, Centerspace owned interests in 83 apartment communities consisting of 14,838 apartment homes.
NOTE 2 • BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Centerspace conducts a majority of its business activities through a consolidated operating partnership, Centerspace, LP (f/k/a IRET Properties), a North Dakota limited partnership (the “Operating Partnership”), as well as through a number of other consolidated subsidiary entities. The accompanying Condensed Consolidated Financial Statements include the Company’s accounts and the accounts of all its subsidiaries in which it maintains a controlling interest, including the Operating Partnership. All intercompany balances and transactions are eliminated in consolidation.
The Condensed Consolidated Financial Statements also reflect the Operating Partnership’s ownership of a joint venture entity in which the Operating Partnership has a general partner or controlling interest. This entity is consolidated into the Company’s operations, with noncontrolling interests reflecting the noncontrolling partners’ share of ownership, income, and expenses.
UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Centerspace’s interim Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. The year-end balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by GAAP. In the opinion of management, all adjustments, consisting solely of normal recurring adjustments necessary for the fair presentation of financial position, results of operations, and cash flows for the interim periods, have been included.
The current period’s results of operations are not necessarily indicative of results which ultimately may be achieved for the year. The interim Condensed Consolidated Financial Statements and accompanying notes thereto should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on February 28, 2022.
USE OF ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
As of March 31, 2022 and December 31, 2021, restricted cash consisted primarily of real estate deposits and escrows held by lenders for real estate taxes, insurance, and capital additions.
LEASES
As a lessor, Centerspace primarily leases multifamily apartment homes which qualify as operating leases with terms that are generally one year or less. Rental revenues are recognized in accordance with ASC 842, Leases, using a method that represents a straight-line basis over the term of the lease. Rental income represents approximately 98.1% of total revenues and includes gross market rent less adjustments for gain or loss to lease, concessions, vacancy loss, and bad debt. Other property revenues represent the remaining 1.9% of total revenues and are primarily driven by other fee income, which is typically recognized when earned, at a point in time.
Some of the Company’s apartment communities have commercial spaces available for lease. Lease terms for these spaces typically range from three to fifteen years. The leases for commercial spaces generally include options to extend the lease for additional terms.
Many of the leases contain non-lease components for utility reimbursement from residents and common area maintenance from commercial tenants. Centerspace has elected the practical expedient to combine lease and non-lease components for all asset classes. The combined components are included in lease income and are accounted for under ASC 842.
The aggregate amount of future scheduled lease income on commercial operating leases, excluding any variable lease income and non-lease components, as of March 31, 2022, was as follows:
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| | (in thousands) |
2022 (remainder) | | $ | 1,958 | |
2023 | | 2,627 | |
2024 | | 2,577 | |
2025 | | 2,528 | |
2026 | | 1,935 | |
Thereafter | | 1,548 | |
Total scheduled lease income - commercial operating leases | | $ | 13,173 | |
REVENUES
Revenue is recognized in accordance with the transfer of goods and services to customers at an amount that reflects the consideration to which the Company expects to be entitled for those goods and services.
Revenue streams that are included in revenues from contracts with customers include:
•Other property revenue: Centerspace recognizes revenue for rental related income not included as a component of a lease, such as application fees, as earned.
•Gains or losses on sales of real estate: A gain or loss is recognized when the criteria for derecognition of an asset are met, including when (1) a contract exists and (2) the buyer obtained control of the nonfinancial asset that was sold.
The following table presents the disaggregation of revenue streams for the three months ended March 31, 2022 and 2021:
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| | | (in thousands) |
| | | Three Months Ended March 31, | | |
Revenue Stream | Applicable Standard | | 2022 | 2021 | | | |
Fixed lease income - operating leases | Leases | | $ | 56,673 | | $ | 43,840 | | | | |
Variable lease income - operating leases | Leases | | 2,523 | | 1,969 | | | | |
Other property revenue | Revenue from contracts with customers | | 1,118 | | 839 | | | | |
Total revenue | | | $ | 60,314 | | $ | 46,648 | | | | |
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates long-lived assets, including investments in real estate, for impairment indicators at least quarterly. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions, expected holding period of each property, and legal and environmental concerns. If indicators exist, the Company compares the expected future undiscounted cash flows for the property against the carrying amount of that property. If the sum of the estimated undiscounted cash flows is less than the carrying amount, an impairment loss is recorded for the difference between the estimated fair value and the carrying amount. If the anticipated holding period for properties, the estimated fair value of properties, or other factors change based on market conditions or otherwise, the evaluation of impairment charges may be different and such differences could be material to the consolidated financial statements. The evaluation of anticipated cash flows is subjective and is based, in part, on assumptions regarding future occupancy, rental rates, and capital requirements that could differ materially from actual results. Reducing planned property holding periods may increase the likelihood of recording impairment losses.
During the three months ended March 31, 2022 and 2021, the Company recorded no impairment charges.
MORTGAGE LOANS RECEIVABLE AND NOTES RECEIVABLE
In March 2020, in connection with the acquisition of Ironwood, an apartment community in New Hope, Minnesota, the Company acquired a tax increment financing note receivable (“TIF”) with a principal balance of $6.1 million and $6.4 million at March 31, 2022 and December 31, 2021, respectively, which appears within other assets in the Condensed Consolidated Balance Sheets. The note bears an interest rate of 4.5% with payments due in February and August of each year.
In December 2019, Centerspace originated a $29.9 million construction loan and a $15.3 million mezzanine loan for the development of a multifamily community located in Minneapolis, Minnesota. During the three months ended September 30, 2021, construction on the project was completed and the lease-up phase began. The construction and mezzanine loans bore and accrued interest at 4.5% and 11.5%, respectively. During the three months ended March 31, 2022, the Company exercised its option to purchase the apartment community in exchange for the loans and cash. As of March 31, 2022, the loans had no remaining balance. As of December 31, 2021, the Company had fully funded the $29.9 million construction loan and $13.4 million of the mezzanine loan, both of which appear within mortgage loans receivable in the Condensed Consolidated Balance Sheets.
VARIABLE INTEREST ENTITIES
Centerspace has determined that its Operating Partnership and each of its less-than-wholly owned real estate partnerships are VIEs, as the limited partners or the functional equivalent of limited partners lack substantive kick-out rights and substantive participating rights. The Company is the primary beneficiary of the VIEs, and the VIEs are required to be consolidated on the balance sheet because the Company has a controlling financial interest in the VIEs and has both the power to direct the activities of the VIEs that most significantly impact the economic performance of the VIEs as well as the obligation to absorb losses or the right to receive benefits from the VIEs that could potentially be significant to the VIEs. Because the Operating Partnership is a VIE, all of the Company’s assets and liabilities are held through a VIE.
NOTE 3 • EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares of beneficial interest (“common shares”) outstanding during the period. Centerspace has issued restricted stock units (“RSUs”) and incentive stock options (“ISOs”) under the 2015 Incentive Plan, Series D Convertible Preferred Units (“Series D preferred units”), and Series E Convertible Preferred Units (“Series E preferred units”), which could have a dilutive effect on the earnings per share upon exercise of the RSUs or ISOs or upon conversion of the Series D or Series E preferred units (refer to Note 4 for further discussion of the Series D and the Series E preferred units). Other than the issuance of RSUs, ISOs, Series D preferred units, and Series E preferred units, there are no outstanding options, warrants, convertible stock or other contractual obligations requiring issuance of additional shares that would result in dilution of earnings. Under the terms of the Operating Partnership’s Agreement of Limited Partnership, limited partners have the right to require the Operating Partnership to redeem their limited partnership units (“Units”) any time following the first anniversary of the date they acquired such Units (“Exchange Right”). Upon the exercise of Exchange Rights, and in Centerspace’s sole discretion, it may issue common shares in exchange for Units on a one-for-one basis.
For the three months ended March 31, 2022 and 2021, performance-based RSUs of 33,000 and 46,000, respectively, were excluded from the calculation of diluted earnings per share because they were anti-dilutive.
For the three months ended March 31, 2022, operating partnership units of 965,000, Series D preferred units of 228,000, Series E preferred units of 2.2 million, time-based RSUs of 14,000, and weighted average stock options of 52,000, were excluded from the calculation of diluted earnings per share because they were anti-dilutive.
For the three months ended March 31, 2021, Series D preferred units of 228,000, time-based RSUs of 19,000, and weighted average stock options of 44,000, were excluded from the calculation of diluted earnings per share because they were anti-dilutive.
The following table presents a reconciliation of the numerator and denominator used to calculate basic and diluted earnings per share reported in the Condensed Consolidated Financial Statements for the three months ended March 31, 2022 and 2021:
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| (in thousands, except per share data) |
| Three Months Ended March 31, | | |
| 2022 | | 2021 | | | | |
NUMERATOR | | | | | | | |
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Net income (loss) attributable to controlling interests | $ | (8,589) | | | $ | (4,867) | | | | | |
Dividends to preferred shareholders | (1,607) | | | (1,607) | | | | | |
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Numerator for basic earnings (loss) per share – net income available to common shareholders | (10,196) | | | (6,474) | | | | | |
Noncontrolling interests – Operating Partnership and Series E preferred units | (2,157) | | | (469) | | | | | |
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Dividends to preferred unitholders | 160 | | | 160 | | | | | |
Numerator for diluted earnings (loss) per share | $ | (12,193) | | | $ | (6,783) | | | | | |
DENOMINATOR | | | | | | | |
Denominator for basic earnings per share weighted average shares | 15,097 | | | 13,078 | | | | | |
Effect of redeemable operating partnership units | — | | | 957 | | | | | |
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Denominator for diluted earnings per share | 15,097 | | | 14,035 | | | | | |
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NET EARNINGS (LOSS) PER COMMON SHARE – BASIC | $ | (0.68) | | | $ | (0.49) | | | | | |
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NET EARNINGS (LOSS) PER COMMON SHARE – DILUTED | $ | (0.68) | | | $ | (0.49) | | | | | |
NOTE 4 • EQUITY AND MEZZANINE EQUITY
Operating Partnership Units. The Operating Partnership had 997,000 and 832,000 outstanding Units at March 31, 2022 and December 31, 2021, respectively. During the three months ended March 31, 2022, we issued 209,000 Units as partial consideration for the acquisition of three apartment communities.
Exchange Rights. Centerspace redeemed Units in exchange for common shares in connection with Unitholders exercising their exchange rights during the three months ended March 31, 2022 and 2021 as detailed in the table below.
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| (in thousands) |
Three Months Ended March 31, | Number of Units | | Net Book Basis |
2022 | 10 | | | $ | (388) | |
2021 | 26 | | | $ | (220) | |
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Pursuant to the exercise of exchange rights, the Company redeemed Units for cash during the three months ended March 31, 2022 and 2021 as detailed in the table below.
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| (in thousands) |
Three Months Ended March 31, | Number of Units | | Aggregate Cost | | Average Price Per Unit |
2022 | 31 | | | $ | 2,903 | | | $ | 93.14 | |
2021 | — | | | $ | 9 | | | $ | 71.55 | |
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Series E Preferred Units (Noncontrolling Interests). On September 1, 2021, Centerspace issued 1.8 million Series E preferred units with a par value of $100 per Series E preferred unit as partial consideration for the acquisition of 17 apartment communities. The Series E preferred unit holders receive a preferred distribution at the rate of 3.875% per year. Each Series E preferred unit is convertible, at the holder’s option, into 1.2048 Units. The Series E preferred units have an aggregate liquidation preference of $181.4 million. The holders of the Series E preferred units do not have voting rights and are required to hold the units for one year before they may elect to convert.
Common Shares and Equity Awards. Common shares outstanding on March 31, 2022 and December 31, 2021, totaled 15.4 million and 15.0 million, respectively. There were 18,759 and 2,801 shares issued upon the vesting of equity awards under the 2015 Incentive Plan during the three months ended March 31, 2022 and 2021, respectively, with a total grant-date fair value of $1.5 million and $164,000, respectively. These shares vested based on performance and service criteria.
Equity Distribution Agreement. Centerspace had an equity distribution agreement in connection with an at-the-market offering (“2019 ATM Program”) through which it could offer and sell common shares having an aggregate sales price of up to $150.0 million. In September 2021, the Company replaced the 2019 ATM Program with a new at-the-market offering (“2021 ATM Program”) through which it may offer and sell common shares having an aggregate sales price of up to $250.0 million, in amounts and at times determined by management. Under the 2021 ATM Program, the Company may enter into separate
forward sale agreements. The proceeds from the sale of common shares under the 2021 ATM Program are intended to be used for general purposes, which may include the funding of acquisitions, construction or mezzanine loans, community renovations, and the repayment of indebtedness. The table below provides details on the sale of common shares during the three months ended March 31, 2022 and 2021 under both the 2019 and 2021 ATM Programs. As of March 31, 2022, common shares having an aggregate offering price of up to $126.6 million remained available under the 2021 ATM Program.
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| (in thousands, except per share amounts) |
Three Months Ended March 31, | Number of Common Shares | | Net Consideration(1) | | Average Net Price Per Share |
2022 | 321 | | | $ | 31,732 | | | $ | 98.89 | |
2021 | 164 | | | $ | 11,859 | | | $ | 72.19 | |
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(1)Total consideration is net of $338 and $181 in commissions and issuance costs during the three months ended March 31, 2022 and 2021, respectively.
Series C Preferred Shares. Series C preferred shares outstanding were 3.9 million shares at March 31, 2022 and December 31, 2021. The Series C preferred shares are nonvoting and redeemable for cash at $25.00 per share at Centerspace’s option after October 2, 2022. Holders of these shares are entitled to cumulative distributions, payable quarterly (as and if declared by the Board of Trustees). Distributions accrue at an annual rate of $1.65625 per share, which is equal to 6.625% of the $25.00 per share liquidation preference ($97.0 million liquidation preference in the aggregate).
Series D Preferred Units (Mezzanine Equity). Series D preferred units outstanding were 165,600 preferred units at March 31, 2022 and December 31, 2021. The Series D preferred units have a par value price of $100 per preferred unit. The Series D preferred unit holders receive a preferred distribution at the rate of 3.862% per year. The Series D preferred units have a put option which allows the holder to redeem any or all of the Series D preferred units for cash equal to the issuance price. Each Series D preferred unit is convertible, at the holder’s option, into 1.37931 Units. The Series D preferred units have an aggregate liquidation preference of $16.6 million. Changes in the redemption value are charged to common shares on the Condensed Consolidated Balance Sheets from period to period. The holders of the Series D preferred units do not have voting rights. Distributions to Series D unitholders are presented in the Condensed Consolidated Statements of Equity within net income (loss) attributable to controlling interests and noncontrolling interests.
NOTE 5 • DEBT
As of March 31, 2022, 49 apartment communities were not encumbered by mortgages and are available to provide credit support for the unsecured borrowings. The Company’s primary unsecured credit facility (“unsecured credit facility”) is a revolving, multi-bank line of credit, with the Bank of Montreal serving as administrative agent. The line of credit has total commitments and borrowing capacity of $250.0 million, based on the value of unencumbered properties. As of March 31, 2022, the additional borrowing availability was $204.0 million beyond the $46.0 million drawn. This unsecured credit facility was amended on September 30, 2021 to extend the maturity date to September 2025 and to provide for a $400.0 million accordion option.
The interest rates on the line of credit and term loans are based, at the Company’s option, on either the lender’s base rate plus a margin, ranging from 25-80 basis points, or the London Interbank Offered Rate (“LIBOR”), plus a margin that ranges from 125-180 basis points based on the consolidated leverage ratio, as defined under the Third Amended and Restated Credit Agreement. The unsecured credit facility and unsecured senior notes are subject to customary financial covenants and limitations. The Company believes that it is in compliance with all such financial covenants and limitations as of March 31, 2022.
In January 2021, Centerspace amended and expanded its private shelf agreement with PGIM, Inc., an affiliate of Prudential Financial, Inc., and certain affiliates of PGIM, Inc. (collectively, “PGIM”) to increase the aggregate amount available for issuance of unsecured senior promissory notes (“unsecured senior notes”) to $225.0 million. Under this agreement, the Company has issued $200.0 million unsecured senior notes with $25.0 million remaining available as of March 31, 2022. In September 2021, the Company entered into a note purchase agreement for the issuance of $125.0 million senior unsecured promissory notes, of which $25.0 million was under the private shelf agreement with PGIM. The following table shows the notes issued under both agreements.
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| (in thousands) | | | |
| Amount | | Maturity Date | Interest Rate |
Series A | $ | 75,000 | | | September 13, 2029 | 3.84 | % |
Series B | $ | 50,000 | | | September 30, 2028 | 3.69 | % |
Series C | $ | 50,000 | | | June 6, 2030 | 2.70 | % |
Series 2021-A | $ | 35,000 | | | September 17, 2030 | 2.50 | % |
Series 2021-B | $ | 50,000 | | | September 17, 2031 | 2.62 | % |
Series 2021-C | $ | 25,000 | | | September 17, 2032 | 2.68 | % |
Series 2021-D | $ | 15,000 | | | September 17, 2034 | 2.78 | % |
In September 2021, Centerspace entered into a $198.9 million Fannie Mae Credit Facility Agreement (the “FMCF”) for the acquisition of 16 apartment communities. The FMCF is currently secured by mortgages on those apartment communities. The notes are interest-only, have varying maturity dates of 7, 10, and 12 years, and a blended, weighted average interest rate of 2.78%. As of March 31, 2022, the FMCF had a balance of $198.9 million. The FMCF is included within mortgages payable on the Condensed Consolidated Balance Sheets.
As of March 31, 2022, Centerspace owned 18 apartment communities that served as collateral for mortgage loans, in addition to the apartment communities secured by the FMCF. All of these mortgage loans were non-recourse to the Company other than for standard carve-out obligations. As of March 31, 2022, the Company believes that there are no material defaults or instances of noncompliance in regards to any of these mortgages payable.
Centerspace also has a $6.0 million operating line of credit. This operating line of credit is designed to enhance treasury management activities and more effectively manage cash balances. This operating line matures on November 29, 2022, with pricing based on a market spread plus the one-month LIBOR index rate.
The following table summarizes indebtedness:
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| (in thousands) | |
| March 31, 2022 | December 31, 2021 | Weighted Average Maturity in Years at March 31, 2022 |
Lines of credit | $ | 46,000 | | $ | 76,000 | | 3.75 |
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Unsecured senior notes (1) | 300,000 | | 300,000 | | 8.63 |
Unsecured debt | 346,000 | | 376,000 | | 7.98 |
Mortgages payable - Fannie Mae credit facility | 198,850 | | 198,850 | | 9.56 |
Mortgages payable - other | 326,113 | | 284,934 | | 6.71 |
Total debt | $ | 870,963 | | $ | 859,784 | | 7.14 |
Weighted average interest rate on lines of credit (rate with swap)(2) | 2.56 | % | 2.74 | % | |
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Weighted average interest rate on unsecured senior notes | 3.12 | % | 3.12 | % | |
Weighted average interest rate on mortgages payable - Fannie Mae credit facility | 2.78 | % | 2.78 | % | |
Weighted average interest rate on mortgages payable - other | 3.85 | % | 3.81 | % | |
Weighted average interest rate on total debt | 3.29 | % | 3.26 | % | |
(1)Included within notes payable on the Condensed Consolidated Balance Sheets.
(2)The interest rate swap was terminated during the three months ended March 31, 2022.
The aggregate amount of required future principal payments on unsecured senior notes and mortgages payable as of March 31, 2022, was as follows:
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| (in thousands) |
2022 (remainder) | $ | 26,443 | |
2023 | 45,988 | |
2024 | 5,012 | |
2025 | 79,850 | |
2026 | 50,088 | |
Thereafter | 663,582 | |
Total payments | $ | 870,963 | |
NOTE 6 • DERIVATIVE INSTRUMENTS
Centerspace’s objective in using interest rate derivatives is to add stability to interest expense and to manage its exposure to interest rate fluctuations. To accomplish this objective, the Company primarily uses interest rate swap contracts to fix variable interest rate debt.
Changes in the fair value of derivatives designated and that qualify as cash flow hedges are recorded in accumulated other comprehensive income (“OCI”) and subsequently reclassified into earnings in the period that the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income for the interest rate swaps will be reclassified to interest expense as interest payments are incurred on the hedged variable rate debt. During the next twelve months, the Company estimates an additional $633,000 will be reclassified as an increase to interest expense.
Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements. Changes in fair value of derivatives not designated in hedging relationships are recorded directly to earnings within other income (loss) in the Condensed Consolidated Statement of Operations. During the three months ended March 31, 2022, the Company recorded a gain of $582,000 related to the interest rate swap not designated in a hedging relationship, prior to its termination.
During the three months ended March 31, 2022, the Company paid $3.2 million to terminate its $75.0 million interest rate swap and its $70.0 million forward swap. As of March 31, 2022 the Company had no remaining interest rate swaps.
As of December 31, 2021, Centerspace had one interest rate swap contract designated as a cash flow hedge of interest rate risk with a notional amount of $75.0 million to fix the interest rate on the line of credit. The Company also had one additional interest rate swap with an effective date of January 31, 2023 and a notional amount of $70.0 million which was not designated as a hedge in a qualifying hedging relationship.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Condensed Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021.
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| | | | | | | (in thousands) |
| | | | | | | | | March 31, 2022 | | December 31, 2021 |
| | | | | | | Balance Sheet Location | | Fair Value | | Fair Value |
Total derivative instruments designated as hedging instruments - interest rate swaps | | | | | | | Accounts Payable and Accrued Expenses | | $ | — | | | $ | 4,610 | |
Total derivative instruments not designated as hedging instruments - interest rate swaps | | | | | | | Accounts Payable and Accrued Expenses | | $ | — | | | $ | 1,097 | |
The table below presents the effect of the Company’s derivative financial instruments on the Condensed Consolidated Statements of Operations as of March 31, 2022 and 2021.
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| (in thousands) |
| Gain (Loss) Recognized in OCI | | Location of Gain (Loss) Reclassified from Accumulated OCI into Income | | Gain (Loss) Reclassified from Accumulated OCI into Income |
Three months ended March 31, | 2022 | | 2021 | | | | 2022 | | 2021 |
Total derivatives in cash flow hedging relationships - Interest rate contracts | $ | 1,581 | | | $ | 2,011 | | | Interest expense | | $ | (304) | | | $ | (1,095) | |
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The Company had agreements with each of its derivative counterparties that contain a provision where if the Company either defaults or is capable of being declared in default on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.
NOTE 7 • FAIR VALUE MEASUREMENTS
Cash and cash equivalents, restricted cash, accounts payable, accrued expenses, and other liabilities are carried at amounts that reasonably approximate their fair value due to their short-term nature. For variable rate line of credit debt that re-prices frequently, fair values are based on carrying values.
In determining the fair value of other financial instruments, Centerspace applies FASB ASC 820, “Fair Value Measurement and Disclosures.” Fair value hierarchy under ASC 820 distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (Levels 1 and 2) and the reporting entity’s own assumptions
about market participant assumptions (Level 3). Fair value estimates may differ from the amounts that may ultimately be realized upon sale or disposition of the assets and liabilities.
Fair Value Measurements on a Recurring Basis
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| (in thousands) |
| Total | | Level 1 | | Level 2 | | Level 3 |
March 31, 2022 | | | | | | | |
Assets | | | | | | | |
Notes receivable | $ | 6,068 | | | — | | | — | | | $ | 6,068 | |
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December 31, 2021 | | | | | | | |
Assets | | | | | | | |
Mortgages and notes receivable | $ | 49,484 | | | — | | | — | | | $ | 49,484 | |
Liabilities | | | | | | | |
Derivative instruments - interest rate swaps | $ | 5,707 | | | $ | — | | | — | | | $ | 5,707 | |
The fair value of the interest rate swaps was determined using the market standard methodology of netting discounted expected variable cash payments and receipts. The variable cash payments and receipts were based on an expectation of future interest rates (a forward curve) derived from observable market interest rate curves. The Company also considered both its own nonperformance risk and the counterparty’s nonperformance risk in the fair value measurement (Level 3).
Centerspace utilizes an income approach with Level 3 inputs based on expected future cash flows to value mortgages and notes receivable. The inputs include market transactions for similar instruments, management estimates of comparable interest rates (range of 3.75% to 10.75%), and instrument specific credit risk (range of 0.5% to 1.0%). Changes in the fair value of these receivables from period to period are reported in interest and other income on the Condensed Consolidated Statements of Operations.
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| (in thousands) |
| Fair Value Measurement at March 31, | | Other Gains (Losses) | | Interest Income | | Total Changes in Fair Value Included in Current-Period Earnings |
Three months ended March 31, 2022 | | | | | | | |
Notes receivable | $ | 6,068 | | | $ | 4 | | | $ | 460 | | | $ | 464 | |
Three months ended March 31, 2021 | | | | | | | |
Mortgage loans and notes receivable | $ | 36,443 | | | $ | 4 | | | $ | 407 | | | $ | 411 | |
As of March 31, 2022 and December 31, 2021, Centerspace has an investment of $890,000 and $903,000, respectively, in a real estate technology venture consisting of privately held entities that develop technology related to the real estate industry. This investment is measured at net asset value (“NAV”) as a practical expedient under ASC 820. As of March 31, 2022, the Company had unfunded commitments of $1.2 million.
Fair Value Measurements on a Nonrecurring Basis
There were no non-financial assets or liabilities measured at fair value on a nonrecurring basis at March 31, 2022 and December 31, 2021.
Financial Assets and Liabilities Not Measured at Fair Value
The fair value of unsecured senior notes and mortgages payable are estimated based on the discounted cash flows of the loans using market research and management estimates of comparable interest rates, excluding any prepayment penalties (Level 3).
The estimated fair values of the Company’s financial instruments as of March 31, 2022 and December 31, 2021, respectively, are as follows:
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| (in thousands) |
| March 31, 2022 | | December 31, 2021 |
| Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
FINANCIAL ASSETS | | | | | | | |
Cash and cash equivalents | $ | 13,313 | | | $ | 13,313 | | | $ | 31,267 | | | $ | 31,267 | |
Restricted cash | $ | 2,409 | | | $ | 2,409 | | | $ | 7,358 | | | $ | 7,358 | |
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FINANCIAL LIABILITIES | | | | | | | |
Revolving lines of credit(1) | $ | 46,000 | | | $ | 46,000 | | | $ | 76,000 | | | $ | 76,000 | |
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Unsecured senior notes | $ | 300,000 | | | $ | 273,973 | | | $ | 300,000 | | | $ | 308,302 | |
Mortgages payable - Fannie Mae | $ | 198,850 | | | $ | 176,055 | | | $ | 198,850 | | | $ | 198,850 | |
Mortgages payable - other | $ | 326,113 | | | $ | 308,363 | | | $ | 284,934 | | | $ | 284,546 | |
(1)Excluding the effect of interest rate swap agreements. Refer to Note 6 for discussion on the fair value of the interest rate swap agreements.
NOTE 8 • ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
Centerspace acquired four new apartment communities for an aggregate acquisition cost of $116.9 million during the three months ended March 31, 2022 compared to acquisitions of $76.9 million in the three months ended March 31, 2021. The acquisitions during the three months ended March 31, 2022 and 2021 are detailed below.
Three Months Ended March 31, 2022
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| Date Acquired | | (in thousands) |
| | Total Acquisition Cost | | Form of Consideration | | Investment Allocation |
Acquisitions | | | Cash | | Units(1) | | Other(2) | | Land | | Building | | Intangible Assets | | Other(3) |
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191 homes - Martin Blu - Minneapolis, MN | January 4, 2022 | | $ | 49,825 | | | $ | 3,031 | | | $ | 18,885 | | | $ | 27,909 | | | $ | 3,547 | | | $ | 45,212 | | | $ | 1,813 | | | $ | (747) | |
31 homes - Zest - Minneapolis, MN | January 4, 2022 | | 9,066 | | | 1,290 | | | 1,748 | | | 6,028 | | | 941 | | | 7,853 | | | 335 | | | (63) | |
45 homes - Elements - Minneapolis, MN | January 4, 2022 | | 11,364 | | | 1,429 | | | 2,249 | | | 7,686 | | | 936 | | | 10,261 | | | 574 | | | (407) | |
130 homes - Noko Apartments - Minneapolis, MN | January 26, 2022 | | 46,619 | | | 3,343 | | | — | | | 43,276 | | | 1,915 | | | 42,754 | | | 1,950 | | | — | |
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Total Acquisitions | | | $ | 116,874 | | | $ | 9,093 | | | $ | 22,882 | | | $ | 84,899 | | | $ | 7,339 | | | $ | 106,080 | | | $ | 4,672 | | | $ | (1,217) | |
(1)Fair value of operating partnership units issued on acquisition.
(2)Assumption of seller's debt upon closing for Martin Blu, Zest, and Elements. Mezzanine and construction loans, financed by Centerspace, exchanged as partial consideration for the acquisition of Noko Apartments.
(3)Debt discount on assumed mortgage.
Three Months Ended March 31, 2021
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| Date Acquired | | (in thousands) |
| | Total Acquisition Cost | | Form of Consideration | | Investment Allocation |
Acquisitions | | | Cash | | | | | | Land | | Building | | Intangible Assets | | |
256 homes - Union Pointe - Longmont, CO | January 6, 2021 | | $ | 76,900 | | | $ | 76,900 | | | | | | | $ | 5,727 | | | $ | 69,966 | | | $ | 1,207 | | | |
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DISPOSITIONS
During the three months ended March 31, 2022 and 2021, Centerspace disposed of no real estate.
NOTE 9 • SEGMENT REPORTING
Centerspace operates in a single reportable segment which includes the ownership, management, development, redevelopment, and acquisition of apartment communities. Each of the operating properties is considered a separate operating segment because each property earns revenues, incurs expenses, and has discrete financial information. The chief operating decision-makers evaluate each property’s operating results to make decisions about resources to be allocated and to assess performance and do not group the properties based on geography, size, or type for this purpose. The apartment communities have similar long-term economic characteristics and provide similar products and services to residents. No apartment community comprises more than 10% of consolidated revenues, profits, or assets. Accordingly, the apartment communities are aggregated into a single reportable segment. “All other” includes non-multifamily components of mixed-use properties and apartment communities the Company has sold.
The members of the executive management team are the chief operating decision-makers. This team measures the performance of the reportable segment based on net operating income (“NOI”), which the Company defines as total real estate revenues less property operating expenses, including real estate taxes. Centerspace believes that NOI is an important supplemental measure of operating performance for real estate because it provides a measure of operations that is unaffected by depreciation, amortization, financing, property management overhead, casualty losses, and general and administrative expense. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders, or cash flow from operating activities as a measure of financial performance.
The following tables present NOI for the three months ended March 31, 2022 and 2021, respectively, along with reconciliations to net income in the Condensed Consolidated Financial Statements. Segment assets are also reconciled to total assets as reported in the Condensed Consolidated Financial Statements.
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| (in thousands) |
Three Months Ended March 31, 2022 | Multifamily | | All Other | | Total |
Revenue | $ | 59,398 | | | $ | 916 | | | $ | 60,314 | |
Property operating expenses, including real estate taxes | 25,544 | | | 329 | | | 25,873 | |
Net operating income | $ | 33,854 | | | $ | 587 | | | $ | 34,441 | |
Property management | | | | | (2,253) | |
Casualty gain (loss) | | | | | (598) | |
Depreciation and amortization | | | | | (31,001) | |
General and administrative expenses | | | | | (4,500) | |
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Interest expense | | | | | (7,715) | |
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Interest and other income | | | | | 1,063 | |
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Net income (loss) | | | | | $ | (10,563) | |
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| (in thousands) |
Three Months Ended March 31, 2021 | Multifamily | | All Other | | Total |
Revenue | $ | 44,241 | | | $ | 2,407 | | | $ | 46,648 | |
Property operating expenses, including real estate taxes | 17,874 | | | 1,367 | | | 19,241 | |
Net operating income | $ | 26,367 | | | $ | 1,040 | | | $ | 27,407 | |
Property management | | | | | (1,767) | |
Casualty gain (loss) | | | | | (101) | |
Depreciation and amortization | | | | | (19,992) | |
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General and administrative expenses | | | | | (3,906) | |
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Interest expense | | | | | (7,231) | |
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Interest and other income | | | | | 431 | |
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Net income (loss) | | | | | $ | (5,159) | |
Segment Assets and Accumulated Depreciation
Segment assets are summarized as follows as of March 31, 2022, and December 31, 2021, respectively, along with reconciliations to the Condensed Consolidated Financial Statements:
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| (in thousands) |
As of March 31, 2022 | Multifamily | | All Other | | Total |
Segment assets | | | | | |
Property owned | $ | 2,364,167 | | | $ | 26,785 | | | $ | 2,390,952 | |
Less accumulated depreciation | (457,985) | | | (7,767) | | | (465,752) | |
Total property owned | $ | 1,906,182 | | | $ | 19,018 | | | $ | 1,925,200 | |
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Cash and cash equivalents | | | | | 13,313 | |
Restricted cash | | | | | 2,409 | |
Other assets | | | | | 24,651 | |
Total Assets | | | | | $ | 1,965,573 | |
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| (in thousands) |
As of December 31, 2021 | Multifamily | | All Other | | Total |
Segment assets | | | | | |
Property owned | $ | 2,244,250 | | | $ | 26,920 | | | $ | 2,271,170 | |
Less accumulated depreciation | (436,004) | | | (7,588) | | | (443,592) | |
Total property owned | $ | 1,808,246 | | | $ | 19,332 | | | $ | 1,827,578 | |
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Mortgage loans receivable | | | | | 43,276 | |
Cash and cash equivalents | | | | | 31,267 | |
Restricted cash | | | | | 7,358 | |
Other assets | | | | | 30,582 | |
Total Assets | | | | | $ | 1,940,061 | |
NOTE 10 • COMMITMENTS AND CONTINGENCIES
Litigation. In the ordinary course of operations, Centerspace becomes involved in litigation. At this time, the Company knows of no material pending or threatened legal proceedings, or other proceedings contemplated by governmental authorities, that would have a material impact on it.
Environmental Matters. Under various federal, state, and local laws, ordinances, and regulations, a current or previous owner or operator of real estate may be liable for the costs of removal of, or remediation of, certain hazardous or toxic substances in, on, around, or under the property. While the Company currently has no knowledge of any material violation of environmental laws, ordinances, or regulations at any of the properties, there can be no assurance that areas of contamination will not be identified at any of its properties or that changes in environmental laws, regulations, or cleanup requirements would not result in material costs.
Restrictions on Taxable Dispositions. Thirty-seven properties, consisting of 6,770 apartment homes, are subject to restrictions on taxable dispositions under agreements entered into with certain of the sellers or contributors of the properties and are effective for varying periods. Centerspace does not believe that the agreements materially affect the conduct of its business or its decisions whether to dispose of restricted properties during the restriction period because it generally holds these and other properties for investment purposes rather than for sale. In addition, where the Company deems it to be in the shareholders’ best interests to dispose of such properties, it generally seeks to structure sales of such properties as tax-deferred transactions under Section 1031 of the Internal Revenue Code. Otherwise, the Company may be required to provide tax indemnification payments to the parties to these agreements.
NOTE 11 • SHARE-BASED COMPENSATION
Share-based awards are provided to officers, non-officer employees, and trustees under the 2015 Incentive Plan approved by shareholders on September 15, 2015, as amended and restated on May 18, 2021 (the “2015 Incentive Plan”) which allows for awards in the form of cash, unrestricted and restricted common shares, stock options, stock appreciation rights, and RSUs up to an aggregate of 775,000 shares over the ten-year period in which the plan is in effect. Under the 2015 Incentive Plan, officers and non-officer employees may earn share awards under a long-term incentive plan, which is a forward-looking program that measures long-term performance over the stated performance period. These awards are payable to the extent deemed earned in shares. The terms of the long-term incentive awards granted under the revised program may vary from year to year.
2022 LTIP Awards
Awards granted to employees on January 1, 2022, consist of an aggregate of 5,849 time-based RSU awards, 13,407 performance RSUs based on total shareholder return (“TSR”), and 30,002 stock options. The time-based awards vest as to one-third of the shares on each of January 1, 2023, January 1, 2024, and January 1, 2025. The stock options vest as to 25% on each of January 1, 2023, January 1, 2024, January 1, 2025, and January 1, 2026. The fair value of stock options was $17.094 per share and was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
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| 2022 |
Exercise price | $ | 110.90 | |
Risk-free rate | 1.44 | % |
Expected term | 6.25 years |
Expected volatility | 21.2 | % |
Dividend yield | 2.597 | % |
The TSR performance RSUs are earned based on the Company’s TSR as compared to the FTSE Nareit Apartment Index over a forward looking three-year period. The maximum number of RSUs eligible to be earned is 26,814 RSUs, which is 200% of the RSUs granted. Earned awards (if any) will fully vest as of the last day of the measurement period. These awards have market conditions in addition to service conditions that must be met for the awards to vest. Compensation expense is recognized ratably based on the grant date fair value, as determined using the Monte Carlo valuation model, regardless of whether the market conditions are achieved and the awards ultimately vest. Therefore, previously recorded compensation expense is not adjusted in the event that the market conditions are not achieved. The Company based the expected volatility on a weighted average of the historical volatility of the Company’s daily closing share price and a select peer average volatility, the risk-free interest rate on the interest rates on U.S. treasury bonds with a maturity equal to the remaining performance period of the award, and the expected term on the performance period of the award. The assumptions used to value the TSR performance RSUs were an expected volatility of 22.40%, a risk-free interest rate of 0.97%, and an expected life of 3 years. The share price at the grant date, January 1, 2022, was $110.90 per share.
Awards granted to employees on February 1, 2022, consist of an aggregate of 1,295 time-based RSU awards which vest as to one-third of the RSUs on each of January 1, 2023, January 1, 2024, and January 1, 2025.
Share-Based Compensation Expense
Share-based compensation expense recognized in the consolidated financial statements for all outstanding share-based awards was $719,000 and $810,000 for the three months ended March 31, 2022 and 2021, respectively.