GBE Grubb & Ellis Company Common Stock

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-K/A

(Amendment No. 2)

 

 

Commission file number 1-8122

GRUBB & ELLIS COMPANY
(Exact name of registrant as specified in its charter)

 

 

1551 North Tustin Avenue, Suite 300, Santa Ana, California 92705
(Address of principal executive offices) (Zip Code)

 

(714) 667-8252
(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   þ      No   o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in its definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   o  Yes      o  No

 

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

 

 

 

The aggregate market value of voting common stock held by non-affiliates of the registrant as of June 30, 2008 was approximately $138,632,960 based on the last sales price on June 30, 2008 on the New York Stock Exchange of $3.85 per share for the registrant’s common stock.

 

The number of shares outstanding of the registrant’s common stock as of May 15, 2009 was 65,265,828 shares.

 

EXPLANATORY NOTE

 

This Amendment No. 2 to our Annual Report on Form 10-K for the year ended December 31, 2008 (the “Second Amended 10-K”), amends our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on May 27, 2009 (the “Original 10-K”), as amended on June 1, 2009 (the Original 10-K as amended, (the “Amended 10-K”). This Second Amended 10-K amends the Amended 10-K solely for the purpose of (i) including the opinion of PKF, an independent registered public accounting firm with respect to their audit of Grubb & Ellis Securities, Inc., a wholly-owned subsidiary of the Company and (ii) clarifying certain disclosures with respect to our previously disclosed material weaknesses in internal controls over financial reporting, management’s remediation initiatives with respect to such material weaknesses, and changes in internal control over financial reporting.

 

This Second Amended 10-K does not reflect events occurring after the filing of the Original 10-K (including, without limitation, the consummation of our recapitalization plan and our private placement of 12% Cumulative Participating Perpetual Convertible Preferred Stock, as disclosed on our Current Reports on Form 8-K filed with the Securities and Exchange Commission on October 26, 2009 and November 12, 2009) and does not modify or update the disclosure in the Original 10-K, other than the amendments noted above, the filing of consents of our independent registered public accounting firms, and the filing of certifications of our principal executive officer and principal financial officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 and Section 906 of the Sarbanes-Oxley Act of 2002.

 

GRUBB & ELLIS COMPANY
FORM 10-K/A (Amendment No. 2)

 

TABLE OF CONTENTS

 

 

GRUBB & ELLIS COMPANY

PART I

 

 

The filing of this Annual Report on Form 10-K (“Report”) was delayed due to the need to restate certain of the Company’s financial statements which is discussed below in this Item 1 under the sub-headings “Restatement of Certain Financial Information and Special Investigation.”

 

General

 

Grubb & Ellis Company (“the Company” or “Grubb & Ellis”), a Delaware corporation founded 50 years ago in Northern California, is one of the country’s largest and most respected commercial real estate services and investment management firms. On December 7, 2007, the Company effected a stock merger (the “Merger”) with NNN Realty Advisors, Inc. (“NNN”), a real estate asset management company and nationally recognized sponsor of public non-traded real estate investment trusts (“REITs”), as well as a sponsor of tax deferred tenant-in-common (“TIC”) 1031 property exchanges and other investment programs. Upon the closing of the Merger, a change of control occurred. The former stockholders of NNN acquired approximately 60% of the Company’s issued and outstanding common stock.

 

With 127 owned and affiliate offices worldwide (54 owned and approximately 73 affiliates) and more than 6,000 professionals, including a brokerage sales force of more than 1,800 brokers, the Company offers property owners, corporate occupants and program investors comprehensive integrated real estate solutions, including transactions, management, consulting and investment advisory services supported by proprietary market research and extensive local market expertise.

 

In certain instances throughout this Report phrases such as “legacy Grubb & Ellis” or similar descriptions are used to reference, when appropriate, Grubb & Ellis prior to the Merger. Similarly, in certain instances throughout this Report the term NNN, “legacy NNN” or similar phrases are used to reference, when appropriate, NNN Realty Advisors, Inc. prior to the Merger.

 

Business Segment Reporting

 

The Company currently reports its revenue by three operating business segments in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information : Investment Management, which includes providing acquisition, financing and disposition services with respect to its programs, asset management services related to its programs, and dealer-manager services by its securities broker-dealer, which facilitates capital raising transactions for its TIC, REIT and other investment programs; Transaction Services, which comprises its real estate brokerage operations; and Management Services, which includes property management, corporate facilities management, project management, client accounting, business services and engineering services for unrelated third parties and the properties owned by the programs it sponsors. Additional information on these business segments can be found in Note 18 of Notes to Consolidated Financial Statements in Item 8 of this Report. Subsequent to the Merger, the legacy NNN reportable segments were realigned into a single operating and reportable segment called Investment Management. This realignment had no impact on the Company’s consolidated balance sheet, results of operations or cash flows.

 

For the year ended December 31, 2008, the Company had revenues of approximately $611.8 million and loss from continuing operations of approximately $279.5 million.

 

Restatement of Certain Financial Information and Special Investigation

 

On March 16, 2009, management and the Audit Committee of the Board of Directors of the Company concluded that the Company’s previously issued audited financial statements for each of the fiscal years ended December 31, 2006 and 2007, the unaudited interim financial statements for each of the quarters ended March 31, June 30 and September 30, 2008 and selected financial data derived from the Company’s

previously issued audited financial statements for the fiscal years ended December 31, 2005 and 2004 included in the Company’s securities filings thereafter should be restated.

 

The Audit Committee reached this conclusion after consulting with and upon the recommendation of management. The Audit Committee and management have discussed this conclusion with Ernst & Young LLP (“EY”), the Company’s independent registered public accounting firm, and management has discussed this conclusion with Deloitte & Touche LLP (“D&T”), the independent registered public accounting firm for NNN prior to the Merger.

 

As a consequence, (i) the Company’s consolidated balance sheets as of December 31, 2006 and December 31, 2007, and for each of the quarters ended March 31, June 30, and September 30, 2008; (ii) the Company’s related consolidated statements of operations, stockholders’ equity and cash flows for each of the fiscal years ended December 31, 2004, December 31, 2005, December 31, 2006 and December 31, 2007 and for each of the quarters ended March 31, June 30 and September 30, 2008 and 2007, and the footnotes thereto; (iii) the related report of EY, with respect to the fiscal year ended December 31, 2007; and (iv) the related reports of D&T, with respect to the fiscal years ended December 31, 2004, December 31, 2005 and December 31, 2006, should no longer be relied upon. The restatement of the Company’s financial statements is based upon a review of the accounting treatment of certain transactions entered into by NNN with respect to certain tenant-in-common investment programs (“TIC Programs”) sponsored by NNN prior to the Merger. During this review, the Company discovered that NNN had recognized fee revenue in 2004, 2005, 2006 and 2007 and the Company had recognized fee revenue in the three interim periods in 2008 in advance of the period in which such fee revenue should have been recognized.

 

After considering management’s recommendation and consulting with EY, the Audit Committee has determined that NNN incorrectly recognized fee revenue under Statement of Financial Accounting Standards Statement No. 66, Accounting for Sales of Real Estate , and Statement of Position 92-1, Accounting for Real Estate Syndication Income , in 2005, 2006 and 2007 and the three interim periods in 2008 in connection with certain TIC Programs in which NNN had various forms of continuing involvement after the close of the sale of the investments in the TIC Programs to third-parties. As a result of the recognition by NNN of the applicable fee revenue in the wrong accounting period, the Company reduced retained earnings as of January 1, 2006 by approximately $8.7 million; increased revenues in 2006 by approximately $518,000; and increased revenues in 2007 by approximately $251,000.

 

The Audit Committee also has determined, after considering management’s recommendation and consulting with EY, that because NNN had various forms of continuing involvement after the close of the sale of the investments in the TIC Programs to third-parties, certain entities involved in the TIC Programs were variable interest entities in which the Company was the primary beneficiary and therefore are required to be consolidated in accordance with FIN 46(R), Consolidation of Variable Interest Entities an Interpretation of ARB 51 . The restatement also will reflect the consolidation of these entities.

 

The determination to restate the Company’s financial statements was prompted by the Audit Committee being made aware in mid-December 2008 of the existence of a letter agreement, wherein a former executive of NNN caused NNN to agree to provide certain investors with a right to exchange their investment in certain TIC Programs for an investment in a different TIC Program (the “Exchange Letter”). As a consequence, the Board of Directors formed a special committee (the “Special Committee”) to investigate the facts and circumstances surrounding the Exchange Letter and to determine whether there were any other similar agreements that might impact the Company’s previously issued financial statements. The Special Committee retained independent outside counsel, Manatt Phelps & Phillips, LLP (“Manatt”), to assist it with this investigation. In connection therewith, the Special Committee asked management to review the accounting treatment regarding the Exchange Letter and any other letter agreements that might be identified in the course of the special investigation. In the course of the special investigation, the Audit Committee and management became aware of additional letter agreements authorized by former executives of NNN (collectively, the “Additional Letters”), some providing for a right of exchange similar to that contained in the Exchange Letter and others in which NNN committed to provide certain investors in certain TIC Programs a specified rate of return. Manatt has concluded its investigation and advised the Board of Directors that it did not uncover in the

course of its investigation any other letter agreements similar to the Exchange Letter and the Additional Letters. In connection with the restatement of certain of the Company’s financial statements as described herein and in Item 8, Note 3 to the consolidated financial statements, management of the Company re-evaluated the effectiveness of its disclosure controls and procedures both prior and subsequent to the Merger. As a result of this re-evaluation, management determined that there was a control deficiency that constituted a material weakness in the Company’s internal controls prior to the Merger that was not adequately remediated as of December 31, 2008. Accordingly, additional enhancements to the control environment have been implemented in 2009 to ensure that controls related to these material weaknesses are strengthened and will operate effectively.

 

Transaction Services

 

Grubb & Ellis has a track record of over 50 years of proven performance in the commercial real estate industry and is one of the largest real estate brokerage firms in the country, offering clients the experience of thousands of successful transactions and the expertise that comes from a nationwide platform. By focusing on the overall business objectives of its clients, Grubb & Ellis utilizes its research capabilities, extensive properties database and expert negotiation skills to create, buy, sell and lease opportunities for both users and owners of commercial real estate. With a comprehensive approach to transactions, Grubb & Ellis offers a full suite of services to clients, from site selection and sale negotiations to needs analysis, occupancy projections, prospect qualification, pricing recommendations, long-term value consultation, tenant representation and consulting services. As one of the most active and largest commercial real estate brokerages in the United States, Grubb & Ellis’ traditional real estate services provide added value to the Company’s real estate investment programs by offering a comprehensive market view and local area expertise. This powerful business combination allows the Company to identify attractive investment properties and quickly acquire them for the benefit of its program investors. In addition, select brokers have the opportunity to cross-sell product through the Company’s Investment Management platform.

 

The Company actively engages its brokerage force in the execution of its marketing strategy. Regional and metro-area managing directors, who are responsible for operations in each major market, facilitate the development of brokers. Through the Company’s specialty practice groups, known as “Specialty Councils,” key personnel share information regarding local, regional and national industry trends and participate in national marketing activities, including trade shows and seminars. This ongoing dialogue among brokers serves to increase their level of expertise as well as their network of relationships, and is supplemented by other more formal education, including recently expanded training programs offering sales and motivational training and cross-functional networking and business development opportunities.

 

In some local markets where the Company does not have owned offices, it has affiliation agreements with independent real estate service providers that conduct business under the Grubb & Ellis brand. The Company’s affiliation agreements provide for exclusive mutual referrals in their respective markets, generating referral fees. The Company’s affiliation agreements are generally multi-year contracts. Through its affiliate offices, the Company has access to more than 1,000 brokers with local market research capabilities.

 

The Company’s Corporate Services Group provides comprehensive coordination of all required real estate related services to help realize the needs of clients’ real estate portfolios and to maximize their business objectives. These services include consulting services, lease administration, strategic planning, project management, account management and international services. As of December 31, 2008, Grubb & Ellis had in excess of 1,800 brokers at its owned and affiliate offices, of which 814 brokers were at its owned offices, down from 927 at December 31, 2007. Approximately 67% and 33% of the Company’s Transaction Services revenue were from leasing and sale transactions, respectively, during 2008.

 

Management Services

 

Grubb & Ellis delivers integrated property, facility, asset, construction, business and engineering management services to a host of corporate and institutional clients. The Company offers customized programs that focus on cost-efficient operations and tenant retention.

The Company manages a comprehensive range of properties including headquarters, facilities and class A office space for major corporations, including many Fortune 500 companies. Grubb & Ellis’ skills extend to management of industrial, manufacturing and warehousing facilities as well as data centers, retail outlets and multi-family properties for real estate users and investors.

 

Additionally, Grubb & Ellis provides consulting services, including site selection, feasibility studies, exit strategies, market forecasts, appraisals, strategic planning and research services.

 

The Company is committed to providing unparalleled client service. In addition to expanding the scope of products and services offered, it is also focused on ensuring that it can support client relationships with best-in-class service. During 2008, the Company continued to expand the number of client service relationship managers, which provide a single point of contact to corporate clients with multi-service needs.

 

Grubb & Ellis Management Services, the Company’s Management Services subsidiary, was recognized as Microsoft Corporation’s top vendor of 2007 from among more than 15,000 vendors. In addition, in 2008 Grubb & Ellis secured significant new management services contracts from Kraft Foods, Sharp Healthcare and Red Mountain West. The Company also secured significant contract renewals with Ingersoll Rand and Qwest Communications. At December 31, 2008, Grubb & Ellis managed approximately 231.0 million square feet, of which 184.1 million were from third parties and 46.9 million related to its investment management programs.

 

Investment Management

 

The Company and its subsidiaries are leading sponsors of real estate investment programs that provide individuals and institutions the opportunity to invest in a broad range of real estate investment vehicles, including tax-deferred 1031 TIC exchanges, public non-traded REITs and real estate investment funds. During the year ended, more than $984.3 million in investor equity was raised for these investment programs; the Company has more than $6.8 billion of assets under management related to the various programs that it sponsors. The Company has completed transaction acquisition and disposition volume totaling approximately $11.9 billion on behalf of more than 55,000 program investors since 1998.

 

Investment management products are distributed through the Company’s broker-dealer subsidiary, Grubb & Ellis Securities Inc. (“GBE Securities”) (formerly NNN Capital Corp.). GBE Securities is registered with the Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority (“FINRA”) and all 50 states. GBE Securities has agreements with an extensive network of broker dealers with approximately 219 selling relationships providing access to over 38,000 licensed registered representatives as of December 31, 2008. Part of the Company’s strategy is to expand its network of broker-dealers to increase the amount of equity that it raises in its various investment programs.

 

Grubb & Ellis Realty Investors, LLC (“GERI”) (formerly Triple Net Properties, LLC), a subsidiary of the Company, is a recognized market leader in the securitized TIC industry as measured by total equity raised according to published reports of OMNI Research and Consulting LLC (“OMNI”). This product strategy allows investors to fractionally own large, institutional-quality real estate assets with the added advantage of qualifying for deferred tax benefits on real estate capital gains. The Company currently sponsors more than 150 TIC Programs and has taken more than 50 programs full cycle (from acquisition through disposition). The Company raised $176.9 million of TIC equity in 2008.

 

Public non-traded REITs are registered with the SEC but are not listed on any of the securities exchanges like a traded REIT. According to the published Stanger Report, Winter 2009, by Robert A. Stanger and Co., an independent financial advisor, approximately $10.3 billion was raised in this sector in 2008. The Company sponsors two demographically focused programs that are actively raising capital, Grubb & Ellis Healthcare REIT, Inc. and Grubb & Ellis Apartment REIT, Inc. which raised $592.7 million in combined capital in 2008.

 

In February 2008, the Company launched its Private Client Management program for high net worth investors. This platform provides comprehensive real estate investment and advisory services to high net worth investors, offering qualified individuals, entities and corporations, the opportunity to benefit from the potential advantages of real estate investment through a passive, sole-ownership vehicle that delivers discretion to the investor. Private Client Management is open to all qualified investors seeking to build or expand their

commercial real estate portfolio, whether their investment objectives are tax-deferred 1031 exchange driven or not. The Company raised more than $193 million of equity through Private Client Management in 2008.

 

In 2008, the Company started a family of U.S. and global open end mutual funds that focus on real estate securities and manage private investment funds exclusively for qualified investors through its 51% ownership in Grubb & Ellis Alesco Global Advisors, LLC (“Alesco”). The Company, through its subsidiary, Alesco, serves as the general partner and investment advisor to six hedge fund limited partnerships, five of which are required to be consolidated: Grubb & Ellis AGA Realty Income Fund, LP, AGA Strategic Realty Fund, L.P., AGA Global Realty Fund LP and AGA Realty Income Partners LP, and one mutual fund which is required to be consolidated, Grubb & Ellis Realty Income Fund. Alesco currently has $2.3 million of investment funds under management.

 

Through its multi-family platform, the Company provides investment management services for TIC and REIT apartment products and currently manages in excess of 13,000 apartment units through Grubb & Ellis Residential Management, Inc., the Company’s multi-family management services subsidiary.

 

Our Opportunity

 

The Company seamlessly integrates its traditional transaction and management services with the innovative investment programs of GERI. All functions of the new Company work together to provide comprehensive service to clients and program investors. Teamed with a forward-looking investment strategy that seeks to capitalize on the nation’s changing demographics, the Company’s various service offerings support its investment programs to provide clients and program investors with a full array of solutions for multiple needs. The proprietary research and demographic investing strategy of the Company establishes a foundation upon which its investment programs are based. The real estate brokerage network of the Company offers keen insight into the available pool of assets nationwide, in order to maximize acquisition opportunities for program investors. The professional property and asset management services of the Company drive value to each of the investment programs from acquisition through ultimate disposition. The Company’s management believes that it has the vision, discipline and strategy to deliver innovative solutions across the full spectrum of commercial real estate, whether it is a need for space, strategic planning or a real estate investment product that meets specific return criteria.

 

The Company re-branded its investment programs as Grubb & Ellis subsequent to the Merger to capitalize on the strength of the brand name. Its TIC Programs are sponsored by GERI, its REIT investment programs are now Grubb & Ellis Healthcare REIT, Inc. and Grubb & Ellis Apartment REIT, Inc. and its FINRA registered broker-dealer is now Grubb & Ellis Securities, Inc. As part of the Company’s strategic plan, management has identified more than $20.0 million of expense synergies, on an annualized basis, a portion of which has been invested in enhancing the management team with the addition of several executives in key operational and management roles.

 

Secured Credit Facility

 

On August 5, 2008, the Company amended (the “First Letter Amendment) its $75.0 million senior secured revolving credit facility revising certain terms of that certain Second Amended and Restated Credit Agreement dated as of December 7, 2007 (the “Credit Facility” or “Line of Credit”) by and among the Company, the guarantors named therein, the financial institutions identified therein as lender parties, Deutsche Bank Securities Inc., as sole book-running manager and sole lead arranger and Deutsche Bank Trust Company Americas, as the initial swing line bank, the initial issuer of Letters of Credit (as defined therein) and administrative agent for the lender parties named therein.

 

The First Letter Amendment, among other things, provided the Company with an extension from September 30, 2008 to March 31, 2009 to dispose of the three real estate assets that the Company had previously acquired on behalf of Grubb & Ellis Realty Advisors, Inc. (“GERA”). Additionally, the First Letter Amendment also, among other things, modified select debt covenants in order to provide greater flexibility to facilitate the Company’s TIC Programs. The modifications made to the debt covenants permit the Company and its Restricted Subsidiaries (as defined in the Credit Facility) to incur certain contingent obligations with

respect to any guarantee of primary obligations of certain tenant-in-common syndications effected by the Company or its Restricted Subsidiaries that comply with requirements set forth in the Credit Facility.

 

On November 4, 2008, the Company further amended (the “Second Letter Amendment”) its Credit Facility as of September 30, 2008. The Second Letter Amendment, among other things, a) reduced the amount available under the Credit Facility from $75,000,000 to $50,000,000 by providing that no advances or letters of credit would be made available to the Company after September 30, 2008 until such time as borrowings are reduced to less than $50,000,000; b) provided that 100% of any net cash proceeds from the sale of certain real estate assets that must be sold by the Company would permanently reduce the Revolving Credit Commitments (as defined in the Credit Facility), provided that the Revolving Credit Commitments shall not be reduced to less than $50,000,000 by reason of the operation of such asset sales; and c) modified the interest rate incurred on borrowings by increasing the applicable margins by 100 basis points and by providing for an interest rate floor for any prime rate related borrowings.

 

Additionally, the Second Letter Amendment, among other things, reduced the limit on guarantees of primary obligations from $125,000,000 to $50,000,000, modified select financial covenants to reflect the impact of the current economic environment on the Company’s financial performance, amended certain restrictions on payments by deleting any dividend/share repurchase limitations and modified the reporting requirements of the Company with respect to real property owned or held.

 

As of September 30, 2008, the Company was not in compliance with certain of its financial covenants related to earnings before taxes, interest, depreciation or amortization, or EBITDA. As a result, part of the Second Letter Amendment included a provision to modify selected covenants. The Debt/EBITDA Ratio (as defined in the Credit Facility) for the quarters ending September 30, 2008 and December 31, 2008 were amended from 3.75:1.00 to 5.50:1.00, while the Debt/EBITDA Ratio for the quarters ending March 31, 2009 and thereafter remain at 3.50:1.00. The Interest Coverage Ratio (as defined in the Credit Facility) for the quarters ending September 30, 2008, December 31, 2008 and March 31, 2009 were amended from 3.50:1.00 to 3.25:1.00, while the Interest Coverage Ratio for the quarters ended June 30, 2009 and September 30, 2009 remained unchanged at 3.50:1.00 and for the quarters ended December 31, 2009 and thereafter remained unchanged at 4.00:1.00. The Recourse Debt/Core EBITDA Ratio (as defined in the Credit Facility) for the quarters ending September 30, 2008 and December 31, 2008 were amended from 2.25:1.00 to 4.25:1.00, while the Recourse Debt/Core EBITDA Ratio for the quarters thereafter remained unchanged at 2.25:1.00. The Core EBITDA (as defined in the Credit Facility) to be maintained by the Company at all times was reduced from $60.0 million to $30.0 million and the Minimum Liquidity to be maintained by the Company at all times was reduced from $25.0 million to $15.0 million. The Company was not in compliance with certain debt covenants as of December 31, 2008, all of which were effectively cured as of such date by the entering into the Third Amendment to the Credit Facility, as described below. As a consequence of the forgoing, and certain provisions of the Third Amendment to the Credit Facility, the $63.0 million outstanding under the Line of Credit has been classified as a current liability as of December 31, 2008.

 

Revised Credit Facility

 

On May 20, 2009, the Company further amended its Credit Facility by entering into a Third Amended and Restated Credit Agreement dated as of May 18, 2009 (the “Third Amendment”). The Third Amendment, among other things, bifurcates the existing credit facility into two revolving credit facilities, (i) a $38,000,000 Revolving Credit A Facility (the “Revolving Credit A Facility” or “Revolving A Credit Advances”) which is deemed fully funded as of the date of the Third Amendment and (ii) a $29,289,245 Revolving Credit B Facility (the “Revolving Credit B Facility”), comprised of revolving credit advances in the aggregate of $25,000,000 which are deemed fully funded as of the date of the Third Amendment and letters of credit advances in the aggregate amount of $4,289,245 which are issued and outstanding as of the date of the Third Amendment. The Third Amendment requires the Company to draw down $4,289,245 under the Revolving Credit B Facility on the date of the Third Amendment and deposit such funds in a cash collateral account to cash collateralize outstanding letters of credit under the Credit Facility and eliminates the swingline features of the Credit Facility and the Company’s ability to cause the lenders to issue any additional letters of credit. In addition, the Third Amendment also changes the termination date of the Credit Facility from December 7,

2010 to March 31, 2010, subject to extension or early termination as described below, and modifies the interest rate incurred on borrowings by initially increasing the applicable margin by 450 basis points (or to 7.00% on prime rate loans and 8.00% on LIBOR based loans). The Third Amendment also eliminated specific financial covenants, and in its place, the Company is required to comply with an approved budget, that has been agreed to by the Company and the lenders, subject to agreed upon variances (“the Approved Budget”). The Company is also required under the Third Amendment, to effect a recapitalization plan (the “Recapitalization Plan”), on or before September 30, 2009 and in connection therewith to effect a prepayment of at least seventy two (72%) percent of the Revolving Credit A Advances (the “Partial Prepayment”). In the event the Company fails to effect the Recapitalization Plan and in connection therewith to effect a Partial Prepayment, the (i) lenders will have the right commencing on October 1, 2009, to exercise warrants, for nominal consideration (the “Warrants”), to purchase common stock of the Company equal to 15% of the common stock of the Company on a fully diluted basis as of such date, subject to adjustment, (ii) the applicable margin automatically increases to 11% on prime rate loans and increases to 12% on LIBOR based loans, (iii) the Company shall be required to amortize an aggregate of $10 million of the Revolving Credit A Facility in three (3) equal installments on the first business day of each of the last three (3) months of 2009, (iv) the Company is obligated to submit a revised budget by October 1, 2009, (v) the Credit Facility will terminate on January 15, 2010, and (vi) no further advances may be drawn under the Credit Facility.

 

In the event that Company effects the Recapitalization Plan and in connection therewith effects a Partial Prepayment on or prior to September 30, 2009, the Warrants automatically will expire and not become exercisable, the applicable margin will automatically be reduced to 3% on prime rate loans and 4% on LIBOR based loans and the Company shall have the right, subject to the requisite approval of the lenders, to seek an extension of the Credit Facility to January 5, 2011, provided the Company also pays a fee of .25% of the then outstanding commitments under the Credit Facility.

 

As a result of the Third Amendment the Company is required to prepay outstanding Revolving Credit A Advances (and to the extent the Revolving Credit A Facility shall be reduced to zero, prepay outstanding Revolving Credit B Advances) in an amount equal to 100% (or, after the Revolving Credit A Advances are reduced by at least the Partial Prepayment amount, in an amount equal to 50%) of Net Cash Proceeds (as defined in the Credit Agreement) from:

 

 

provided, however , that (a) the Net Cash Proceeds received from the sale of the certain real property assets shall be used to prepay outstanding Revolving Credit B Advances and to the extent Revolving Credit B Advances shall be reduced to zero, to prepay outstanding Revolving Credit A Advances, (b) the Company shall prepay outstanding Revolving Credit B Advances in an amount equal to 100% of the Net Cash Proceeds from the sale of the Danbury Corporate Center in Danbury Connecticut (the “Danbury Property”) unless the Company is then not in compliance with the Recapitalization Plan in which event Revolving Credit A Advances shall be prepaid first and (c) the Company’s 2008 tax refund was used to prepay outstanding Revolving Credit B Advances upon the closing of the Third Amendment.

 

The Third Amendment requires the Company to (a) sell the Danbury Property by June 1, 2009, unless such date is extended with the applicable approval of the lenders and (b) use its commercially reasonable best efforts to sell four other commercial properties, including the two other GERA Properties (as defined below), by September 30, 2009.

Certain Real Estate Held for Sale

 

During the first half of 2007, the Company acquired three commercial properties — the Danbury Property in Danbury, Connecticut, Abrams Center in Dallas, Texas and 6400 Shafer Court in Rosemont, Illinois — for an aggregate contract price of $122.2 million, along with acquisition costs of approximately $1.3 million, and assumed obligations of approximately $542,000. The Company acquired the three properties pursuant to its warehousing strategy to accumulate these assets with the intention to hold them for future sale to GERA, the Company’s affiliated publicly traded special purpose acquisition company formed by the Company in September 2005. The Company funded its equity position in these acquisitions primarily with borrowings from its Credit Facility.

 

Simultaneously with the acquisition of the third property in June 2007, the Company closed two non-recourse mortgage loan financings with Wachovia Bank, National Association in an aggregate amount of $120.5 million. The proceeds of the mortgage loans were used to finance the purchase of this third property, to fund certain required reserves for all three properties, to pay the lender’s fees and costs and to repay certain amounts borrowed by the Company through its Credit Facility with respect to the first two properties purchased.

 

As a result of GERA failing to obtain the requisite consents of its stockholders in February 2008 to approve the acquisition of the three commercial office properties from the Company, GERA was unable to effect a business combination within the proscribed deadline of March 3, 2008 in accordance with its charter and was required to liquidate. Consequently, pursuant to a proxy statement filed by GERA with the SEC on March 24, 2008, at a special meeting of GERA’s stockholders held on April 14, 2008, the stockholders approved the dissolution and plan of liquidation of GERA. In the first quarter of 2008 the Company wrote-off its investment in GERA of approximately $5.8 million, including its stock and warrant purchases, operating advances and third party costs. The Company also paid third-party legal, accounting, printing and other costs (other than monies paid to stockholders of GERA on liquidation) associated with the dissolution and liquidation of GERA. In addition, the various exclusive service agreements that the Company had previously entered into with GERA for transaction services, property and facilities management, and project management, were no longer of any force or effect.

 

As of September 30, 2008, the Company initiated a plan to sell five properties it classified as real estate held for investment in its financial statements as of September 30, 2008. These five properties are comprised of the three commercial properties that were initially intended to be transferred to GERA as discussed above (the “GERA Properties”) and two other properties that the Company previously acquired with the intention of transferring to a strategic office fund that ultimately was never launched. As of December 31, 2008, the Company had a covenant within its Credit Facility that required the sale of the GERA Properties before March 31, 2009. The downturn in the global capital markets significantly lessened the probability that the Company would be able to achieve relief from this covenant through amendment or other financial resolutions by March 31, 2009. Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company assessed the value of the assets. In addition, the Company reviewed the valuation of its other owned properties and real estate investments. This valuation review resulted in the Company recognizing an impairment charge of approximately $90.4 million against the carrying value of the properties and real estate investments during the year ended December 31, 2008.

 

On October 31, 2008, the Company entered into that certain Agreement for the Purchase and Sale of Real Property and Escrow Instructions to effect the sale of the Danbury Property located at 39 Old Ridgebury Road, Danbury, Connecticut, to an unaffiliated entity for a purchase price of $76 million. This agreement was amended and restated in its entirety by that certain Danbury Merger Agreement dated as of January 23, 2009, as amended by the First Amendment to Danbury Merger Agreement dated as of January 23, 2009 (the “First Danbury Amendment”), which reduced the purchase price to $73.5 million. In accordance with the terms of the Danbury Merger Agreement, as amended by the First Danbury Amendment, the Company received one half of the buyer’s deposits in an amount of $3.125 million from the buyer upon the execution of the Danbury Merger Agreement, which released deposit remains subject to the terms of the Danbury Merger Agreement and the remaining $3.125 million of deposits continued to be held in escrow pending the closing. On May 19,

2009, the Company and the buyer entered into the Second Amendment to the Danbury Merger Agreement (the “Second Danbury Amendment”) pursuant to which the remaining $3.125 million of deposits held in escrow were released to the Company (and remain subject to the terms of the Danbury Merger Agreement, as amended) and the purchase price was reduced to $72.4 million. In accordance with the Second Danbury Amendment, the closing of the sale of the property, is expected to occur on or before June 1, 2009.

 

The Third Amendment to the Credit Facility requires the Company to (a) sell the Danbury Property by June 1, 2009, unless such date is extended with the applicable approval of the lenders and (b) use its best efforts to sell the four other commercial properties, including the two other GERA Properties, by September 30, 2009.

 

Industry and Competition

 

The U.S. commercial real estate services industry is large and highly fragmented, with thousands of companies providing asset management, investment management and brokerage services. In recent years the industry has experienced substantial consolidation, a trend that is expected to continue.

 

The top 25 brokerage companies collectively completed nearly $1.2 trillion in investment sales and leasing transactions globally in 2007, according to the latest available survey published by National Real Estate Investor, which is the most recent available survey. The Company ranked 13th in this survey, including transactions in its affiliate offices.

 

Within the management services business, according to a recent survey published in 2008 by National Real Estate Investor, the top 25 companies in the industry manage over 8.3 billion square feet of commercial property. The Company ranks as the seventh largest property management company in this survey with 265.6 million square feet under management at year end 2007, including property under management in its affiliate offices. The largest company in the survey had 1.9 billion square feet under management.

 

The Company competes in a variety of service businesses within the commercial real estate industry. Each of these business areas is highly competitive on a national as well as local level. The Company faces competition not only from other regional and national service providers, but also from global real estate providers, boutique real estate advisory firms and appraisal firms. Although many of the Company’s competitors are local or regional firms that are substantially smaller than the Company, some competitors are substantially larger than the Company on a local, regional, national and/or international basis. The Company’s significant competitors include CB Richard Ellis, Jones Lang LaSalle and Cushman & Wakefield, all of which have global platforms. The Company believes that it needs such a platform in order to effectively compete for the business of large multi-national corporations that are increasingly seeking a single real estate services provider.

 

The Company believes there are only limited barriers to entry in its investment management business. Its programs face competition generally from REITs, institutional pension plans and other public and private real estate companies and private real estate investors for the acquisition of properties and for raising capital to create programs to make these acquisitions. It also competes against other real estate companies who may be chosen by a broker-dealer as an investment platform instead of the Company and with other broker-dealers and other properties for viable tenants for its programs’ properties. Finally, GBE Securities faces competition from institutions that provide or arrange for other types of financing through private or public offerings of equity or debt and from traditional bank financings. While there can be no assurances that the Company will be able to continue to compete effectively, maintain current fee levels or margins, or maintain or increase its market share, based on its competitive strengths, the Company believes that it can operate successfully in the future in this highly competitive industry. The ability to do so, however, depends upon the Company’s ability to, among other things, successfully manage through the current, unprecedented disruption and dislocation of the credit markets and the weakening national and global economics. Specifically, as our business involves the acquisition, disposition, and financing of commercial properties, many of such activities are dependent, either directly or indirectly, and in whole or in part, with the availability and cost of credit. The disruption in the global capital market which began in 2008 has adversely affected our businesses and will continue to do so until such time as credit is once again available at reasonable costs. In addition, the health of real estate

investment and leasing markets is dependent on the level of economic activity on a regional and local basis. The significant slowdown in overall economic activity in 2008 has adversely affected many sectors of our business and will continue to do so until economic conditions change.

 

Environmental Regulation

 

Federal, state and local laws and regulations impose environmental zoning restrictions, use controls, disclosure obligations and other restrictions that impact the management, development, use, and/or sale of real estate. Such laws and regulations tend to discourage sales and leasing activities, as well as the willingness of mortgage lenders to provide financing, with respect to some properties. If transactions in which the Company is involved are delayed or abandoned as a result of these restrictions, the brokerage business could be adversely affected. In addition, a failure by the Company to disclose known environmental concerns in connection with a real estate transaction may subject the Company to liability to a buyer or lessee of property.

 

The Company generally undertakes a third-party Phase I investigation of potential environmental risks when evaluating an acquisition for a sponsored program. A Phase I investigation is an investigation for the presence or likely presence of hazardous substances or petroleum products under conditions that indicate an existing release, a post release or a material threat of a release. A Phase I investigation does not typically include any sampling. The Company’s programs may acquire a property with environmental contamination, subject to a determination of the level of risk and potential cost of remediation.

 

Various environmental laws and regulations also can impose liability for the costs of investigating or remediation of hazardous or toxic substances at sites currently or formerly owned or operated by a party, or at off-site locations to which such party sent wastes for disposal. As a property manager, the Company could be held liable as an operator for any such contamination, even if the original activity was legal and the Company had no knowledge of, or did not cause, the release or contamination. Further, because liability under some of these laws is joint and several, the Company could be held responsible for more than its share, or even all, of the costs for such contaminated site if the other responsible parties are unable to pay. The Company could also incur liability for property damage or personal injury claims alleged to result from environmental contamination, or from asbestos-containing materials or lead-based paint present at the properties that it manages. Insurance for such matters may not always be available, or sufficient to cover the Company’s losses. Certain requirements governing the removal or encapsulation of asbestos-containing materials, as well as recently enacted local ordinances obligating property managers to inspect for and remove lead-based paint in certain buildings, could increase the Company’s costs of legal compliance and potentially subject the Company to violations or claims. Although such costs have not had a material impact on the Company’s financial results or competitive position in 2008, the enactment of additional regulations, or more stringent enforcement of existing regulations, could cause the Company to incur significant costs in the future, and/or adversely impact the brokerage and management services businesses. See Note 20 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information.

 

Seasonality

 

Notwithstanding the Company’s expanded business platform as a consequence of the Merger, a substantial portion of the Company’s revenues are derived from brokerage transaction services, which are seasonal in nature. As a consequence, the Company’s revenue stream and the related commission expense are also subject to seasonal fluctuations. However, the Company’s non-variable operating expenses, which are treated as expenses when incurred during the year, are relatively constant in total dollars on a quarterly basis. The Company has typically experienced its lowest quarterly revenue from transaction services in the quarter ending March 31 of each year with higher and more consistent revenue in the quarters ending June 30 and September 30. The quarter ending December 31 has historically provided the highest quarterly level of revenue due to increased activity caused by the desire of clients to complete transactions by calendar year-end. Transaction services revenue represented 39.3% of the $611.8 million in total revenue for 2008.

Regulation

 

Transaction and Property Management Services

 

The Company and its brokers, salespersons and, in some instances, property managers are regulated by the states in which it does business. These regulations may include licensing procedures, prescribed professional responsibilities and anti-fraud provisions. The Company’s activities are also subject to various local, state, national and international jurisdictions’ fair advertising, trade, housing and real estate settlement laws and regulations and are affected bylaws and regulations relating to real estate and real estate finance and development. Because the size and scope of real estate sales transactions have increased significantly during the past several years, both the difficulty of ensuring compliance with the numerous state statutory requirements and licensing regimes and the possible liability resulting from non-compliance have increased.

 

Dealer-Manager Services

 

The securities industry is subject to extensive regulation under federal and state law. Broker-dealers are subject to regulations covering all aspects of the securities business. In general, broker-dealers are required to register with the SEC and to be members of FINRA or the New York Stock Exchange (“NYSE”). As a member of FINRA, GBE Securities’ broker-dealer business is subject to the requirements of the Securities Exchange Act of 1934 as amended (the “Exchange Act”) and the rules promulgated thereunder relating to broker-dealers and to the Rules of Fair Practice of FINRA. These regulations establish, among other things, the minimum net capital requirements for GBE Securities’ broker-dealer business. Such business is also subject to regulation under various state laws in all 50 states and the District of Columbia, including registration requirements.

 

Service Marks

 

The Company has registered trade names and service marks for the “Grubb & Ellis” name and logo and certain other trade names. The “Grubb & Ellis” brand name is considered an important asset of the Company, and the Company actively defends and enforces such trade names and service marks.

 

Real Estate Markets

 

The Company’s business is highly dependent on the commercial real estate markets, which in turn are impacted by numerous factors, including but not limited to the general economy, availability and terms of credit and demand for real estate in local markets. Changes in one or more of these factors could either favorably or unfavorably impact the volume of transactions, demand for real estate investments and prices or lease terms for real estate. Consequently, the Company’s revenue from transaction services, investment management operations and property management fees, operating results, cash flow and financial condition are impacted by these factors, among others.

 

The Merger

 

Upon the closing of the Merger, which occurred on December 7, 2007, the 43,779,740 shares of common stock of NNN that were issued and outstanding immediately prior to the Merger were automatically converted into 38,526,171 shares of common stock of the Company, and the 2,249,850 NNN restricted stock and stock options that were issued and outstanding immediately prior to the Merger were automatically converted into 1,979,868 shares of restricted stock and stock options of the Company. The shares of the Company’s common stock issued in connection with the Merger were registered under the Securities Act of 1933, as amended (the “Securities Act”), and the Company’s common stock, including the shares of common stock issued pursuant to the Merger, continue to trade on the NYSE under the symbol “GBE.”

 

Unless otherwise indicated, all pre-merger NNN share data has been adjusted to reflect the conversion as a result of the Merger (see Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information).

 

Subsequent to the closing of the Merger, in December 2007, the Company relocated its headquarters from Chicago, Illinois to Santa Ana, California, changed its fiscal year from June 30 to December 31, and

appointed EY as its independent registered public accounting firm to audit financial statements of the Company going forward.

 

Employees

 

As of December 31, 2008, the Company had approximately 5,000 employees including more than 800 transaction professionals working in 54 owned offices. Nearly 2,600 employees serve as property and facilities management staff at the Company’s client-owned properties and the Company’s clients reimburse the Company fully for their salaries and benefits. The Company considers its relationship with its employees to be good and has not experienced any interruptions of its operations as a result of labor disagreements.

 

Availability of this Report

 

The Company’s internet address is www.grubb-ellis.com . On the Investor Relations page on this web site, the Company posts its Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q, its Current Reports on Form 8-K and its proxy statements as soon as reasonably practicable after it files them electronically with the SEC. All such filings on the Investor Relations web page are available to be viewed free of charge. Information contained on our website is not part of this Report on Form 10-K or our other filings with the SEC. We assume no obligation to update or revise any forward-looking statements in the Annual Report on Form 10-K, whether as a result of new information, future events or otherwise, unless we are required to do so by law.

 

In addition, a copy of this Report on Form 10-K is available without charge by contacting Investor Relations, Grubb & Ellis Company, 1551 North Tustin Avenue, Suite 300, Santa Ana, California 92705.

 

 

Risks Related to the Company’s Business in General

 

We currently have restricted borrowing capacity under our senior secured credit facility, our senior secured credit facility imposes operating restrictions and covenants which the Company may be unable to maintain compliance with in future periods, and in an event of default, all of our borrowings would become immediately due and payable.

 

Our Credit Facility imposes, and any further amendment or refinancing thereof, may impose, operating and other restrictions on the Company and many of its subsidiaries. These restrictions will affect, and in many respects will limit or prohibit, our ability and our guarantor subsidiaries’ abilities to:

 

 

As a condition to entering into the Third Amendment to the Credit Facility the lenders thereunder required the Company to submit for lender pre-approval the Approved Budget and the Recapitalization Plan. The Third Amendment eliminated specific financial covenants; however, the Third Amendment imposes restrictions on the Company’s ability to operate outside of the Approved Budget, subject to a permitted negative cumulative cash flow variance equal to the greater of (a) 15% cumulative negative variance between actual and projected cash flow in the Approved Budget for the applicable period and (b) a $1,500,000 cumulative negative variance

between actual and projected cash flow in the Approved Budget for the applicable period (the “Permitted Variance”); provided, however, that the Company’s failure to comply with the Permitted Variance, as a consequence of general economic conditions or otherwise, in any week shall not constitute an Event of Default unless such noncompliance has occurred for three consecutive calendar weeks. In addition the Third Amendment also requires the Company to implement the Recapitalization Plan and complete each step provided in the Recapitalization Plan by the dates set for such completion.

 

In the event the Company fails to effect the Recapitalization Plan and in connection therewith to effect a Partial Prepayment on or before September 30, 2009, the (i) lenders will have the right commencing on October 1, 2009, to exercise the Warrants, for nominal consideration, to purchase common stock of the Company equal to 15% of the common stock of the Company on a fully diluted basis as of such date, subject to adjustment, (ii) the applicable margin automatically increases to 11% on prime rate loans and increases to 12% on LIBOR based loans, (iii) the Company shall be required to amortize an aggregate of $10 million of the Revolving Credit A Facility in three (3) equal installments on the first business day of each of the last three (3) months of 2009, (iv) the Company is obligated to submit a revised budget by October 1, 2009, (v) the Credit Facility will terminate on January 15, 2010, and (vi) no further advances may be drawn under the Credit Facility. In the event that the Credit Facility terminates on January 15, 2010, the Company will be required to repay the Credit Facility in its entirety at that time, and there can be no assurances that the Company will have access to alternative funding sources, or if such sources are available to the Company, that they will be on favorable terms and conditions to the Company.

 

In addition, the Company is required to prepay outstanding Revolving Credit A Advances (and to the extent the Revolving Credit A Facility shall be reduced to zero, prepay outstanding Revolving Credit B Advances) in an amount equal to 100% (or, after the Revolving Credit A Advances are reduced by at least the Partial Prepayment amount, in an amount equal to 50%) of Net Cash Proceeds (as defined in the Credit Agreement) from:

 

 

provided, however , (a) that the Net Cash Proceeds received from the sale of the certain real property assets shall be used to prepay outstanding Revolving Credit B Advances and to the extent Revolving Credit B Advances shall be reduced to zero, to prepay outstanding Revolving Credit A Advances, (b) the Company shall prepay outstanding Revolving Credit B Advances in an amount equal to 100% of the Net Cash Proceeds from the sale of the Danbury Property unless the Company is then not in compliance with the Recapitalization Plan in which event Revolving Credit A Advances shall be prepaid first and (c) the Company’s 2008 tax refund was used to prepay outstanding Revolving Credit B Advances upon the closing of the Third Amendment.

 

The Company’s ability to comply with these covenants may be affected by many events beyond its control and the Company’s future operating results may not allow the Company to comply with the covenants, or in the event of a default, to remedy that default. There can be no assurance that the Company will continue to comply in future periods.

 

The Company’s failure to comply with these covenants or to comply with the other restrictions contained in its Credit Facility could result in a default, which could cause such indebtedness under its existing Credit Facility to become immediately due and payable. If the Company is unable to repay outstanding borrowings when due, the lenders under the Credit Facility will have the right to proceed against the collateral granted to the lenders to secure the debt, which is substantially all of the assets of the Company. In the event that the Company is in default of its existing Credit Facility, the Company may seek to explore a variety of options,

including but not limited to accessing alternative debt or equity capital or effective asset sales, although there can be no assurances that any such alternatives will be available to the Company, or, if available to the Company, on terms and conditions favorable to the Company.

 

The restrictions contained in our Credit Facility could also limit our ability to plan for or react to market conditions or meet capital needs and adversely affect our ability to finance ongoing operations, acquisitions and investments.

 

Based upon the Third Amendment to the Credit Facility, the Company did not have any further ability to borrow under the Credit Facility as of the date of the Third Amendment, as the Credit Facility was fully drawn. The Company may only borrow under the Revolving Credit B Facility to the extent that it repays outstanding Revolving Credit B Advances thereunder and such advances are used to pay expenses in compliance with the Approved Budget or to fund Permitted Cash Reserves (as defined in the Credit Facility).

 

The ongoing downturn in the general economy and the real estate market has negatively impacted and could continue to negatively impact the Company’s business and financial results.

 

Periods of economic slowdown or recession, significantly reduced access to credit, declining employment levels, decreasing demand for real estate, declining real estate values or the perception that any of these events may occur, can reduce transaction volumes or demand for services for each of our business lines. The current recession and the downturn in the real estate market have resulted in and may continue to result in:

 

 

 

The declining real estate market in the United States, the availability and cost of credit, increased unemployment, volatile oil prices, declining consumer confidence and the instability of United States banking and financial institutions, have contributed to increased volatility, an overall economic slowdown and diminished expectations for the economy and markets going forward. The fragile state of the credit markets, the fear of a global recession for an extended period and the current economic environment have impacted real estate services and investment management firms like ours through reduced transaction volumes, falling transaction values, lower real estate valuations, liquidity restrictions, market volatility, and the loss of confidence. As a consequence, similar to other real estate services and investment management firms, our stock price has declined significantly.

 

These negative economic conditions have caused a reduced demand for overall amount of sale and leasing activity in the commercial real estate industry and the demand for our transaction and management services and investment management services. Our revenues and profitability depend upon on the overall demand for our services from our clients. As a result of the economic conditions in 2008, we were not in compliance with certain of our financial covenants under our Credit Facility as of September 30, 2008. In November 2008, the applicable financial covenants were amended for certain periods in the Second Letter Amendment to the Credit Facility effective as of September 30, 2008. We were not in compliance with certain debt covenants as of December 31, 2008, all of which were effectively cured as of such date by the Third Amendment. As a consequence of the foregoing and certain provisions of the Third Amendment, the $63.0 million outstanding under the Credit Facility has been classified as a current liability as of December 31, 2008.

The Third Amendment restricts our ability to operate outside of the Approved Budget without the permission of the requisite majority of lenders. In addition, we are required to remit Net Cash Proceeds from the sale of assets including real estate assets to repay advances under the Credit Facility and pursue additional sources of capital in accordance with the Recapitalization Plan. All of these demands put the Company’s liquidity and financial resources at risk.

 

Due the economic downturn, it may take us longer to dispose of real estate assets and investments and the selling prices may be lower than originally anticipated. If this occurs, fees from transaction services will be reduced. In addition, the performance of certain properties in the investment management portfolio may be negatively impacted, which would likewise affect our fees. As a result, the carrying value of certain of our real estate investments may become impaired and we could record losses as a result of such impairment or we could experience reduced profitability related to declines in real estate values. As of September 30, 2008, the Company initiated a plan to sell the properties it classified as real estate held for investment in its financial statements as of September 30, 2008. As of December 31, 2008, the Company’s Credit Facility included a covenant which required the sale of certain of these assets before March 31, 2009. The downturn in the global credit markets significantly lessened the probability that the Company would be able to achieve relief from this covenant through amendment or other financial resolutions as of March 31, 2009. Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company assessed the value of the assets. In addition, the Company reviewed the valuation of its other owned properties and real estate investments. This valuation review resulted in the Company recognizing an impairment charge of approximately $90.4 million against the carrying value of the properties and real estate investments during the year ended December 31, 2008. The Third Amendment to the Credit Facility requires the Company to (a) sell the Danbury Property by June 1, 2009, unless such date is extended with the applicable approval of the lenders and (b) use its commercially reasonable best efforts to sell the four other commercial properties, including the two other GERA Properties, by September 30, 2009. In order to satisfy the covenants in our Credit Agreement, we may be forced to reduce the purchase price of these properties in order to sell the properties which may result in further impairment.

 

We are not able to predict the severity or duration of the current adverse economic environment or the disruption in the financial markets. The real estate market tends to be cyclical and related to the condition of the overall economy and to the perceptions of investors, developers and other market participants as to the economic outlook. The ongoing downturn in the general economy and the real estate market has negatively impacted and could continue to negatively impact the Company’s business and results of operations.

 

The ongoing adverse developments in the credit markets and the risk of continued market deterioration have adversely affected the Company’s revenues, expenses and operating results and may continue to do so.

 

Our business lines are sensitive to credit cost and availability as well as market place liquidity. In addition, the revenues in all our businesses are dependent to some extent on overall volume of activity and pricing in the commercial real estate market. In 2008, the credit markets experienced an unprecedented level of disruption and uncertainty. This disruption and uncertainty has reduced the availability and significantly increased the cost of most sources of funding. In certain cases, sources of funding have been eliminated.

 

Disruptions in the credit markets have adversely affected, and may continue to adversely affect, our business of providing services to owners, purchasers, sellers, investors and occupants of real estate in connection with acquisitions, dispositions and leasing of real property. If our clients are unable to obtain credit on favorable terms, there will be fewer completed acquisitions, dispositions and leases of property. In addition, if purchasers of real estate are not able to obtain favorable financing resulting in a lack of disposition opportunities for funds whom we act as advisor, our fee revenues will decline and we may also experience losses on real estate held for investment.

 

The recent decline in real estate values and the inability to obtain financing has either eliminated or severely reduced the availability of the Company’s historical funding sources for its investment management programs, and to the extent credit remains available for these programs, it is currently more expensive. The Company may not be able to continue to access sources of funding for its investment management programs

or, if available to the Company, the Company may not be able to do so on favorable terms. Any decision by lenders to make additional funds available to the Company in the future for its investment management programs will depend upon a number of factors, such as industry and market trends in our business, the lenders’ own resources and policies concerning loans and investments, and the relative attractiveness of alternative investment or lending opportunities.

 

The depth and duration of the current credit market and liquidity disruptions are impossible to predict. In fact, the magnitude of the recent credit market disruption has exceeded the expectations of most if not all market participants. This uncertainty limits the Company’s ability to develop future business plans and the Company believes that it limits the ability of other participants in the credit markets and the real estate markets to do so as well. This uncertainty may lead market participants to act more conservatively than in recent history, which may continue to depress demand and pricing in our markets.

 

If the Company fails to meet its payment or other obligations under its senior secured credit facility, then the lenders under such credit facility could foreclose on, and acquire control of, substantially all of its assets.

 

Any material downturn in the Company’s revenue or increase in its costs and expenses could impair its ability to meet its debt obligations. The Company’s lenders under the senior secured Credit Facility have a lien on substantially all of the Company’s assets and the assets of the Company’s subsidiaries including their respective accounts receivable, cash, general intangibles, investment property and future acquired material property. If the Company fails to meet its payment or other obligations under the Credit Facility, the lenders under such Credit Facility will be entitled to foreclose on substantially all of the assets of the Company and the Company’s subsidiaries and liquidate these assets.

 

We experienced additional, unanticipated costs and may have additional risk and further costs as a result of the restatement of our financial statements.

 

As a result of the restatement of certain audited and unaudited financial data, and the special investigation in connection therewith, we incurred substantial, additional unanticipated costs for accounting and legal fees. The restatement and special investigation was also time-consuming and affected management’s attention and resources. Further, there are no assurances that we will not become involved in legal proceedings in the future in relation to these restatements. In connection with any such potential proceedings, any incurred expenses not covered by available insurance or any adverse resolution could have a material adverse effect on the Company. Any such future legal proceedings could also be time-consuming and distract our management from the conduct of our business.

 

The Company may not be able to obtain additional financing when the Company needs it or on acceptable terms, and any such financing, or the failure to obtain financing, may adversely affect the market price of the Company’s common stock.

 

There can be no assurance that the anticipated cash flow from operations will be sufficient to meet all of the Company’s cash requirements. The Company intends to continue to make investments to support the Company’s business growth and may require additional funds to respond to business challenges. Accordingly, the Company may need to complete additional equity or debt financings to secure additional funds. The Company cannot assure you that further equity or debt financing will be available on acceptable terms, if at all. If the market price of the Company’s common stock does not increase significantly the Company will have limited ability to address financing needs through an equity offering or such equity financing may result in significant dilution to existing stockholders. In addition, the terms of any debt financing may restrict the Company’s financial and operating flexibility. The Company’s inability to obtain any needed financing, or the terms on which it may be available, could have a material adverse effect on the Company’s business.

We have received a notice from the New York Stock Exchange (“NYSE”) that we did not meet its continued listing requirements. If we are unable to rectify this non-compliance in accordance with NYSE rules, our common stock will be delisted from trading on the NYSE, which could have a material adverse effect on the liquidity and value of our common stock.

 

On February 20, 2009, we received notification from NYSE Regulation, Inc. that we were not in compliance with the NYSE’s continued listing standard requiring that the average closing price of our common stock be above $1.00 per share over a 30 consecutive trading-day period. Under the NYSE’s rules, we normally would have six months, or until August 20, 2009, for our share price and average share price to comply with the share price standard. However, on February 26, 2009, the NYSE temporarily suspended the application of its continued listing criteria relating to a minimum average trading price of $1.00 until June 30, 2009. Companies currently below the $1.00 minimum level that do not regain compliance during the suspension period recommence their compliance period upon reinstitution of the share price standard and thereupon receive the remaining balance of their compliance period. If the share price and average share price of our common stock do not regain compliance with the $1.00 requirement during the suspension period, under the NYSE’s temporary rulemaking we will have until on or about December 20, 2009, in which to comply with the share price standard.

 

If we are unable to regain compliance with the NYSE’s continued listing standard within the required time frame, our common stock will be delisted from the NYSE. As a result, we likely would have our common stock quoted on the Over-the-Counter Bulletin Board (“OTC BB”) in order to have our common stock continue to be traded on a public market. Securities that trade on the OTC BB generally have less liquidity and greater volatility than securities that trade on the NYSE. Delisting from the NYSE also may preclude us from using certain state securities law exemptions, which could make it more difficult and expensive for us to raise capital in the future and more difficult for us to provide compensation packages sufficient to attract and retain top talent. In addition, because issuers whose securities trade on the OTC BB are not subject to the corporate governance and other standards imposed by the NYSE, and such issuers receive less news and analyst coverage, our reputation may suffer, which could result in a decrease in the trading price of our shares. The delisting of our common stock from the NYSE, therefore, could significantly disrupt the ability of investors to trade our common stock and could have a material adverse effect on the value and liquidity of our common stock.

 

The Company is in a highly competitive business with numerous competitors, some of which may have greater financial and operational resources than it does.

 

The Company competes in a variety of service disciplines within the commercial real estate industry. Each of these business areas is highly competitive on a national as well as on a regional and local level. The Company faces competition not only from other national real estate service providers, but also from global real estate service providers, boutique real estate advisory firms, consulting and appraisal firms. Depending on the product or service, the Company also faces competition from other real estate service providers, institutional lenders, insurance companies, investment banking firms, investment managers and accounting firms, some of which may have greater financial resources than the Company does. The Company is also subject to competition from other large national firms and from multi-national firms that have similar service competencies to it. Although many of the Company’s competitors are local or regional firms that are substantially smaller than it, some of its competitors are substantially larger than it on a local, regional, national or international basis. In general, there can be no assurance that the Company will be able to continue to compete effectively with respect to any of its business lines or on an overall basis, or to maintain current fee levels or margins, or maintain or increase its market share.

 

The TIC business in general, from which the Company has historically generated significant revenues, materially contracted in 2008.

 

The Company has historically generated significant revenues from fees earned through the transaction structuring and property management of its TIC Programs. In 2008, however, with the nationwide decline in real estate values and the global credit crises, the TIC industry contracted significantly. According to the research of OMNI, approximately $3.7 billion of TIC equity was raised in 2006. In 2008, the amount of TIC

equity raised declined by approximately 66% to $1.24 billion. Moreover, OMNI has indicated that based on the current year-to-date activity through the first part of 2009, should the current trends remain constant throughout the entire calendar year, the TIC industry would raise approximately $300.0 million in 2009, an approximately 90% decline from 2006. As the Company has historically generated a significant amount of revenue from its TIC operations, the rapid and steep decline in this industry may have a material, adverse effect on the Company’s business and results of operations if it is unable to generate revenues in its other business segments, of which there can be no assurances, to make up for the loss of TIC-related revenues.

 

As a service-oriented company, the Company depends on key personnel, and the loss of its current personnel or its failure to hire and retain additional personnel could harm its business.

 

The Company depends on its ability to attract and retain highly skilled personnel. The Company believes that its future success in developing its business and maintaining a competitive position will depend in large part on its ability to identify, recruit, hire, train, retain and motivate highly skilled executive, managerial, sales, marketing and customer service personnel. Competition for these personnel is intense, and the Company may not be able to successfully recruit, assimilate or retain sufficiently qualified personnel. Since July 2008, the Company has been conducting a search to identify and hire a Chief Executive Officer. Shortly after the resignation of the Company’s Chief Executive Officer in July 2008, the Company appointed an interim Chief Executive Officer. As of the date of filing this Form 10-K, the Company has not yet identified and hired a permanent Chief Executive Officer. The Company’s ability to attract new employees may be limited by certain restrictions in its senior secured credit facility, including limitations on cash bonus payments to new hires and may only make cash payments that exceed those limits if it receives approval from the administrative agent, which cannot be guaranteed. We use equity incentives to attract and retain our key personnel. In 2008, and the first quarter of 2009, our stock price declined significantly, resulting in the decline in value of previously provided equity awards, which may result in an increase risk of loss of key personnel. The performance of our stock may also diminish our ability to offer attractive incentive awards to new hires. The Company’s failure to recruit and retain necessary executive, managerial, sales, marketing and customer service personnel could harm its business and its ability to obtain new customers.

 

The Company plans to expand its business to include international operations that could subject it to social, political and economic risks of doing business in foreign countries.

 

Although the Company does not currently conduct significant business outside the United States, the Company intends to expand its business to include international operations. There can be no assurance that the Company will be able to successfully expand its business in international markets. Current global economic conditions may restrict, limit or delay the Company’s ability to expand its business into international markets or make such expansion less economically feasible. If the Company expands into international markets, circumstances and developments related to international operations that could negatively affect the Company’s business or results of operations include, but are not limited to, the following factors:

 

 

 

Additionally, the Company may establish joint ventures with foreign entities for the provision of brokerage services abroad, which may involve the purchase or sale of the Company’s equity securities or the equity securities of the joint venture participant(s). In these joint ventures, the Company may not have the right or power to direct the management and policies of the joint venture and other participants may take action contrary to the Company’s instructions or requests and against the Company’s policies and objectives. In addition, the other participants may become bankrupt or have economic or other business interests or goals that are inconsistent with the Company. If a joint venture participant acts contrary to the Company’s interest, then it could have a material adverse effect on the Company’s business and results of operations.

 

Failure to manage any future growth effectively may have a material adverse effect on the Company’s financial condition and results of operations.

 

Management will need to successfully manage any future growth effectively. The Company has pursued an aggressive expansion strategy in the transaction services business. The integration and additional growth may place a significant strain upon management, administrative, operational and financial infrastructure. The Company’s ability to grow also depends upon its ability to successfully hire, train, supervise and manage additional executive officers and new employees, obtain financing for its capital needs, expand its systems effectively, allocate its human resources optimally, maintain clear lines of communication between its transactional and management functions and its finance and accounting functions, and manage the pressures on its management and administrative, operational and financial infrastructure. Additionally, managing future growth may be difficult due to the new geographic locations and business lines of the Company. There can be no assurance that the Company will be able to accurately anticipate and respond to the changing demands it will face as it integrates and continues to expand its operations, and it may not be able to manage growth effectively or to achieve growth at all. Any failure to manage the future growth effectively could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

Risks Related to the Company’s Transaction Services and Management Services Business

 

The Company’s quarterly operating results are likely to fluctuate due to the seasonal nature of its business and may fail to meet expectations, which may cause the price of its securities to decline.

 

Historically, the majority of legacy Grubb & Ellis revenue has been derived from the transaction services that it provides. Such services are typically subject to seasonal fluctuations. Legacy Grubb & Ellis typically experienced its lowest quarterly revenue in the quarter ending March 31 of each year with higher and more consistent revenue in the quarters ending June 30 and September 30. The quarter ending December 31 has historically provided the highest quarterly level of revenue due to increased activity caused by the desire of clients to complete transactions by calendar year-end. However, the Company’s non-variable operating expenses, which are treated as expenses when incurred during the year, are relatively constant in total dollars on a quarterly basis. As a result, since a high proportion of these operating expenses are fixed, declines in revenue could disproportionately affect the Company’s operating results in a quarter. In addition, the Company’s quarterly operating results have fluctuated in the past and will likely continue to fluctuate in the future. If the Company’s quarterly operating results fail to meet expectations, the price of the Company’s securities could fluctuate or decline significantly.

 

If the properties that the Company manages fail to perform, then its business and results of operations could be harmed.

 

The Company’s success partially depends upon the performance of the properties it manages. The Company could be adversely affected by the nonperformance of, or the deteriorating financial condition of, certain of its clients. The revenue the Company generates from its property management business is generally a percentage of aggregate rent collections from the properties. The performance of these properties will

depend upon the following factors, among others, many of which are partially or completely outside of the Company’s control:

 

 

These or other factors may negatively impact the properties that the Company manages, which could have a material adverse effect on its business and results of operations.

 

If the Company fails to comply with laws and regulations applicable to real estate brokerage and mortgage transactions and other business lines, then it may incur significant financial penalties.

 

Due to the broad geographic scope of the Company’s operations and the real estate services performed, the Company is subject to numerous federal, state and local laws and regulations specific to the services performed. For example, the brokerage of real estate sales and leasing transactions requires the Company to maintain brokerage licenses in each state in which it operates. If the Company fails to maintain its licenses or conduct brokerage activities without a license or violate any of the regulations applicable to our licenses, then it may be required to pay fines (including treble damages in certain states) or return commissions received or have our licenses suspended or revoked. In addition, because the size and scope of real estate sales transactions have increased significantly during the past several years, both the difficulty of ensuring compliance with the numerous state licensing regimes and the possible loss resulting from non-compliance have increased. Furthermore, the laws and regulations applicable to the Company’s business, both in the United States and in foreign countries, also may change in ways that increase the costs of compliance. The failure to comply with both foreign and domestic regulations could result in significant financial penalties which could have a material adverse effect on the Company’s business and results of operations.

 

The Company may have liabilities in connection with real estate brokerage and property and facilities management activities.

 

As a licensed real estate broker, the Company and its licensed employees and independent contractors that work for it are subject to statutory due diligence, disclosure and standard-of-care obligations. Failure to fulfill these obligations could subject the Company or its employees to litigation from parties who purchased, sold or leased properties that the Company or they brokered or managed. The Company could become subject to claims by participants in real estate sales, as well as building owners and companies for whom we provide management services, claiming that the Company did not fulfill its statutory obligations as a broker.

 

In addition, in the Company’s property and facilities management businesses, it hires and supervises third-party contractors to provide construction and engineering services for its managed properties. While the Company’s role is limited to that of a supervisor, the Company may be subject to claims for construction defects or other similar actions. Adverse outcomes of property and facilities management litigation could have a material adverse effect on the Company’s business, financial condition and results of operations.

Environmental regulations may adversely impact the Company’s business and/or cause the Company to incur costs for cleanup of hazardous substances or wastes or other environmental liabilities.

 

Federal, state and local laws and regulations impose various environmental zoning restrictions, use controls, and disclosure obligations which impact the management, development, use, and/or sale of real estate. Such laws and regulations tend to discourage sales and leasing activities, as well as mortgage lending availability, with respect to some properties. A decrease or delay in such transactions may adversely affect the results of operations and financial condition of the Company’s real estate brokerage business. In addition, a failure by the Company to disclose environmental concerns in connection with a real estate transaction may subject it to liability to a buyer or lessee of property.

 

In addition, in its role as a property manager, the Company could incur liability under environmental laws for the investigation or remediation of hazardous or toxic substances or wastes at properties it currently or formerly managed, or at off-site locations where wastes from such properties were disposed. Such liability can be imposed without regard for the lawfulness of the original disposal activity, or the Company’s knowledge of, or fault for, the release or contamination. Further, liability under some of these laws may be joint and several, meaning that one liable party could be held responsible for all costs related to a contaminated site. The Company could also be held liable for property damage or personal injury claims alleged to result from environmental contamination, or from asbestos-containing materials or lead-based paint present at the properties it manages. Insurance for such matters may not be available or sufficient.

 

Certain requirements governing the removal or encapsulation of asbestos-containing materials, as well as recently enacted local ordinances obligating property managers to inspect for and remove lead-based paint in certain buildings, could increase the Company’s costs of legal compliance and potentially subject it to violations or claims. Although such costs have not had a material impact on its financial results or competitive position during fiscal year 2006, 2007 or 2008, the enactment of additional regulations, or more stringent enforcement of existing regulations, could cause it to incur significant costs in the future, and/or adversely impact its brokerage and management services businesses.

 

Risks Related to the Company’s Investment Management and Broker-Dealer Business

 

Declines in asset value and reductions in distributions in investment programs could adversely affect the Company business, as it could cause harm to the Company’s reputation, cause the loss of management contracts and third-party broker-dealer selling agreements, limit the Company’s ability to sign future third-party broker-dealer selling agreements and potentially expose the Company to legal liability.

 

The current market value of many of the properties owned through the Company’s investment programs have recently decreased as a result of the overall decline in the economy and commercial real estate generally. In addition, there have been reductions in distributions in numerous investment programs in 2008, in certain instances to a zero percent distribution rate. Significant declines in value and reductions in distributions in the investment programs sponsored by the Company could adversely affect the Company’s reputation and the Company’s ability to attract investors for future investment programs. In addition, significant declines in value and reductions in distributions could cause the Company to lose asset and property management contracts for its investment management programs, cause the Company to lose third-party broker-dealer selling agreements for existing investment programs, including its REITs, and limit the Company’s ability to sign future third-party broker-dealer agreements. The loss of value may be significant enough to cause certain investment programs to go into foreclosure or result in a complete loss of equity for program investors. Significant losses in asset value and investor equity and reductions in distributions increases the risk of claims or legal actions by program investors. Any such legal liability could result in further damage to the Company’s reputation, loss of third-party broker-dealer selling agreements and incurrence of legal expenses.

 

The Company currently provides its Investment Management services primarily to its programs. Its revenue depends on the number of its programs, on the price of the properties acquired or disposed of by these programs, and on the revenue generated by the properties under its management.

 

The Company derives fees for Investment Management services based on a percentage of the price of the properties acquired or disposed of by its programs and for management services based on a percentage of the

rental amounts of the properties in its programs. The Company is responsible for the management of all of the properties owned by its programs, but as of December 31, 2008 it had subcontracted the property management of approximately 18.0% of its programs’ office, medical office and healthcare related facilities and retail properties (based on square footage) and 30.3% of its programs’ multi-family apartment units to third parties. For REITs, investment decisions are controlled by the Board of Directors of REITs that are independent of the Company. Investment decisions of these Boards affect the fees earned by the Company. As a result, if any of the Company’s programs are unsuccessful, both its Transaction Services and Investment Management services fees will be reduced, if any are paid at all. In addition, failures of the Company’s programs to provide competitive investment returns could significantly impair its ability to market future programs. The Company’s inability to spread risk among a large number of programs could cause it to be over-reliant on a limited number of programs for its revenues. There can be no assurance that the Company will maintain current levels of transaction and management services for its programs’ properties.

 

The Company may be unable to grow its programs, which would cause it to fail to satisfy its business strategy.

 

A significant element of the Company business strategy is the growth in the number of its programs. The consummation of any future program will be subject to raising adequate capital for the investment, identifying appropriate assets for acquisition and effectively and efficiently closing the transactions. There can be no assurance that the Company will be able to identify and invest in additional properties or will be able to raise adequate capital for new programs in the future. If the Company is unable to consummate new programs in the future, it will not be able to continue to grow the revenue it receives from either transaction or management services.

 

The inability to access investors for the Company’s programs through broker-dealers or other intermediaries could have a material adverse effect on its business.

 

The Company’s ability to source capital for its programs depends significantly on access to the client base of securities broker-dealers and other financial investment intermediaries that may offer competing investment products. The Company believes that its future success in developing its business and maintaining a competitive position will depend in large part on its ability to continue to maintain these relationships as well as finding additional securities broker-dealers to facilitate offerings by its programs or to find investors for the Company’s REITs, TIC Programs and other investment programs. The Company cannot be sure that it will continue to gain access to these channels. In addition, competition for capital is intense and the Company may not be able to obtain the capital required to complete a program. The inability to have this access could have a material adverse effect on its business and results of operations.

 

The termination of any of the Company’s broker-dealer relationships, especially given the limited number of key broker-dealers, could have a material adverse effect on its business.

 

The Company’s securities programs are sold through third-party broker-dealers who are members of its selling group. While the Company has established relationships with its selling group, it is required to enter into a new agreement with each member of the selling group for each new program it offers. In addition, the Company’s programs may be removed from a selling broker-dealer’s approved program list at any time for any reason. The Company cannot assure you of the continued participation of existing members of its selling group nor can the Company make an assurance that its selling group will expand. While the Company continues to diversify and add new investment channels for its programs, a significant portion of the growth in recent years in the number of TIC Programs it sponsors and in its REITs has been as a result of capital raised by a relatively limited number of broker-dealers. Loss of any of these key broker-dealer relationships, or the failure to develop new relationships to cover the Company’s expanding business through new investment channels, could have a material adverse effect on its business and results of operations.

 

Misconduct by third-party selling broker-dealers or the Company’s sales force, could have a material adverse effect on its business.

 

The Company relies on selling broker-dealers and the Company’s sales force to properly offer its securities programs to customers in compliance with its selling agreements and with applicable regulatory requirements.

While these persons are responsible for their activities as registered broker-dealers, their actions may nonetheless result in complaints or legal or regulatory action against the Company.

 

A significant amount of the Company’s revenue has historically been derived from fees earned through the transaction structuring and property management of its TIC Programs, which programs rely primarily on Section 1031 of the Internal Revenue Code to provide for deferral of capital gains taxes to make these programs attractive. A change in this tax code section or a complete revocation of this section as it relates specifically to TICs could materially impact these programs.

 

Section 1031 of the Internal Revenue Code provides for the deferral of capital gains taxes which would ordinarily arise from the sale of real estate through a tax-deferred exchange of property, which defers the recognition of capital gains tax until such time as the replacement property is sold in a taxable transaction. These transactions are referred to as 1031 exchanges. In 2002, the Internal Revenue Service, or IRS, issued advance ruling guidelines outlining the requirements for properly structured TIC arrangements, which the Company believes validate the TIC structure generally and as it employs it. However, as recently as May 2006, the Senate Finance Committee proposed a bill in the negotiations over the budget reconciliation tax-cutting package to modify Section 1031 treatment for TICs as a way to raise additional tax revenue. The proposal was unsuccessful, but the Company cannot assure you that in the future there will not be attempts to limit or disallow the tax deferral benefits for TIC transactions. For the year ended December 31, 2008, approximately 1.4% of the Company’s total revenue was derived from TIC acquisition fees, although this amount is declining due to a significant contraction in the industry in 2008 (see Risk Factor above, “The TIC business in general, from which the Company has historically generated significant revenues, materially contracted in 2008”) If the Company were no longer able to structure TIC Programs as 1031 exchanges for its investors, it could lose a significant amount of revenue in the future, which might materially affect its results of operations. Moreover, any attempt to limit or disallow the tax deferral benefits of the 1031 exchange generally would have a material adverse effect on the real estate industry generally and on the Company’s business and results of operations.

 

A significant amount of the Company’s programs are structured to provide favorable tax treatment to investors or REITs. If a program fails to satisfy the requirements necessary to permit this favorable tax treatment, the Company could be subject to claims by investors and its reputation for structuring these transactions would be negatively affected, which would have an adverse effect on its financial condition and results of operations.

 

The Company structures TIC Programs and public non-traded REITs to provide favorable tax treatment to investors. For example, its TIC investors are able to defer the recognition of gain on sale of investment or business property if they enter into a 1031 exchange. Similarly, qualified REITs generally are not subject to federal income tax at corporate rates, which permits REITs to make larger distributions to investors ( i.e. without reduction for federal income tax imposed at the corporate level). If the Company fails to properly structure a TIC transaction or if a REIT fails to satisfy the complex requirements for qualification and taxation as a REIT under the Internal Revenue Code, the Company could be subject to claims by investors as a result of additional tax they may be required to pay or because they are unable to receive the distributions they expected at the time they made their investment. In addition, any failure to satisfy applicable tax regulations in structuring its programs would negatively affect the Company’s reputation, which would in turn affect its ability to earn additional fees from new programs. Claims by investors could lead to losses and any reduction in the Company’s fees would have a material adverse effect on its revenues.

 

Any future co-investment activities the Company undertakes could subject it to real estate investment risks which could lead to the need for substantial capital contributions, which may impact its cash flows and financial condition and, if it is unable to make them, could damage its reputation and result in adverse consequences to its holdings.

 

The Company may from time to time invest its capital in certain real estate investments with other real estate firms or with institutional investors such as pension plans. Any co-investment will generally require the Company to make initial capital contributions, and some co-investment entities may request additional capital from the Company and its subsidiaries holding investments in those assets. These contributions could

adversely impact the Company’s cash flows and financial condition. Moreover, the failure to provide these contributions could have adverse consequences to the Company’s interests in these investments. These adverse consequences could include damage to the Company’s reputation with its co-investment partners as well as dilution of ownership and the necessity of obtaining alternative funding from other sources that may be on disadvantageous terms, if available at all.

 

Geographic concentration of program properties may expose the Company’s programs to regional economic downturns that could adversely impact their operations and, as a result, the fees the Company is able to generate from them, including fees on disposition of the properties as the Company may be limited in its ability to dispose of properties in a challenging real estate market.

 

The Company’s programs generally focus on acquiring assets satisfying particular investment criteria, such as type or quality of tenants. There is generally no or little focus on the geographic location of a particular property. The Company cannot guarantee, however, that its programs will have, or will be able to maintain, a significant amount of geographic diversity. Although the Company’s property programs are located in 31 states, a majority of these properties (by square footage) are located in Texas, California, Florida and North Carolina. Geographic concentration of properties exposes the Company’s programs to economic downturns in the areas where the properties are located. A regional recession or other major, localized economic disruption in a region, such as earthquakes and hurricanes, in any of these areas could adversely affect the Company’s programs’ ability to generate or increase their operating revenues, attract new tenants or dispose of unproductive properties. Any reduction in program revenues would effectively reduce the fees the Company generates from them, which would adversely affect the Company’s results of operations and financial condition.

 

The failure of Triple Net Properties, LLC, recently renamed Grubb & Ellis Realty Investors, LLC (“GERI”) and Triple Net Properties Realty, Inc. (“Realty”), subsidiaries of the Company acquired in the Merger, to hold certain required real estate licenses may subject Realty and the Company to penalties, such as fines, restitution payments and termination of management agreements, and to the suspension or revocation of certain broker licenses.

 

Although Realty was required to have real estate licenses in states in which it acted as a broker for NNN’s investment programs and received real estate commissions prior to 2007, Realty did not hold a license in certain of those states when it earned fees for those services. In addition, almost all of GERI’s revenue was based on an arrangement with Realty to share fees from NNN’s programs. GERI did not hold a real estate license in any state, although most states in which properties of NNN’s programs were located may have required GERI to hold a license in order to share fees. As a result, Realty and the Company may be subject to penalties, such as fines (which could be a multiple of the amount received), restitution payments and termination of management agreements, and to the suspension or revocation of certain of Realty’s real estate broker licenses.

 

If third-party managers providing property management services for the Company’s programs’ office, medical office and healthcare related facilities, retail and multi-family properties are negligent in their performance of, or default on, their management obligations, the tenants may not renew their leases or the Company may become subject to unforeseen liabilities. If this occurs, it could have an adverse effect on the Company’s financial condition and operating results.

 

The Company has entered into agreements with third-party management companies to provide property management services for a significant number of the Company’s programs’ properties, and the Company expects to enter into similar third-party management agreements with respect to properties the Company’s programs acquire in the future. The Company does not supervise these third-party managers and their personnel on a day-to-day basis and the Company cannot assure you that they will manage the Company’s programs’ properties in a manner that is consistent with their obligations under the Company’s agreements, that they will not be negligent in their performance or engage in other criminal or fraudulent activity, or that these managers will not otherwise default on their management obligations to the Company. If any of the foregoing occurs, the relationships with the Company’s programs’ tenants could be damaged, which may cause the tenants not to renew their leases, and the Company could incur liabilities resulting from loss or injury to

the properties or to persons at the properties. If the Company is unable to lease the properties or the Company become subject to significant liabilities as a result of third-party management performance issues, the Company’s operating results and financial condition could be substantially harmed.

 

The Company or its new programs may be required to incur future indebtedness to raise sufficient funds to purchase properties.

 

One of the Company’s business strategies is to develop new programs. The development of a new program requires the identification and subsequent acquisition of properties when the opportunity arises. In some instances, in order to effectively and efficiently complete a program, the Company may provide deposits for the acquisition of property or actually purchase the property and warehouse it temporarily for the program. If the Company does not have cash on hand available to pay these deposits or fund an acquisition, the Company or the Company’s programs may be required to incur additional indebtedness, which indebtedness may not be available on acceptable terms. If the Company incurs substantial debt, the Company could lose its interests in any properties that have been provided as collateral for any secured borrowing, or the Company could lose its assets if the debt is recourse to it. In addition, the Company’s cash flow from operations may not be sufficient to repay these obligations upon their maturity, making it necessary for the Company to raise additional capital or dispose of some of its assets. The Company cannot assure you that it will be able to borrow additional debt on satisfactory terms, or at all. The Third Amendment to the Credit Agreement includes a restrictive covenant which prohibits the Company from incurring such indebtedness unless consistent with the Approved Budget without the consent of the requisite majority of lenders.

 

The Company may be required to repay loans the Company guaranteed that were used to finance properties acquired by the Company’s programs.

 

From time to time the Company has provided guarantees of loans for properties under management. As of December 31, 2008, there were 151 properties under management with loan guarantees of approximately $3.5 billion in total principal outstanding with terms ranging from 1 to 10 years, secured by properties with a total aggregate purchase price of approximately $4.8 billion as of December 31, 2008. The Company’s guarantees consisted of the following as of December 31, 2008. In addition, the consolidated variable interest entities (“VIEs”) and unconsolidated VIEs are jointly and severally liable on the non-recourse mortgage debt related to the interests in the Company’s TIC investments totaling $277.8 million and $385.3 million as of December 31, 2008, respectively.

 

 

 

 

As property values and performance decline, the risk of exposure under these guarantees increases. Management evaluates these guarantees to determine if the guarantee meets the criteria required to record a liability in accordance with Financial Accounting Standards Board (“FASB”) Financial Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN No. 45”). As of December 31, 2008, the Company recorded a liability of $9.1 million related to recourse guarantees of debt of properties under management which matured in January and April 2009. Any other such liabilities were insignificant as of December 31, 2008 and 2007. The Third Amendment to the Credit Facility includes a restrictive covenant which prohibits the Company from providing any additional guarantees unless consistent with the Approved Budget without the consent of the requisite majority of lenders.

The revenue streams from the Company’s management services may be subject to limitation or cancellation.

 

The agreements under which the Company provides advisory and management services to public non-traded REITs may generally be terminated by each REIT following a notice period, with or without cause. The Company cannot assure you that these agreements will not be terminated and the board of directors and management of Grubb & Ellis Healthcare REIT has informed the Company that it does not intend to renew its Advisory Agreement with the Grubb & Ellis Healthcare REIT Advisor, LLC, a subsidiary of the Company, upon the termination of the Advisory Agreement on September 20, 2009. In addition, if the Company has a significant amount of TIC Programs selling their properties or public non-traded REITs liquidating in the same period, the Company’s revenues would decrease unless it is able to find replacement programs to generate new fees. The Company is currently in the process of liquidating two of its public non-traded REITs and, as a result, the Company’s management fees from these REITs have been reduced due to the number of properties that have been sold. Any decrease in the Company’s fees, as a result of termination of a contract or customary close out or liquidation of a program, could have a material adverse effect on the Company’s business, results of operations and financial condition.

 

Future pressures to lower, waive or credit back the Company’s fees could reduce the Company’s revenue and profitability.

 

The Company has on occasion waived or credited its fees for real estate acquisitions and financings for the Company’s TIC Programs to improve projected investment returns and attract TIC investors. There has also been a trend toward lower fees in some segments of the third-party asset management business, and fees paid for the management of properties in the Company’s TIC Programs or public non-traded REITs could follow these trends. In order for the Company to maintain its fee structure in a competitive environment, the Company must be able to provide clients with investment returns and service that will encourage them to be willing to pay such fees. The Company cannot assure you that it will be able to maintain its current fee structures. Fee reductions on existing or future new business could have a material adverse impact on the Company’s revenue and profitability.

 

Regulatory uncertainties related to the Company’s broker-dealer services could harm the Company’s business.

 

The securities industry in the United States is subject to extensive regulation under both federal and state laws. Broker-dealers are subject to regulations covering all aspects of the securities business. The SEC, FINRA, and other self-regulatory organizations and state securities commissions can censure, fine, issue cease-and-desist orders to, suspend or expel a broker-dealer or any of its officers or employees. The ability to comply with applicable laws and rules is largely dependent on an internal system to ensure compliance, as well as the ability to attract and retain qualified compliance personnel. The Company could be subject to disciplinary or other actions in the future due to claimed noncompliance with these securities regulations, which could have a material adverse effect on the Company’s operations and profitability.

 

The Company depends upon its programs’ tenants to pay rent, and their inability to pay rent may substantially reduce certain fees the Company receives which are based on gross rental amounts.

 

The Company’s programs are subject to varying degrees of risk that generally arise from the ownership of real estate. For example, the income the Company is able to generate from management fees is derived from the gross rental income on the properties in its programs. The rental income depends upon the ability of the tenants of the Company’s programs’ properties to generate enough income to make their lease payments to the Company. Changes beyond the Company’s control may adversely affect the tenants’ ability to make lease payments or could require them to terminate their leases. Either an inability to make lease payments or a termination of one or more leases could reduce the management fees the Company receives. These changes include, among others, the following:

 

 

 

Due to these changes, among others, tenants and lease guarantors, if any, may be unable to make their lease payments.

 

Defaults by tenants or the failure of any lease guarantors to fulfill their obligations, or other early termination of a lease could, depending upon the size of the leased premises and the Company’s ability as property manager to successfully find a substitute tenant, have a material adverse effect on the Company’s revenue.

 

Conflicts of interest inherent in transactions between the Company’s programs and the Company, and among its programs, could create liability for the Company that could have a material adverse effect on its results of operations and financial condition.

 

These conflicts include but are not limited to the following:

 

 

The Company cannot assure you that one or more of these conflicts will not result in claims by investors in its programs, which could have a material adverse effect on its results of operations and financial condition.

 

The offerings conducted to raise capital for the Company’s TIC Programs are done in reliance on exemptions from the registration requirements of the Securities Act. A failure to satisfy the requirements for the appropriate exemption could void the offering or, if it is already completed, provide the investors with rescission rights, either of which would have a material adverse effect on the Company’s reputation and as a result its business and results of operations.

 

The securities of the Company’s TIC Programs are offered and sold in reliance upon a private placement offering exemption from registration under the Securities Act and applicable state securities laws. If the Company or its dealer-manager failed to comply with the requirements of the relevant exemption and an offering were in process, the Company may have to terminate the offering. If an offering was completed, the

investors may have the right, if they so desired, to rescind their purchase of the securities. A rescission offer could also be required under applicable state securities laws and regulations in states where any securities were offered without registration or qualification pursuant to a private offering or other exemption. If a number of holders sought rescission at one time, the applicable program would be required to make significant payments which could adversely affect its business and as a result, the fees generated by the Company from such program. If one of the Company’s programs was forced to terminate an offering before it was completed or to make a rescission offer, the Company’s reputation would also likely be significantly harmed. Any reduction in fees as a result of a rescission offer or a loss of reputation would have a material adverse effect on the Company’s business and results of operations.

 

The inability to identify suitable refinance options may negatively impact investment program performance and cause harm to the Company’s reputation, cause the loss of management contracts and third-party broker-dealer selling agreements, limit the Company’s ability to sign future third-party broker-dealer selling agreements and potentially expose the Company to legal liability.

 

The availability of real estate financing has greatly diminished over the past year as a result of the global credit crisis and overall decline in the real estate market. As a result, the Company may not be able to refinance some or all of the loans maturing in its investment management portfolio. Failure to obtain suitable refinance options may have a negative impact on investment returns and may potentially cause investments to go into foreclosure or result in a complete loss of equity for program investors. Any such negative impact on distributions, foreclosure or loss of equity in an investment program could adversely affect the Company’s reputation and the Company’s ability to attract investors for future investment programs. In addition, it could cause the Company to lose asset and property management contracts, cause the Company to lose third-party broker-dealer selling agreements for existing investment programs, including its REITs, and limit the Company’s ability to sign future third-party broker-dealer agreements. Significant losses in investor equity and reductions in distributions increases the risk of claims or legal actions by program investors. Any such legal liability could result in damage to the Company’s reputation, loss of third-party broker-dealer selling agreements and incurrence of legal expenses.

 

An increase in interest rates may negatively affect the equity value of the Company’s programs or cause the Company to lose potential investors to alternative investments, causing the fees the Company receives for transaction and management services to be reduced.

 

Although in the last two years, interest rates in the United States have generally decreased, if interest rates were to rise, the Company’s financing costs would likely rise and the Company’s net yield to investors may decline. This downward pressure on net yields to investors in the Company’s programs could compare poorly to rising yields on alternative investments. Additionally, as interest rates rise, valuations of commercial real estate properties typically decline. A decrease in both the attractiveness of the Company’s programs and the value of assets held by these programs could cause a decrease in both transaction and management services revenues, which would have an adverse effect on the Company’s results of operations.

 

Increasing competition for the acquisition of real estate may impede the Company’s ability to make future acquisitions which would reduce the fees the Company generates from these programs and could adversely affect the Company’s operating results and financial condition.

 

The commercial real estate industry is highly competitive on an international, national and regional level. The Company’s programs face competition from REITs, institutional pension plans, and other public and private real estate companies and private real estate investors for the acquisition of properties and for raising capital to create programs to make these acquisitions. Competition may prevent the Company’s programs from acquiring desirable properties or increase the price they must pay for real estate. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase, resulting in increased demand and increased prices paid for these properties. If the Company’s programs pay higher prices for properties, investors may experience a lower return on investment and be less inclined to invest in the Company’s next program which may decrease the Company’s profitability. Increased competition for properties may also preclude the Company’s programs from acquiring properties that would generate the most

attractive returns to investors or may reduce the number of properties the Company’s programs could acquire, which could have an adverse effect on the Company’s business.

 

Illiquidity of real estate investments could significantly impede the Company’s ability to respond to adverse changes in the performance of the Company’s programs’ properties and harm the Company’s financial condition.

 

Because real estate investments are relatively illiquid, the Company’s ability to promptly facilitate a sale of one or more properties or investments in the Company’s programs in response to changing economic, financial and investment conditions may be limited. In particular, these risks could arise from weakness in the market for a property, changes in the financial condition or prospects of prospective purchasers, changes in regional, national or international economic conditions, and changes in laws, regulations or fiscal policies of jurisdictions in which the property is located. Fees from the disposition of properties would be materially affected if the Company were unable to facilitate a significant number of property dispositions for the Company’s programs.

 

Uninsured and underinsured losses may adversely affect operations.

 

Should a property sustain damage or an occupant sustain an injury, the Company may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. In the event of a substantial property loss or personal injury, the insurance coverage may not be sufficient to pay the full damages. In the event of an uninsured loss, the Company could lose some or all of its capital investment, cash flow and anticipated profits related to one or more properties. Inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it not feasible to use insurance proceeds to replace a property after it has been damaged or destroyed. Under these circumstances, the insurance proceeds the Company receives, if any, might not be adequate to restore the Company’s economic position with respect to the property. In the event of a significant loss at one or more of the properties in the Company’s programs, the remaining insurance under the applicable policy, if any, could be insufficient to adequately insure the remaining properties. In this event, securing additional insurance, if possible, could be significantly more expensive than the current policy. A loss at any of these properties or an increase in premium as a result of a loss could decrease the income from or value of properties under management in the Company’s programs, which in turn would reduce the fees the Company receives from these programs. Any decrease or loss in fees could have a material adverse effect on the Company’s financial condition or results of operations.

 

The Company carries commercial general liability, fire and extended coverage insurance with respect to the Company’s programs’ properties. The Company obtains coverage that has policy specifications and insured limits that the Company believes are customarily carried for similar properties. The Company cannot assure you, however, that particular risks that are currently insurable will continue to be insurable on an economic basis or that current levels of coverage will continue to be available. In addition, the Company generally does not obtain insurance against certain risks, such as floods.

 

Risks Related to the Company in General

 

Delaware law and provisions of the Company’s amended and restated certificate of incorporation and restated bylaws contain provisions that could delay, deter or prevent a change of control.

 

The anti-takeover provisions of Delaware law impose various impediments on the ability or desire of a third party to acquire control of the Company, even if a change of control would be beneficial to its existing stockholders, and the Company will be subject to these Delaware anti-takeover provisions. Additionally, the Company’s amended and restated certificate of incorporation and its restated bylaws contain provisions that might enable its management to resist a proposed takeover of the Company. The provisions include:

 

 

 

These provisions could discourage, delay or prevent a change of control of the Company or an acquisition of the Company at a price that its stockholders may find attractive. These provisions also may discourage proxy contests and make it more difficult for the Company’s stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of the Company’s common stock.

 

As a consequence the amendments to the Company’s amended and restated certificate of incorporation adopted in connection with the Merger, the Company has a staggered board, which may entrench management and discourage unsolicited stockholder proposals that may be deemed to be in the best interests of stockholders.

 

The Company’s amended and restated certificate of incorporation provides that its board of directors be divided into three classes, each of which will generally serve for a term of three years with only one class of directors being elected in each year. As a result, at any annual meeting, only a minority of the board of directors will be considered for election. Since the Company’s staggered board would prevent its stockholders from replacing a majority of its board of directors at any annual meeting, it may entrench management and discourage unsolicited stockholder proposals that may be deemed to be in the best interests of stockholders.

 

The Company has the ability to issue blank check preferred stock, which could adversely affect the voting power and other rights of the holders of its common stock.

 

The Company does not currently have any issued and outstanding preferred stock. However, the board of directors has the right to issue “blank check” preferred stock, which may affect the voting rights of holders of common stock and could deter or delay an attempt to obtain control of the Company. There are ten million shares of preferred stock authorized. Subject to the requisite lender approval under the Credit Facility, the Company’s board of directors is authorized, without any further stockholder approval, to issue one or more additional series of preferred stock. The Company is authorized to fix and state the voting rights, powers, designations, preferences and relative participation or other special rights of each such series of preferred stock and any qualifications, limitations and restrictions thereon. Preferred stock typically ranks prior to the common stock with respect to dividend rights, liquidation preferences, or both, and may have full, limited, or expanded voting rights. Accordingly, issuances of preferred stock could adversely affect the voting power and other rights of the holders of common stock and could negatively affect the market price of the Company’s common stock.

 

The Company has registration rights outstanding, which could have a negative impact on its share price if exercised.

 

Pursuant to the Company’s registration rights agreement with Kojaian Ventures, L.L.C. and Kojaian Holdings, LLC, and the registration rights of the holders of Warrants issued to the lenders under the Company’s Credit Facility, the holders of such rights could, in the future, cause the Company to file additional registration statements with respect to its shares of common stock, which could have a negative impact on the market price of the Company’s common stock.

 

Future sales of the Company’s common stock could adversely affect its stock price

 

The Company issued the Warrants to its lenders in connection with the execution of the Third Amendment to its Credit Facility. The Warrants are exercisable for nominal consideration to purchase that number of shares of common stock of the Company which equal 15% of the fully diluted common stock of the Company as of October 1, 2009, subject to adjustment and are entitled to certain registration rights. The Warrants are not exercisable until such date (and remain exercisable until September 30, 2019), and in the event the Company effects the Recapitalization Plan and the Partial Prepayment on or before September 30, 2009, the warrants shall automatically terminate and become null and void. The issuance of shares of common stock of the Company upon exercise of the Warrants could materially adversely impact the market price of the Company’s common stock.

In addition, there are an aggregate of 1,077,175 Company shares subject to issuance upon the exercise of outstanding options. Accordingly, these shares will be available for sale in the open market, subject to vesting restrictions, and, in the case of affiliates, certain volume limitations. The sale of shares either pursuant to the exercise of outstanding options or as after the satisfaction of vesting restriction of certain restricted stock could also cause the price of the Company’s common stock to decline.

 

 

Not Applicable

 

 

The Company leases all of its office space through non-cancelable operating leases. The terms of the leases vary depending on the size and location of the office. As of December 31, 2008, the Company leased over 747,000 square feet of office space in 73 locations under leases which expire at various dates through June 30, 2020. For those leases that are not renewable, the Company believes that there are adequate alternatives available at acceptable rental rates to meet its needs, although there can be no assurances in this regard. Many of our offices that contain employees of the Transaction Services, Investment Management or Management Services segments also contain employees of other segments. The Company’s Corporate Headquarters are in Santa Ana, California. See Note 20 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information, which is incorporated herein by reference.

 

 

On September 16, 2004, Triple Net Properties, LLC (which was re-named Grubb & Ellis Realty Investors, LLC (“GERI”) after the Merger), learned that the SEC Staff was conducting an investigation referred to as “In the matter of Triple Net Properties, LLC.” The SEC Staff requested information from Triple Net Properties relating to disclosure in the Triple Net Securities Offerings. The SEC Staff also requested information from NNN Capital Corp. (which was re-named GBE Securities after the Merger), the dealer-manager for the Triple Net securities offerings. The SEC Staff requested financial and other information regarding the Triple Net securities offerings and the disclosures included in the related offering documents from each of Triple Net Properties and NNN Capital Corp.

 

On June 2, 2008, the Company was notified by the SEC Staff that the SEC closed the investigation without any enforcement action against the Company or its subsidiaries. As a result, the shares of common stock owned by Mr. Thompson, the founder of Triple Net Properties and the former Chairman of the Company that were being held in the escrow account pending the outcome of the SEC investigation were returned to Mr. Thompson and the escrow agreement was terminated.

 

General

 

Grubb & Ellis and its subsidiaries are involved in various claims and lawsuits arising out of the ordinary conduct of its business, as well as in connection with its participation in various joint ventures and partnerships, many of which may not be covered by the Company’s insurance policies. In the opinion of management, the eventual outcome of such claims and lawsuits is not expected to have a material adverse effect on the Company’s financial position or results of operations.

 

The Company held its Annual Meeting of Stockholders on December 3, 2008 (the “Annual Meeting”). At the Annual Meeting, the Company’s stockholders voted upon each of the following matters:

 

1. The election of three (3) Class A directors, each to serve for a term of three (3) years expiring in 2011 and until their successors are elected and qualified, for which our Board of Directors nominated Harold H. Greene, Devin I. Murphy and D. Fleet Wallace for election at the Annual Meeting;

 

2. The ratification of the appointment, by the Board of Directors, of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2008;

 

3. A proposal submitted by a stockholder to adopt a resolution to amend the Amended and Restated Bylaws of the Company to require the Company to hold the Annual Meeting on December 3, 2008 and to prevent the Company from delaying such meeting to a later date; and

 

4. A proposal submitted by a stockholder to adopt a resolution to amend the Amended and Restated Bylaws of the Company to require stockholder approval for adjournment of a stockholder meeting at which a quorum is present.

 

With respect to matter number 1, each of Harold H. Greene, Devin I. Murphy and D. Fleet Wallace were elected to serve for a term of three (3) years expiring in 2011 and until their successors are elected and qualified. The results of the election are below:

 

 

In addition, each of Glenn L. Carpenter, Gary H. Hunt, C. Michael Kojaian, Robert J. McLaughlin and Rodger D. Young continue to serve on the Board in accordance with their respective terms.

 

With respect to matter number 2: 54,145,810 votes were cast in favor; 125,647 votes were cast against; there were 49,736 abstentions; and there were no broker non-votes.

 

With respect to matter number 3: 20,912,450 votes were cast in favor; 11,464,320 votes were cast against; there were 21,944,423 abstentions; and there were no broker non-votes. Accordingly, since a majority of all issued and outstanding shares as of the record date for the Annual Meeting (of which there were 64,628,798 shares) voting in favor of this proposal was required for this proposal to be approved, the proposal was defeated.

 

With respect to matter number 4: 30,522,726 votes were cast in favor; 23,673,747 votes were cast against; there were 124,720 abstentions; and there were no broker non-votes. Accordingly, since a majority of all issued and outstanding shares as of the record date for the Annual Meeting (of which there were 64,628,798 shares) voting in favor of this proposal was required for this proposal to be approved, the proposal was defeated.

GRUBB & ELLIS COMPANY

PART II

 

 

Market and Price Information

 

The principal market for the Company’s common stock is the NYSE. The following table sets forth the high and low sales prices of the Company’s common stock on the respective market for each quarter of the years ended December 31, 2008 and 2007.

 

 

As of May 15, 2009, there were 1,071 registered holders of the Company’s common stock and 65,265,828 shares of common stock outstanding. Sales of substantial amounts of common stock, including shares issued upon the exercise of warrants or options, or the perception that such sales might occur, could adversely affect prevailing market prices for the common stock.

 

The Company declared first and second quarter cash dividends in 2008 for an aggregate of $0.2050 per share for the year. On July 11, 2008, the Company’s Board of Directors approved the suspension of future dividend payments. Legacy NNN declared aggregate quarterly cash dividends in 2007 of $0.33 per share and the Company declared a fourth quarter cash dividend in 2007 of $0.03 for an aggregate of $0.36 per share in cash dividends for the year.

 

Sales of Unregistered Securities

 

During 2008, the Company implemented a deferred compensation plan that allows for the granting of “phantom” shares of company stock to participants under a deferred compensation plan arrangement. These awards vest over three to five years. Vested phantom stock awards are paid according to distribution elections made by the participants at the time of vesting and are expected to be settled by the Company purchasing shares of Company common stock in the open market from time to time and delivering such shares to the participant. During 2008, the Company awarded an aggregate of 5.4 million phantom shares to certain employees with an aggregate value on the various grant dates of $22.5 million. On December 31, 2008, an aggregate of 5.2 million phantom share grants were outstanding. Generally, upon vesting, recipients of the grants are entitled to receive the number of phantom shares granted, regardless of the value of the shares upon the date of vesting; provided, however, grants with respect to 900,000 phantom shares had a guaranteed minimum share price ($3.1 million in the aggregate) that will result in the Company paying additional compensation to the participants should the value of the shares upon vesting be less than the grant date value of the shares.

 

The issuances by the Company of the “phantom” share awards in the transactions described above were exempt from the registration requirements of Section 5 of the Securities Act pursuant to Section 4(2) of the Securities Act, as amended, as such transactions did not involve a public offering by the Company.

Equity Compensation Plan Information

 

The following table provides information on equity compensation plans of the Company as of December 31, 2008.

 

 

Grubb & Ellis Stock Performance

 

This section entitled, “Grubb & Ellis Stock Performance” is not to be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C or to the liabilities of Section 18 of the Exchange Act, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into any filing under the Securities Act or the Exchange Act.

 

The graph below matches the cumulative 66-month total return to shareholders on Grubb & Ellis Company’s common stock versus the cumulative total returns of the S&P 500 index, and a customized peer group of three companies that includes: CB Richard Ellis Group Inc, Grubb & Ellis Company and Jones Lang Lasalle Inc. The graph assumes that the value of the investment in the company’s common stock, in the peer group, and the S&P 500 index (including reinvestment of dividends) was $100 on 6/30/2003 and tracks it through 12/31/2008.

COMPARISON OF 66 MONTH CUMULATIVE TOTAL RETURN*
Among Grubb & Ellis Company, The S&P 500 Index
And A Peer Group

 

 

*$100 invested on 6/30/03 in stock & index-including reinvestment of dividends. Fiscal year ended December 31.

 

Copyright ^© 2009 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

The following tables set forth the selected historical consolidated financial data for Grubb & Ellis and its subsidiaries, as of and for the years ended, December 31, 2008, 2007 (restated), 2006 (restated), 2005 (restated), and 2004 (restated). GERI (formerly Triple Net Properties) was the accounting acquirer of Realty and NNN Capital Corp. The selected historical consolidated financial data as of and for the years ended December 31, 2008, 2007 (restated) and 2006 (restated) has been derived from the audited financial statements included in Item 8. of this Report. The selected historical financial data as of and for the years ended December 31, 2005 (restated) and 2004 (restated) have been derived from the audited consolidated financial statements not included in this Report. Historical results are not necessarily indicative of the results that may be expected for any future period.

 

The selected historical consolidated financial data for the years ended December 31, 2007 (restated), 2006 (restated), 2005 (restated) and 2004 (restated) has been restated to correct accounting errors related to the timing of revenue recognition relating to certain tenant-in-common investment programs sponsored by GERI and the consolidation of certain entities that should have been consolidated into the Company’s financial statements as described in Item 8, Note 3 to the consolidated financial statements. The selected historical consolidated financial data set forth below should be read in conjunction with Item 7 and the consolidated financial statements.

 

The impact of the restatement on fiscal year 2007 resulted in an increase in net income of $230,000, or less than $.01 per basic and diluted share, an increase in total assets of $12.1 million, an increase in total liabilities of $5.5 million and an increase in minority interest liability of $11.2 million. The impact of the restatement on fiscal year 2006 resulted in an increase in net income of $3.9 million, or $0.19 per basic and diluted share, a increase in total assets of $19.7 million, an increase in total liabilities of $18.1 million and an increase in minority interest liability of $6.3 million. The impact of the restatement resulted on fiscal year 2005 resulted in a decrease in net income of $8.1 million, or $0.47 per basic and diluted share, an increase in total assets of $39.7 million, an increase in total liabilities of $47.4 million and an increase in minority interest liability of $993,000. The impact of the restatement on fiscal year 2004 resulted in an decrease in net income of $619,000, or $0.04 per basic and diluted share and an increase in total liabilities of $619,000.

 

 

 

 

 

 

Note Regarding Forward-Looking Statements

 

The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the restatement of previously issued financial statements, as discussed in Item 8, Note 3 to the consolidated financial statements.

 

This Annual Report contains statements that are forward-looking and as such are not historical facts. Rather, these statements constitute projections, forecasts or forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You should not place undue reliance on these statements. Forward-looking statements include information concerning the Company’s liquidity and possible or assumed future results of operations, including descriptions of the Company’s business strategies. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” “seek,” “will,” “may” or similar expressions. These statements are based on certain assumptions that the Company has made in light of its experience in the industry as well as its perceptions of the historical trends, current conditions, expected future developments and other factors the Company believes are appropriate under these circumstances.

 

All such forward-looking statements speak only as of the date of this Annual Report. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

As you read this Annual Report, you should understand that these statements are no guarantees of performance or results. They involve risks, uncertainties and assumptions. You should understand the risks and uncertainties discussed in “Item 1A — Risk Factors” and elsewhere in this Annual Report, could affect the Company’s actual financial results and could cause actual results to differ materially from those expressed in the forward-looking statements. Some important factors include, but are not limited to:

 

 

 

Overview and Background

 

The Company is a commercial real estate services and investment management firm. The Merger was accounted for using the purchase method of accounting based on accounting principles generally accepted in the United States (“GAAP”) and as such, although structured as a reverse merger, NNN is considered the acquirer of legacy Grubb & Ellis. As a consequence, the operating results for the twelve months ended December 31, 2008 reflect the consolidated results of the Company as a result of the Merger, while the twelve months ended December 31, 2007 includes the full year operating results of legacy NNN and the operating results of legacy Grubb & Ellis for the period from December 8, 2007 through December 31, 2007. The year ended December 31, 2006 includes solely the operating results of legacy NNN.

 

Unless otherwise indicated, all pre-Merger legacy NNN share data have been adjusted to reflect the conversion as a result of the Merger (see Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information).

 

Critical Accounting Policies

 

The Company’s consolidated financial statements have been prepared in accordance with GAAP. Certain accounting policies are considered to be critical accounting policies, as they require management to make assumptions about matters that are highly uncertain at the time the estimate is made and changes in the accounting estimate are reasonably likely to occur from period to period. The Company believes that the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Revenue Recognition

 

Transaction Services

 

Real estate sales commissions are recognized when earned which is typically the close of escrow. Receipt of payment occurs at the point at which all Company services have been performed, and title to real property has passed from seller to buyer, if applicable. Real estate leasing commissions are recognized upon execution of appropriate lease and commission agreements and receipt of full or partial payment, and, when payable upon certain events such as tenant occupancy or rent commencement, upon occurrence of such events. All other commissions and fees are recognized at the time the related services have been performed and delivered by the Company to the client, unless future contingencies exist.

 

Investment Management

 

The Company earns fees associated with its transactions by structuring, negotiating and closing acquisitions of real estate properties to third-party investors. Such fees include acquisition fees for locating and acquiring the property and selling it to various TIC investors, REITs and its various real estate funds. The Company accounts for acquisition and loan fees in accordance with AICPA Statement of Position 92-1 (“SOP 92-1”), Accounting for Real Estate Syndication Income , and Statement of Financial Accounting

Standards No. 66 (“SFAS No. 66”), Accounting for Sales of Real Estate . In general, the Company records the acquisition and loan fees upon the close of sale to the buyer if the buyer is independent of the seller, collection of the sales price, including the acquisition fees and loan fees, is reasonably assured, and the Company is not responsible for supporting operations of the property. Organizational marketing expense allowance (“OMEA”), fees are earned and recognized from gross proceeds of equity raised in connection with offerings and are used to pay formation costs, as well as organizational and marketing costs. When the Company does not meet the criteria for revenue recognition under SFAS No. 66 and SOP 92-1, revenue is deferred until revenue can be reasonably estimated or until the Company defers revenue up to its maximum exposure to loss. The Company earns disposition fees for disposing of the property on behalf of the REIT, investment fund or TIC. The Company recognizes the disposition fee when the sale of the property closes. The Company is entitled to loan advisory fees for arranging financing related to properties under management.

 

The Company earns captive asset and property management fees primarily for managing the operations of real estate properties owned by the real estate programs, REITs and limited liability companies that invest in real estate or value funds it sponsors. Such fees are based on pre-established formulas and contractual arrangements and are earned as such services are performed. The Company is entitled to receive reimbursement for expenses associated with managing the properties; these expenses include salaries for property managers and other personnel providing services to the property. Each property in the Company’s TIC Programs may also be charged an accounting fee for costs associated with preparing financial reports. The Company is also entitled to leasing commissions when a new tenant is secured and upon tenant renewals. Leasing commissions are recognized upon execution of leases.

 

Through its dealer-manager, the Company facilitates capital raising transactions for its programs its dealer-manager acts as a dealer-manager exclusively for the Company’s programs and does not provide securities services to any third party. The Company’s wholesale dealer-manager services are comprised of raising capital for its programs through its selling broker-dealer relationships. Most of the commissions, fees and allowances earned for its dealer-manager services are passed on to the selling broker-dealers as commissions and to cover offering expenses, and the Company retains the balance. Accordingly, the Company records these fees net of the amounts paid to its selling broker-dealer relationships.

 

Management Services

 

Management fees are recognized at the time the related services have been performed by the Company, unless future contingencies exist. In addition, in regard to management and facility service contracts, the owner of the property will typically reimburse the Company for certain expenses that are incurred on behalf of the owner, which are comprised primarily of on-site employee salaries and related benefit costs. The amounts which are to be reimbursed per the terms of the services contract, are recognized as revenue by the Company in the same period as the related expenses are incurred. In certain instances, the Company sub contracts its property management services to independent property managers, in which case the Company passes a portion of their property management fee on to the sub contractor, and the Company retains the balance. Accordingly, the Company records these fees net of the amounts paid to its sub contractors.

 

Basis of Presentation and Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned controlled subsidiaries’ variable interest entities (“VIEs”) in which the Company is the primary beneficiary and partnerships/LLCs in which the Company is the managing member or general partner and the other partners/members lack substantive rights (hereinafter collectively referred to as the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. For acquisitions of an interest in an entity or newly formed joint venture or limited liability company, the Company evaluates the entity to determine if the entity is deemed a VIE, and if the Company is deemed to be the primary beneficiary, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN No. 46(R)”).

 

The Company consolidates entities that are VIEs when the Company is deemed to be the primary beneficiary of the VIE. For entities in which (i) the Company is not deemed to be the primary beneficiary,

(ii) the Company’s ownership is 50.0% or less and (iii) the Company has the ability to exercise significant influence, the Company uses the equity accounting method (i.e. at cost, increased or decreased by the Company’s share of earnings or losses, plus contributions less distributions). The Company also uses the equity method of accounting for jointly-controlled tenant-in-common interests. As events occur, the Company will reconsider its determination of whether an entity is a VIE and who the primary beneficiary is to determine if there is a change in the original determinations and will report such changes on a quarterly basis.

 

Purchase Price Allocation

 

In accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations (“SFAS 141”), the purchase price of acquired properties is allocated to tangible and identified intangible assets and liabilities based on their respective fair values. The allocation to tangible assets (building and land) is based upon determination of the value of the property as if it were vacant using discounted cash flow models similar to those used by independent appraisers. Factors considered include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. Additionally, the purchase price of the applicable property is allocated to the above or below market value of in-place leases and the value of in-place leases and related tenant relationships.

 

The value allocable to the above or below market component of the acquired in-place leases is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) the Company’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above market leases are included in identified intangible assets and below market lease values are included in liabilities in the accompanying consolidated financial statements and are amortized to rental revenue over the weighted-average remaining term of the acquired leases with each property.

 

The total amount of identified intangible assets acquired is further allocated to in-place lease costs and the value of tenant relationships based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with that respective tenant. Characteristics considered in allocating these values include the nature and extent of the credit quality and expectations of lease renewals, among other factors. These allocations are subject to change within one year of the date of purchase based on information related to one or more events identified at the date of purchase that confirm the value of an asset or liability of an acquired property.

 

Impairment of Long-Lived Assets

 

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , long-lived assets are periodically evaluated for potential impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. In the event that periodic assessments reflect that the carrying amount of the asset exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the asset, the Company would recognize an impairment loss to the extent the carrying amount exceeded the fair value of the property. The Company estimates the fair value using available market information or other industry valuation techniques such as present value calculations. This valuation review resulted in the recognition of an impairment charge of approximately $90.4 million against the carrying value of the properties and real estate investments during the year ended December 31, 2008. No impairment losses were recognized for the years ended December 31, 2007 and 2006.

 

The Company recognizes goodwill and other non-amortizing intangible assets in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). Under SFAS No. 142, goodwill is recorded at its carrying value and is tested for impairment at least annually or more frequently if impairment indicators exist at a level of reporting referred to as a reporting unit. The Company recognizes goodwill in accordance with SFAS No. 142 and tests the carrying value for impairment during the fourth quarter of each year. The goodwill impairment analysis is a two-step process. The first step used to identify potential

impairment involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. To estimate the fair value of its reporting units, the Company used a discounted cash flow model and market comparable data. Significant judgment is required by management in developing the assumptions for the discounted cash flow model. These assumptions include cash flow projections utilizing revenue growth rates, profit margin percentages, discount rates, market/economic conditions, etc. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered to not be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment. The second step of the process involves the calculation of an implied fair value of goodwill for each reporting unit for which step one indicated a potential impairment. The implied fair value of goodwill is determined by measuring the excess of the estimated fair value of the reporting unit as calculated in step one, over the estimated fair values of the individual assets, liabilities and identified intangibles. During the fourth quarter of 2008, the Company identified the uncertainty surrounding the global economy and the volatility of the Company’s market capitalization as goodwill impairment indicators. The Company’s goodwill impairment analysis resulted in the recognition of an impairment charge of approximately $172.7 million during the year ended December 31, 2008. The Company also analyzed it’s trade name for impairment pursuant to SFAS No. 142 and determined that the trade name was not impaired as of December 31, 2008. Accordingly, no impairment charge was recorded related to the trade name during the year ended December 31, 2008. In addition to testing goodwill and it’s trade name for impairment, the Company tested the intangible contract rights for impairment during the fourth quarter of 2008. The intangible contract rights represent the legal right to future disposition fees of a portfolio of real estate properties under contract. As a result of the current economic environment, a portion of these disposition fees may not be recoverable. Based on the Company’s analysis for the current and projected property values, condition of the properties and status of mortgage loans payable, the Company determined that there are certain properties for which receipt of disposition fees was improbable. As a result, the Company recorded an impairment charge of approximately $8.6 million related to the impaired intangible contract rights as of December 31, 2008.

 

Insurance and Claim Reserves

 

The Company has maintained partially self-insured and deductible programs for, general liability, workers’ compensation and certain employee health care costs. In addition, the Company assumed liabilities at the date of the Merger representing reserves related to a self insured errors and omissions program of the acquired company. Reserves for all such programs are included in accrued claims and settlements and compensation and employee benefits payable, as appropriate. Reserves are based on the aggregate of the liability for reported claims and an actuarially-based estimate of incurred but not reported claims. As of the date of the Merger, the Company entered into a premium based insurance policy for all error and omission coverage on claims arising after the date of the Merger. Claims arising prior to the date of the Merger continue to be applied against the previously mentioned liability reserves assumed relative to the acquired company.

 

The Company is also subject to various proceedings, lawsuits and other claims related to commission disputes and environmental, labor and other matters, and is required to assess the likelihood of any adverse judgments or outcomes to these matters. A determination of the amount of reserves, if any, for these contingencies is made after careful analysis of each individual issue. New developments in each matter, or changes in approach such as a change in settlement strategy in dealing with these matters, may warrant an increase or decrease in the amount of these reserves.

 

Recently Issued Accounting Pronouncements

 

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value instruments. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (the “FSP”). The FSP amends SFAS No. 157 to delay the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). There was no effect on the Company’s consolidated financial statements as a result of the adoption of SFAS No. 157 as of January 1,

2008 as it relates to financial assets and financial liabilities. For items within its scope, the FSP defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company will adopt SFAS No. 157 as it relates to non-financial assets and non-financial liabilities in the first quarter of 2009 and does not believe adoption will have a material effect on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company adopted SFAS No. 159 on a prospective basis on January 1, 2008. The adoption of SFAS No. 159 did not have a material impact on the consolidated financial statements since the Company did not elect to apply the fair value option for any of its eligible financial instruments or other items on the January 1, 2008 effective date.

 

In December 2007, the FASB issued revised SFAS No. 141, Business Combinations, (“SFAS No. 141R”). SFAS No. 141R will change the accounting for business combinations and will require an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS No. 141R will have an impact on accounting for business combinations once adopted but the effect is dependent upon acquisitions at that time.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51, (“SFAS No. 160”). SFAS No. 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires that noncontrolling interests be presented as a component of consolidated stockholders’ equity, eliminates minority interest accounting such that the amount of net income attributable to the noncontrolling interests will be presented as part of consolidated net income in the accompanying consolidated statements of operations and not as a separate component of income and expense, and requires that upon any changes in ownership that result in the loss of control of the subsidiary, the noncontrolling interest be re-measured at fair value with the resultant gain or loss recorded in net income. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company will adopt SFAS No. 160 in the first quarter of 2009 and does not believe the adoption will have a material effect on its consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (“SFAS No. 161”). SFAS No. 161 is intended to improve financial reporting of derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 achieves these improvements by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company will adopt SFAS No. 161 in the first quarter of 2009 and does not believe the adoption will have a material effect on its consolidated financial statements.

 

In April 2008, the FASB issued FSP SFAS No. 142-3, Determination of the Useful Life of Intangible Assets, (“FSP SFAS 142-3”). FSP SFAS 142-3 is intended to improve the consistency between the useful life of recognized intangible assets under SFAS No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”), and the period of expected cash flows used to measure the fair value of the assets under SFAS No. 141R. FSP SFAS 142-3 amends the factors an entity should consider in developing renewal or

extension assumptions in determining the useful life of recognized intangible assets. In addition to the required disclosures under SFAS No. 142, FSP SFAS 142-3 requires disclosure of the entity’s accounting policy regarding costs incurred to renew or extend the term of recognized intangible assets, the weighted average period to the next renewal or extension, and the total amount of capitalized costs incurred to renew or extend the term of recognized intangible assets. FSP SFAS 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company will adopt FSP SFAS 142-3 on January 1, 2009. The adoption of FSP SFAS 142-3 is not expected to have a material impact on the consolidated financial statements.

 

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”) , which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the computation of earnings per share under the two-class method described in SFAS No. 128, Earnings per Share . FSP EITF 03-6-1, which will apply to the Company because it grants instruments to employees in share-based payment transactions that meet the definition of participating securities, is effective retrospectively for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company will adopt FSP EITF 03-6-1 in the first quarter of 2009 and does not believe the adoption will have a material effect on its consolidated financial statements.

 

In December 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) Statement of Financial Account Standards (“FAS”) No. 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4”). The purpose of this FSP is to improve disclosures by public entities and enterprises until pending amendments to SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), and FIN 46(R) are finalized and approved by the FASB. The FSP amends SFAS 140 to require public entities to provide additional disclosures about transferors’ continuing involvements with transferred financial assets. It also amends FIN 46(R) to require public enterprises to provide additional disclosures about their involvement with variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for financial statements issued for fiscal years and interim periods ending after December 15, 2008. For periods after the initial adoption date, comparative disclosures are required. The Company adopted the FSP and FIN 46(R)-8 on December 31, 2008.

 

RESULTS OF OPERATIONS

 

Overview

 

The Company reported revenue of $611.8 million for the year ended December 31, 2008, compared with revenue of $217.9 million for the same period of 2007. Approximately $442.0 million of the increase was attributed to a full year of results from the Transaction Services and Management Services businesses. The remaining decrease of $48.1 million was attributed to a net decrease of $48.1 million in Investment Management revenue. The decrease in revenue as compared to the prior year period can be attributed to lower acquisition fees as a result of less tenant-in-common equity raise and lower disposition fees, only partially offset by an increase in acquisition fees related to our public non-traded REITs as a result of a significant increase in equity raised. Additionally, $6.8 million of property management fees related to captive management programs were recorded in management services revenue as the property management related to those programs was transferred subsequent to the Merger. The Company completed a total of 50 acquisitions and 9 dispositions on behalf of the investment programs it sponsors at values of approximately $1.2 billion and $225.8 million, respectively, during the year ended December 31, 2008. The net acquisitions from the Investment Management business allowed the Company to grow its captive assets under management by approximately 17.5% from $5.8 billion as of December 31, 2007 to $6.8 billion as of December 31, 2008.

 

The net loss for the year ended December 31, 2008 was $330.9 million, or $5.21 per diluted share, and included a non-cash charge of $181.3 million for goodwill and intangible assets impairment, a non-cash charge of $90.4 million for real estate related impairments (of which $32.9 million was recorded in the fourth quarter), a $28.0 million charge, $18.9 million of which is non-cash, which includes an allowance for bad debt

on related party receivables and advances and an expected loss on the sale of two properties under management for which the Company has a recourse obligation, a second quarter non-cash charge of $8.9 million for depreciation and amortization related to the reclassification of five assets held for sale to assets held for investment, a first quarter net write-off of its investment in GERA of $5.8 million and $14.7 million of merger and integration related costs. In addition, the year-to-date results included approximately $11.7 million of stock-based compensation, $1.2 million for amortization of contract rights and other identified intangible assets and $1.8 million of recognized loss on marketable equity securities.

 

As of September 30, 2008, the Company initiated a plan to sell the properties it classified as real estate held for investment in its financial statements as of September 30, 2008. As of December 31, 2008, the Company had a covenant within its Credit Facility which required the sale of certain of these assets before March 31, 2009. The downturn in the global capital markets significantly lessened the probability that the Company would be able to achieve relief from this covenant through amendment or other financial resolutions by March 31 2009. Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company assessed the value of the assets. In addition, the Company reviewed the valuation of its other owned properties and real estate investments. This valuation review resulted in the Company recognizing an impairment charge of approximately $90.4 million against the carrying value of the properties and real estate investments as of December 31, 2008.

 

As a result of the Merger in December 2007, the newly combined Company’s operating segments were evaluated for reportable segments. The legacy NNN reportable segments were realigned into a single operating and reportable segment called Investment Management. This realignment had no impact on the Company’s consolidated balance sheet, results of operations or cash flows.

 

The Company reports its revenue by three operating business segments in accordance with the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information . Transaction Services, which comprises its real estate brokerage operations; Investment Management which includes providing acquisition, financing and disposition services with respect to its programs, asset management services related to its programs, and dealer-manager services by its securities broker-dealer, which facilitates capital raising transactions for its TIC, REIT and other investment programs; and Management Services, which includes property management, corporate facilities management, project management, client accounting, business services and engineering services for unrelated third parties and the properties owned by the programs it sponsors. Additional information on these business segments can be found in Note 18 of Notes to Consolidated Financial Statements in Item 8 of this Report.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

The following summarizes comparative results of operations for the periods indicated.

 

 

 

 

Revenue

 

Transaction Services Revenue

 

The Company earns revenue from the delivery of transaction and management services to the commercial real estate industry. Transaction fees include commissions from leasing, acquisition and disposition, and agency leasing assignments as well as fees from appraisal and consulting services. Management fees, which include reimbursed salaries, wages and benefits, comprise the remainder of the Company’s Transaction Services revenue, and include fees related to both property and facilities management outsourcing as well as project management and business services.

 

The Transaction services segment was acquired from the legacy Grubb & Ellis on December 7, 2007 which includes brokerage commission, valuation and consulting revenue. As of December 31, 2008, legacy Grubb & Ellis had 814 brokers, down from 927 as of December 31, 2007.

 

Investment Management Revenue

 

Investment management revenue of $101.6 million for the year ended December 31, 2008, which includes transaction, captive management and dealer-manager businesses, was comprised primarily of transaction fees of $43.4 million, asset and property management fees of $38.0 million and dealer-manager fees of $15.1 million.

 

Transaction related fees decreased $39.8 million, or 47.8%, to $43.4 million for the year ended December 31, 2008, compared to approximately $83.2 million for the same period in 2007. The year-over-year decrease in transaction fees was primarily due to decreases of $14.6 million in real estate acquisition fees, $13.5 million in real estate disposition fees, $5.0 million in OMEA fees, and $6.6 million in other transaction related fees.

 

Acquisition fees decreased approximately $14.6 million, or 31.3%, to $32.1 million for the year ended December 31, 2008, compared to approximately $46.7 million for the same period in 2007. The year-over-year decrease in acquisition fees was primarily attributed to a decrease of approximately $19.1 million in fees earned from the Company’s TIC Programs and a decrease of approximately $2.8 million in fees earned from the Company’s other real estate funds and joint ventures, partially offset by an increase of $3.1 million from the non-traded REIT programs and $4.2 million from Private Client Management. During the year ended December 31, 2008, the Company acquired 50 properties on behalf of its sponsored programs for an approximate aggregate total of $1.2 billion, compared to 77 properties for an approximate aggregate total of $2.0 billion during the same period in 2007.

 

Disposition fees decreased approximately $13.5 million, or 74.5%, to approximately $4.6 million for the year ended December 31, 2008, compared to approximately $18.2 million for the same period in 2007. The decrease reflects lower sales volume and lower sales values due to current market conditions. Fees on dispositions as a percentage of aggregate sales price was 2.6% for the year ended December 31, 2008, compared to 2.4% for the same period in 2007, primarily due to a change in the mix of properties sold. Offsetting the disposition fees during the year ended December 31, 2008 and 2007 was $1.2 million and $3.2 million, respectively, of amortization of identified intangible contract rights associated with the acquisition of Realty as they represent the right to future disposition fees of a portfolio of real properties under contract.

 

OMEA fees decreased approximately $5.0 million, or 54.3%, to $4.2 million for the year ended December 31, 2008, compared to approximately $9.1 million for the same period in 2007. OMEA fees as a percentage of equity raised for the year ended December 31, 2008 was 2.4%, compared to 2.0% for the same period in 2007. The decrease in OMEA fees earned was primarily due to a decline in TIC equity raised, declining to $176.9 million in TIC equity raised in 2008, compared to $452.2 million in TIC equity raised in 2007.

 

The Company completed a total of 50 acquisitions and 9 dispositions on behalf of the investment programs it sponsors at values in excess of $1.2 billion and $225.8 million, respectively, during 2008. The net acquisitions from the Investment Management business allowed the Company to grow its captive assets under

management by more than 17.0% during 2008. As of December 31, 2008, the value of the Company’s assets under management was in excess of $6.8 billion.

 

Captive management fees were down approximately 7.5% year-over-year and include the movement of approximately $6.8 million of revenue to the Company’s management services segment. Exclusive of this transfer of revenue, captive management fees increased approximately 9.1% year-over-year.

 

Management Services Revenue

 

Management Services revenue includes asset and property management fees as well as reimbursed salaries, wages and benefits from the Company’s third party property management and facilities outsourcing services, along with business services fees. Management Services revenue was $253.7 million for the year ended December 31, 2008 and $16.4 million from December 8, 2007 through December 31, 2007. Following the closing of the merger, Grubb & Ellis Management Services assumed management of nearly 27.1 million square feet of NNN’s 46.9 million-square-foot captive investment management portfolio. As of December 31, 2008, the Company managed 231.0 million square feet of property.

 

Rental Revenue

 

Rental revenue includes pass-through revenue for the master lease accommodations related to the Company’s TIC Programs.

 

Operating Expense Overview

 

Operating expenses increased $691.7 million, or 393.9%, to $867.3 million for the year ended December 31, 2008, compared to $175.6 million for the same period in 2007. The increase includes approximately $455.6 million due to the legacy Grubb & Ellis business, $18.0 million in real estate related impairments, $181.3 million in goodwill and intangible asset impairments, a $28.0 million charge which includes an allowance for bad debt on related party receivables and advances and an expected loss on the sale of two properties under management for which the Company has a recourse obligation, $8.3 million due to additional merger related costs and $4.2 million in additional non-cash stock based compensation.

 

Compensation costs

 

Compensation costs increased $398.9 million, or 383.2%, to $503.0 million for the year ended December 31, 2008, compared to $104.1 million for the same period in 2007 due to approximately $406.3 million of compensation costs attributed to legacy Grubb & Ellis’ operations. Compensation costs related to the investment management business decreased approximately 9.4% to $56.6 million, for the year ended December 31, 2008, compared to $62.5 million for the same period in 2007. Included in the compensation cost was non-cash stock compensation expense which increased by $4.2 million to $11.7 million for the year ended December 31, 2008 compared to $7.5 million for the same period in 2007.

 

General and Administrative

 

General and administrative expense increased approximately $75.4 million, or 170.4%, to $119.7 million for the year ended December 31, 2008, compared to $44.3 million for the same period in 2007 due to approximately $48.4 million of general and administration expenses attributed to legacy Grubb & Ellis operations and an increase of $27.0 million related to the investment management business, primarily due to an increase in allowances for bad debt on related party receivables and advances.

 

General and administrative expense was 19.6% of total revenue for the year ended December 31, 2008, compared with 20.3% for the same period in 2007.

 

Depreciation and Amortization

 

Depreciation and amortization increased approximately $7.7 million, or 293.4%, to $10.3 million for the year ended December 31, 2008, compared to $2.6 million for the same period in 2007. The increase includes approximately $6.3 million due to the legacy Grubb & Ellis business. Included in depreciation and amortization expense was approximately $3.5 million for amortization of other identified intangible assets.

Rental Expense

 

Rental expense includes pass-through expenses for master lease accommodations related to the Company’s TIC Programs.

 

Interest Expense

 

Interest expense increased approximately $3.7 million, or 172.8%, to $5.9 million for the year ended December 31, 2008, compared to $2.2 million for the same period in 2007. Interest expense is primarily comprised of interest expense related to the Company’s Line of Credit.

 

Real Estate Related Impairments

 

The Company recognized an impairment charge of approximately $18.0 million during the year ended December 31, 2008 related to certain unconsolidated real estate investments. The impairment charges were recognized against the carrying value of the investments during the year ended December 31, 2008. In addition, the Company recognized approximately $72.4 million in real estate related impairments related to six properties held for sale as of December 31, 2008, for which the net income (loss) of the properties are classified as discontinued operations. See Discontinued Operations discussion below.

 

Goodwill and Intangible Assets Impairment

 

The Company recognized a goodwill and intangible assets impairment charge of approximately $181.3 million during the year ended December 31, 2008. The total impairment charge of $181.3 million is comprised of $172.7 million related to goodwill impairment and $8.6 million related to the impairment of intangible contract rights. The Company recognizes goodwill in accordance with SFAS No. 142 and tests the carrying value for impairment during the fourth quarter of each year. The goodwill impairment analysis is a two-step process. The first step used to identify potential impairment involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. To estimate the fair value of its reporting units, the Company used a discounted cash flow model and market comparable data. Significant judgment is required by management in developing the assumptions for the discounted cash flow model. These assumptions include cash flow projections utilizing revenue growth rates, profit margin percentages, discount rates, market/economic conditions, etc. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered to not be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment. The second step of the process involves the calculation of an implied fair value of goodwill for each reporting unit for which step one indicated a potential impairment. The implied fair value of goodwill is determined by measuring the excess of the estimated fair value of the reporting unit as calculated in step one, over the estimated fair values of the individual assets, liabilities and identified intangibles. During the fourth quarter of 2008, the Company identified the uncertainty surrounding the global economy and the volatility of the Company’s market capitalization as goodwill impairment indicators. The Company’s goodwill impairment analysis resulted in the recognition of an impairment charge of approximately $172.7 million during the year ended December 31, 2008. The Company also analyzed its trade name for impairment pursuant to SFAS No. 142 and determined that the trade name was not impaired as of December 31, 2008. Accordingly, no impairment charge was recorded related to the trade name during the year ended December 31, 2008. In addition to testing goodwill and its trade name for impairment, the Company tested the intangible contract rights for impairment during the fourth quarter of 2008. The intangible contract rights represent the legal right to future disposition fees of a portfolio of real estate properties under contract. As a result of the current economic environment, a portion of these disposition fees may not be recoverable. Based on our analysis for the current and projected property values, condition of the properties and status of mortgage loans payable associated with these contract rights, the Company determined that there are certain properties for which receipt of disposition fees was improbable. As a result, the Company recorded an impairment charge of approximately $8.6 million related to the impaired intangible contract rights as of December 31, 2008.

Equity in Earnings (Losses) of Unconsolidated Real Estate

 

In the first quarter of 2008, the Company wrote off its investment in GERA, which resulted in a net impact of approximately $5.8 million, including $4.5 million related to stock and warrant purchases and $1.3 million related to operating advances and third party costs. Equity in losses also includes $10.3 million in equity in earnings related to seven LLCs that are consolidated pursuant to FIN No. 46(R). The consolidated LLCs record equity in earnings based on the LLCs pro rata ownership interest in the underlying unconsolidated properties.

 

Minority Interests

 

Minority interest in loss increased by $13.7 million, or 697.6%, to $11.7 million during the year ended December 31, 2008, compared to minority interest in income of $2.0 million for the same period in 2007. Minority interest in loss includes $8.6 million in real estate related impairments recorded at the underlying properties during the year ended December 31, 2008.

 

Discontinued Operations

 

In accordance with SFAS No. 144, for the year ended December 31, 2008, discontinued operations included the net income (loss) of six properties and two limited liability company (“LLC”) entities classified as held for sale as of December 31, 2008. The net loss of $51.4 million during the year ended December 31, 2008 includes approximately $72.4 million of real estate related impairments. During October 2008, the Company initiated a plan to sell the properties it classified as held for investment in its financial statements as of September 30, 2008. As of December 31, 2008, the Company had a covenant within its Credit Facility which required the sale of certain of these assets before March 31, 2009. The downturn in the global capital markets significantly lessened the probability that the Company would be able to achieve relief from this covenant through amendment or other financial resolutions by March 31, 2009. Pursuant to SFAS No. 144, the Company assessed the value of the assets. The impairment charges were recognized against the carrying value of the properties during the year ended December 31, 2008. (See Note 19 of the Notes to Consolidated Financial Statements in Item 8 of this Report for additional information.)

 

Income Tax

 

The Company recognized a tax expense from continuing operations of approximately $16.9 million for the year ended December 31, 2008, compared to a tax expense of $18.1 million for the same period in 2007. In 2008 and 2007, the reported effective income tax rates were (6.42%) and 40.38%, respectively. The 2008 effective tax rate was negatively impacted by impairments of Goodwill and the recording of a valuation allowance against deferred tax assets to the extent the realization of the associated tax benefit is not more-likely-than-not. Based on management’s evaluation of the Company’s tax position, it is believed the amounts related to the valuation allowances are appropriately accrued. The Company’s deferred tax assets are primarily attributable to impairments of various real estate holdings. (See Note 24 of the Notes to Consolidated Financial Statements in Item 8 of this Report for additional information.)

 

Net (Loss) Income

 

As a result of the above items, the Company recognized a net loss of approximately $330.9 million, or $5.21 per diluted share for the year ended December 31, 2008, compared to net income of $21.1 million, or $0.55 per diluted share, for the same period in 2007.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

The following summarizes comparative results of operations for the periods indicated.

 

 

 

 

Revenue

 

Transaction Services Revenue

 

The Company earns revenue from the delivery of transaction and management services to the commercial real estate industry. Transaction fees include commissions from leasing, acquisition and disposition, and agency leasing assignments as well as fees from appraisal and consulting services. Management fees, which include reimbursed salaries, wages and benefits, comprise the remainder of the Company’s Transaction Services revenue, and include fees related to both property and facilities management outsourcing as well as project management and business services.

 

Transaction services segment was acquired from the legacy Grubb & Ellis on December 7, 2007 which includes brokerage commission, valuation and consulting revenue. As of December 31, 2007, legacy Grubb & Ellis had 927 brokers, up from 917 at December 31, 2006.

 

Investment Management Revenue

 

Investment management revenue of $149.7 million for the year ended December 31, 2007, which includes transaction, captive management and dealer-manager businesses, was comprised primarily of transaction fees of $83.2 million, asset and property management fees of $41.0 million and dealer-manager fees of $18.0 million.

 

Transaction related fees increased $27.0 million, or 48.0%, for the year ended December 31, 2007, primarily due to increases of $20.7 million in real estate acquisition fees, $2.5 million in real estate disposition fees, $1.4 million in OMEA fees and $2.4 million in other transaction related fees.

 

Acquisition fees increased $20.7 million, or 79.4%, to $46.7 million for the year ended December 31, 2007, compared to $26.0 million for the same period in 2006. Net fees as a percentage of aggregate acquisition price increased to 2.3% for the twelve months ended December 31, 2007, compared to 1.9% for the same period in 2006, which resulted in $8.5 million in additional fees earned during 2007. During the year ended December 31, 2007, the Company acquired 77 properties (including six which were still owned as of December 31, 2007) on behalf of its sponsored programs for an approximate aggregate total of $2.0 billion, compared to 45 properties for an approximate aggregate total of $1.4 billion during the same period in 2006. This increase in acquisition volume in 2007 resulted in an additional $11.9 million in net fees.

 

The $2.5 million increase in real estate disposition fees for the year ended December 31, 2007 was primarily due to an increase in fees realized from the sales of properties, with $18.2 million in net fees realized from the disposition of 28 properties, with an average sales price of $31.3 million per property for the year ended December 31, 2007, compared to $15.7 million in fees realized from the disposition of 22 properties for the same period in 2006 with an average sales price of $37.9 million per property. Included in the fees realized from the sales of properties were $5.7 million in fees earned as a result of the continuing liquidation of G REIT, Inc. (“G REIT”) for the year ended December 31, 2007, compared to $5.3 million for the same period in 2006. The disposition fees were reduced during the years ended December 31, 2007 and 2006 in the amount of $3.2 million and $410,000, respectively, as a result of amortizing the identified intangible contract rights associated with the acquisition of Realty as they represent the right to future disposition fees of a portfolio of real properties under contract. Fees on dispositions as a percentage of aggregate sales price was 2.4% for the year ended December 31, 2007, compared to 1.9% for the same period in 2006 (excluding one property sold in 2006 for which the Company waived the entire amount of the disposition fee), primarily due to a change in the mix of properties sold.

 

OMEA fees increased $1.4 million, or 18.2%, to $9.1 million for the twelve months ended December 31, 2007, compared to $7.7 million for the same period in 2006. OMEA fees as a percentage of equity raised for the year ended December 31, 2007 was 2.0%, compared to 1.5% for the same period in 2006. The increase in OMEA fees earned was primarily due to $2.5 million in non-recurring credits issued in 2006 partially offset by $900,000 due to lower TIC equity raised in 2007 of $451.0 million, compared to $510.0 million in TIC equity raised in 2006.

The diversified platform created as a result of the merger has already generated new revenue opportunities. The Company’s largest TIC investment during the fourth quarter of 2007 was generated from the net proceeds of a Transaction Services client that was re-invested on a tax deferred basis through GERI’s TIC platform.

 

The Company completed a total of 77 acquisitions and 30 dispositions on behalf of the investment programs it sponsors at values in excess of $2.0 billion and $880.0 million, respectively, during 2007. The net acquisitions from the Investment Management business allowed the Company to grow its captive assets under management by more than 27.0% during 2007. At December 31, 2007, the value of the Company’s assets under management was in excess of $5.7 billion.

 

The $6.4 million, or 18.6%, increase in captive management revenue was primarily due to an increase in property and asset management fees of $6.2 million, or 18.6%, to $41.0 million for the year ended December 31, 2007, compared to $34.6 million for 2006. This increase was primarily the result of the growth in recurring revenue, as total square footage of assets under management increased to an average of approximately 29.4 million for the year ended December 31, 2007, compared to approximately 26.2 million for the same period in 2006. Property and asset management fees per average square foot were $1.39 for the year ended December 31, 2007, compared to $1.32 for the same period in 2006. The increase in property and asset management fees per average square foot was primarily due to a change in product mix. During 2007, assets managed under TIC Programs and within Grubb & Ellis Healthcare REIT, Inc. (“Healthcare REIT”) and Grubb & Ellis Apartment REIT, Inc. (“Apartment REIT”) increased to approximately 83.7% of average assets under management compared to 75.7% in 2006, while assets managed under G REIT and T REIT, Inc. (“T REIT”) decreased to approximately 5.7%, compared to 17.6% in 2006 as a result of the liquidation of those entities. Property and asset management fees in TIC Programs earn up to 6% and in Healthcare REIT and Apartment REIT earn up to approximately 4% plus 1% of each REIT’s average invested assets, while G REIT and T REIT programs earn approximately 4%.

 

Management Services Revenue

 

Management Services revenue includes asset and property management fees as well as reimbursed salaries, wages and benefits from the Company’s third party property management and facilities outsourcing services, along with business services fees. Revenue was $16.4 million from December 8, 2007 through December 31, 2007. Following the closing of the merger, Grubb & Ellis Management Services assumed management of nearly 23 million square feet of NNN’s 41.7 million-square-foot captive investment management portfolio. The Company expects to transfer 6 million square feet of outsourced property management during the first half of 2008. At December 31, 2007, the Company managed 216 million square feet of property.

 

Rental Revenue

 

Rental revenue includes pass-through revenue for the master lease accommodations related to the Company’s TIC Programs.

 

Operating Expense Overview

 

Operating expenses increased $78.0 million, or 79.8%, for the year ended December 31, 2007, compared to the same period in 2006. Of the $78.0 million, $47.0 million was due to the Grubb & Ellis legacy business from December 8, 2007 to December 31, 2007. The remaining $31.0 million of the increase was attributed to legacy NNN’s Investment Management business, including $7.5 million in rental related expense, $10.2 million resulting from operations of the Company’s broker-dealer acquired in December 2006, $5.5 million in compensation related costs, $7.5 million in non-cash stock based compensation, $6.4 million in merger related costs, offset by a decrease of $4.7 million in interest expense and a net decrease of approximately $500,000 in other operating costs.

 

Compensation costs

 

Compensation costs increased $54.7 million, or 110.5%, to $104.1 million for the year ended December 31, 2007, compared to $49.4 million for the same period in 2006. Approximately $41.7 million of the increase was attributed to compensation costs from legacy Grubb & Ellis’ operations from December 8 through December 31, 2007. The remaining $13.0 million of the increase was related to the investment

management business which increased to $62.5 million, or 26.3%, for the year ended December 31, 2007, compared to $49.5 million for the same period in 2006. The increase of $5.5 million, or 11.1%, in compensation related costs, which included $2.1 million in reimbursable salaries, wages and benefits, was primarily due to an increase in full-time equivalent employees of approximately 89%. Contributing to the increase in compensation costs was $7.5 million in non-cash stock based compensation.

 

General and Administrative

 

General and administrative expense increased $14.1 million, or 46.6%, to $44.3 million for the year ended December 31, 2007, compared to $30.2 million for the same period in 2006. Approximately $4.7 million of the increase was attributed to general and administration expenses from the legacy Grubb & Ellis operations from December 8, 2007 through December 31, 2007. The remaining $9.4 million of the increase was related to the investment management business which increased to $39.6 million for the year ended December 31, 2007, compared to $30.2 million for the same period in 2006. The increase was primarily due to a $10.2 million increase resulting from operations of the Company’s broker-dealer acquired in December 2006, partially offset by decrease of $1.2 million related to non-recurring credits granted to certain investors in 2006.

 

Depreciation and Amortization

 

Depreciation and amortization increased $813,000, or 45.0%, to $2.6 million for the year ended December 31, 2007, compared to $1.8 million for the same period in 2006. Approximately $885,000 of the increase was attributed to depreciation and amortization expense from the legacy Grubb & Ellis operations from December 8 through December 31, 2007.

 

Rental Expense

 

Rental expense includes pass-through expenses for master lease accommodations related to the Company’s TIC Programs.

 

Interest Expense

 

Interest expense decreased $4.6 million, or 68.0%, to $2.2 million for the year ended December 31, 2007, compared to $6.8 million for the same period in 2006. The decrease was related to the investment management business and was primarily comprised of a decrease of approximately $2.0 million related to a prepayment penalty assessed to the Company in 2006 related to the early payoff and termination of the line of credit with Wachovia Bank National Association along with a decrease of approximately $1.3 million in interest expense in 2007 as a result of the line of credit having been paid off in 2006. In addition, interest expense related to preferred membership units decreased by approximately $1.1 million in 2007 as the preferred membership units were paid off in 2006.

 

Discontinued Operations

 

In 2007, GERI acquired 13 properties to resell to its sponsored programs. In accordance with SFAS No. 144, for the year ended December 31, 2007, discontinued operations included the net income (loss) of one property and its associated limited liability company (“LLC”) entity sold to a joint venture, two properties and the associated LLCs resold to Healthcare REIT and ten properties and their associated LLCs classified as held for sale as of December 31, 2007. In addition, for the year ended December 31, 2007, discontinued operations included the net income (loss) of six properties and two LLCs owned by the Company and classified as held for sale. (See Note 19 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information).

 

Income Tax

 

The Company incurred a tax provision of $18.1 million for the year ended December 31, 2007, compared to a tax benefit of $7.4 million for the same period in 2006. Effective with the close of NNN’s 144A private equity offering on November 16, 2006, GERI became a wholly-owned subsidiary, which caused a change in GERI’s tax status from a non-taxable partnership to a taxable C corporation. The change in tax status required NNN to recognize a one time income tax benefit of $6.0 million for the future tax effects attributable to temporary differences between GAAP basis and tax accounting principles as of the effective date of

November 15, 2006. The $25.6 million decrease in tax expense was primarily a result of the nonrecurring tax benefit noted above coupled with the inclusion of 12 months of book income in 2007 versus six weeks of book income in 2006 due to the change in tax status. In addition, the Company is subject to the highest federal income tax rate of 35% in 2007, compared to a 34% statutory tax rate in 2006. (See Note 24 of Notes to Consolidated Financial Statements in Item 8 of this Report for additional information).

 

Net Income

 

As a result of the above items, net income increased $1.1 million to $21.1 million, or $0.55 per fully diluted share, for the year ended December 31, 2007, compared to net income of $20.0 million, or $1.01 per fully diluted share, for the same period in 2006.

 

Liquidity and Capital Resources

 

As of December 31, 2008, cash and cash equivalents decreased by approximately $16.3 million, from a cash balance of $49.3 million as of December 31, 2007. The Company’s operating activities used net cash of $33.6 million, as the Company repaid net operating liabilities totaling $20.2 million primarily related to incentive compensation and deferred commissions paid during the first quarter, which attained peak levels during the quarter ended December 31, 2007. Other operating activities used net cash totaling $13.4 million. Investing activities used net cash of $76.3 million primarily for acquisition funding of Company sponsored real estate programs. Financing activities provided net cash of $93.6 million primarily through borrowings including $55.0 million under the Company’s Line of Credit and mortgage financing of Company sponsored real estate programs. Financing activities for the year ended December 31, 2008 also included dividend payments of $15.1 million related to the dividends declared by the Company in December 2007 and the first and second quarters of 2008, $30.0 million for repayment of mezzanine financing on two of the assets held for sale and $13.0 million for repayment of mortgage debt in connection with the restructuring of the financing related to two of the assets held for sale.

 

Current Sources of Capital and Liquidity

 

The Company believes that it will have sufficient capital resources to satisfy its liquidity needs over the next twelve-month period. The Company expects to meet its short-term liquidity needs, which may include principal repayments of debt obligations, investments in various real estate investor programs and institutional funds and capital expenditures, through current and retained cash flow earnings, the sale of real estate properties, additional long-term secured and unsecured borrowings and proceeds from the potential issuance of debt or equity securities and the potential sale of other assets. The Credit Facility restricts our ability to operate outside of the Approved Budget without the permission of the requisite majority of lenders. In addition, we are required to remit Net Cash Proceeds from the sale of assets including real estate assets to repay advances under the Credit Facility and pursue additional sources of capital in accordance with the Recapitalization Plan. All of these demands put the Company’s liquidity and financial resources at risk. As of the date of filing this Form 10-K, the Company had approximately $67.3 million outstanding under the Credit Facility.

 

On October 31, 2008, the Company entered into that certain Agreement for the Purchase and Sale of Real Property and Escrow Instructions to effect the sale of the Danbury Property to an unaffiliated entity for a purchase price of $76.0 million. This agreement was amended and restated in its entirety by that certain Danbury Merger Agreement dated as of January 23, 2009, as amended by the First Amendment to Danbury Merger Agreement dates as of January 23, 2009 which reduced the purchase price to $73.5 million. In accordance with the terms of the Danbury Merger Agreement, as amended by the First Danbury Amendment, the Company received one half of the buyer’s deposits in an amount of $3.125 million from the buyer upon the execution of the Danbury Merger Agreement, which released escrow deposit remains subject to the terms of the Danbury Merger Agreement, and the remaining $3.125 million of deposits continued to be held in escrow pending the closing. On May 19, 2009, the Company and the buyer entered into the Second Danbury Amendment pursuant to which the remaining $3.125 million of deposits held in escrow were released to the Company (and remain subject to the terms of the Danbury Merger Agreement, as amended), and the purchase

price was reduced to $72.4 million. In accordance with the Second Danbury Amendment, the closing of the sale of the property expected to occur on or before June 1, 2009.

 

In February 2007, the Company entered into a $25.0 million revolving line of credit with LaSalle Bank N.A. This line of credit consisted of $10.0 million for use in property acquisitions and $15.0 million for general corporate purposes and bore interest at prime plus 0.50% or three-month LIBOR plus 1.50%, at the Company’s option, on each drawdown.

 

On December 7, 2007, the Company entered into the Credit Facility to replace its revolving line of credit with LaSalle Bank N.A. The Credit Facility is for general corporate purposes which at the time generally bore interest at either the prime rate or LIBOR based rates plus an applicable margin ranging from 1.50% to 2.50%. As of December 31, 2007, the Company had $8.0 million outstanding under the Credit Facility.

 

On August 5, 2008, the Company entered into the First Letter Amendment to its Credit Facility. The First Letter Amendment, among other things, provided the Company with an extension from September 30, 2008 to March 31, 2009 to dispose of the three real estate assets that the Company had previously acquired on behalf of GERA. Additionally, the First Letter Amendment also, among other things, modified select debt and financial covenants in order to provide greater flexibility to facilitate the Company’s TIC Programs.

 

On November 4, 2008, the Company amended (the “Second Letter Amendment”) its Credit Agreement. The effective date of the Second Letter Amendment is September 30, 2008. (Certain capitalized terms set forth below that are not otherwise defined herein have the meaning ascribed to them in the Credit Facility, as amended.

 

The Second Letter Amendment, among other things, a) reduced the amount available under the Credit Facility from $75.0 million to $50.0 million by providing that no advances or letters of credit shall be made available to the Company after September 30, 2008 until such time as borrowings have been reduced to less than $50.0 million; b) provided that 100% of any net cash proceeds from the sale of certain real estate assets that have to be sold by the Company shall permanently reduce the Revolving Credit Commitments, provided that the Revolving Credit Commitments shall not be reduced to less than $50.0 million by reason of the operation of such asset sales; and c) modified the interest rate incurred on borrowings by increasing the applicable margins by 100 basis points and by providing for an interest rate floor for any prime rate related borrowings.

 

Additionally, the Second Letter Amendment, among other things, modified restrictions on guarantees of primary obligations from $125.0 million to $50.0 million, modifies select financial covenants to reflect the impact of the current economic environment on the Company’s financial performance, amended certain restrictions on payments by deleting any dividend/share repurchase limitations and modified the reporting requirements of the Company with respect to real property owned or held.

 

As of September 30, 2008, the Company was not in compliance with certain of its financial covenants related to EBITDA. As a result, part of the Second Letter Amendment included a provision to modify selected covenants. The Debt/EBITDA ratio for the quarters ending September 30, 2008 and December 31, 2008 were amended from 3.75:1.00 to 5.50:1.00, while the Debt/EBITDA Ratio for the quarters ending March 31, 2009 and thereafter remain at 3.50:1.00. The Interest Coverage Ratio for the quarters ending September 30, 2008, December 31, 2008 and March 31, 2009 were amended from 3.50:1.00 to 3.25:1.00, while the Interest Coverage Ratio for the quarters ended June 30, 2009 and September 30, 2009 remained unchanged at 3.50:1.00 and for the quarters ended December 31, 2009 and thereafter remained unchanged at 4.00:1.00. The Recourse Debt/Core EBITDA Ratio for the quarters ending September 30, 2008 and December 31, 2008 were amended from 2.25:1.00 to 4.25:1.00, while the Recourse Debt/Core EBITDA Ratio for the quarters thereafter remained unchanged at 2.25:1.00. The Core EBITDA to be maintained by the Company at all times was reduced from $60.0 million to $30.0 million and the Minimum Liquidity to be maintained by the Company at all times was reduced from $25.0 million to $15.0 million. The Company was not in compliance with certain debt covenants as of December 31, 2008, all of which were effectively cured as of such date by the Third Amendment to the Credit Facility described below. As a consequence of the foregoing, and certain provisions

of the Third Amendment, the $63.0 million outstanding under the Credit Facility has been classified as a current liability as of December 31, 2008. See “Risk Factors” set forth in Item 1A. of Part I above.

 

On May 20, 2009, the Company further amended its Credit Facility by entering into the Third Amendment. The Third Amendment, among other things, bifurcates the existing credit facility into two revolving credit facilities, (i) a $38,000,000 Revolving Credit A Facility which is deemed fully funded as of the date of the Third Amendment, and (ii) a $29,289,245 Revolving Credit B Facility, comprised of revolving credit advances in the aggregate of $25,000,000 which are deemed fully funded as of the date of the Third Amendment and letters of credit advances in the aggregate amount of $4,289,245 which are issued and outstanding as of the date of the Third Amendment. The Third Amendment requires the Company to draw down $4,289,245 under the Revolving Credit B Facility on the date of the Third Amendment and deposit such funds in a cash collateral account to cash collateralize outstanding letters of credit under the Credit Facility and eliminates the swingline features of the Credit Facility and the Company’s ability to cause the lenders to issue any additional letters of credit. In addition, the Third Amendment also changes the termination date of the Credit Facility from December 7, 2010 to March 31, 2010 and modifies the interest rate incurred on borrowings by initially increasing the applicable margin by 450 basis points (or to 7.00% on prime rate loans and 8.00% on LIBOR based loans).

 

The Third Amendment also eliminated specific financial covenants, and in its place, the Company is required to comply with the Approved Budget, that has been agreed to by the Company and the lenders, subject to agreed upon variances. The Company is also required under the Third Amendment to effect the Recapitalization Plan, on or before September 30, 2009 and in connection therewith to effect the Partial Prepayment of the Revolving A Credit Facility. In the event the Company fails to effect the Recapitalization Plan and in connection therewith to reduce the Revolving Credit A Credit Facility by the Partial Prepayment amount, the (i) lenders will have the right commencing on October 1, 2009, to exercise the Warrants, for nominal consideration, to purchase common stock of the Company equal to 15% of the common stock of the Company on a fully diluted basis as of such date, subject to adjustment, (ii) the applicable margin automatically increases to 11% on prime rate loans and increases to 12% on LIBOR based loans, (iii) the Company shall be required to amortize an aggregate of $10 million of the Revolving Credit A Facility in three (3) equal installments on the first business day of each of the last three (3) months of 2009, (iv) the Company is obligated to submit a revised budget by October 1, 2009, (v) the Credit Facility will terminate on January 15, 2010, and (vi) no further advances may be drawn under the Credit Facility.

 

In the event that Company effects the Recapitalization Plan and the Partial Prepayment amount on or prior to September 30, 2009, the Warrants automatically will expire and not become exercisable, the applicable margin will automatically be reduced to 3% on prime rate loans and 4% on LIBOR based loans and the Company shall have the right, subject to the requisite approval of the lenders, to seek an extension of the term of the Credit Facility to January 5, 2011, provided the Company also pays a fee of .25% of the then outstanding commitments under the Credit Facility.

 

As a result of the Third Amendment the Company is required to prepay Revolving Credit A Advances (and to the extent the Revolving Credit A Facility shall be reduced to zero, prepay outstanding Revolving Credit B Advances) in an amount equal to 100% (or, after the Revolving Credit A Advances are reduced by at least the Partial Prepayment amount, in an amount equal to 50%) of Net Cash Proceeds (as defined in the Credit Agreement) from:

 

 

provided, however , that (a) the Net Cash Proceeds received from the sale of the certain real property assets shall be used to prepay outstanding Revolving Credit B Advances and to the extent Revolving Credit B Advances shall be reduced to zero, to prepay outstanding Revolving Credit A Advances, (b) the Company shall prepay outstanding Revolving Credit B Advances in an amount equal to 100% of the Net Cash Proceeds from the sale of the Danbury Property unless the Company is then not in compliance with the Recapitalization Plan in which event Revolving Credit A Advances shall be prepaid first and (c) the Company’s 2008 tax refund was used to prepay outstanding Revolving Credit B Advances upon the closing of the Third Amendment.

 

The Third Amendment requires the Company to (a) sell the Danbury Property by June 1, 2009, unless such date is extended with the applicable approval of the lenders and (b) use its commercially reasonable best efforts to sell four other commercial properties, including the two other GERA Properties, by September 30, 2009.

 

As part of the Company’s strategic plan, management has identified more than $20.0 million of expense synergies, on an annualized basis, a portion of which has been invested in enhancing the management team with the addition of several executives in key operational and management roles. In connection with the Merger, the Company announced its intention to pay a $0.41 per share dividend per annum, which equates to approximately $26.5 million on an annual basis. The Company declared and paid such dividends for holders of records at the end of each of the fourth calendar quarter of 2007 and the first and second calendar quarters of 2008. On July 11, 2008, the Company’s Board of Directors approved the suspension of future dividend payments. In addition, the Board of Directors approved a share repurchase program under which the Company may repurchase up to $25 million of its common stock through the end of 2009. As of December 31, 2008, the Company has repurchased 532,000 shares of its common stock for $1.8 million. The Third Amendment to the Credit Agreement restricts the Company’s ability to repurchase any additional shares.

 

Long-Term Liquidity Needs

 

The Company expects to meet its long-term liquidity needs, which may include principal repayments of debt obligations, investments in various real estate investor programs and institutional funds and capital expenditures, through current and retained cash flow earnings, the sale of real estate properties, additional long-term secured and unsecured borrowings and proceeds from the potential issuance of debt or equity securities and the potential sale of other assets. The Credit Facility restricts our ability to operate outside of the Approved Budget without the permission of the requisite majority of lenders, and the failure to operate within the Approved Budget by more than the greater of $1,500,000 or 15% on a cumulative basis for more than three consecutive weeks would, absent the requisite approval, result in an event of default of the Credit Facility and make the entire balance due and payable. In addition, we are required to remit Net Cash Proceeds from the sale of assets including real estate assets to repay advances under the Credit Facility and pursue additional sources of capital in accordance with the Recapitalization Plan. The Company’s Credit Facility requires the Company to implement the Recapitalization Plan and complete each step provided in the Recapitalization Plan by the dates set for such completion. In the event the Company is unable to effect the Partial Prepayment in connection with the Recapitalization Plan by September 30, 2009, the Company is required to amortize $10 million of the Revolving Credit A Facility in three equal installments on the first business day of each of the last three months of 2009 and the entire Credit Facility would become due and payable on January 15, 2010. In addition, the Company would not have access to any further advances under the Revolving Credit B Facility which would greatly reduce the Company’s liquidity. All of these demands put the Company’s liquidity and financial resources at risk.

 

Factors That May Influence Future Sources of Capital and Liquidity

 

Although Realty was required to have real estate licenses in all of the states in which it acted as a broker for NNN’s programs and received real estate commissions prior to 2007, Realty did not hold a license in certain of those states when it earned fees for those services. In addition, almost all of Triple Net Properties’ revenue was based on an arrangement with Realty to share fees from NNN’s programs. Triple Net Properties did not hold a real estate license in any state, although most states in which properties of NNN’s programs were located may have required Triple Net Properties to hold a license in order to share fees. As a result, Realty and the Company may be subject to penalties, such as fines (which could be a multiple of the amount

received), restitution payments and termination of management agreements, and to the suspension or revocation of certain of Realty’s real estate broker licenses. As of December 31, 2008, no liabilities have been accrued for the failure to hold real estate licenses. To the extent that Realty or the Company incurs any liability arising from the failure to comply with real estate broker licensing requirements in certain states, Anthony W. Thompson, Louis J. Rogers and Jeffrey T. Hanson have agreed to forfeit to the Company up to an aggregate of 4,124,120 shares of the Company common stock. In addition, Mr. Thompson has agreed to indemnify the Company, to the extent the liability incurred by the Company for such matters exceeds the deemed $46,865,000 value of these shares (based upon the $11.36 per share value of such shares as of such agreement), up to an additional $9,435,000 in cash. These shares are held in escrow in connection with an independent escrow agreement entered into on November 14, 2006 between NNN, Messrs. Thompson, Rogers and Hanson and the escrow agent. The above indemnifications expire on November 16, 2009. Since Mr. Hanson is entitled over time to receive up to 743,160 shares from Messrs. Thompson and Rogers (557,370 from Mr. Thompson and 185,790 from Mr. Rogers) from the shares held in the indemnification and escrow agreement, he is a party to it as well and his liability is limited to those shares. If Mr. Hanson’s right to receive the shares vests, then to the extent shares attributable to his ownership are available, and not subject to potential claims, under the indemnification and escrow agreement, he will be permitted to remove 88,000 shares on each of January 1, 2008 and 2009 to pay taxes. As Mr. Hanson’s right to receive the shares vests, then to the extent shares attributable to his ownership are available, and not subject to potential claims, under the indemnification and escrow agreement, he will be permitted to remove certain shares to pay taxes. On January 20, 2009, Mr. Hanson was permitted to remove 247,695 shares from the escrow to pay taxes.

 

On November 16, 2007, the Company completed the acquisition of a 51% membership interest in Grubb & Ellis Alesco Global Advisors, LLC (“Alesco”). Pursuant to the Intercompany Agreement between the Company and Alesco, dated as of November 16, 2007, the Company committed to invest $20.0 million in seed capital into the open and closed end real estate funds that Alesco expects to launch. Additionally, upon achievement of certain earn-out targets, the Company is required to purchase up to an additional 27% interest in Alesco for $15.0 million. The Company is allowed to use $15.0 million of seed capital to fund the earn-out payments. As of December 31, 2008, the Company has invested $500,000 in seed capital into the open and closed end real estate funds that Alesco launched during 2008.

 

Cash Flow

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Net cash used in operating activities increased $69.5 million to $36.0 million for the year ended December 31, 2008, compared to net cash provided by operating activities of $33.5 million for the same period in 2007. Net cash used in operating activities included a decrease in net income of $351.9 million adjusted for an increase in non-cash reconciling items, the most significant of which was $181.3 million in goodwill impairment, $90.4 million in real estate related impairments, $11.7 million in stock-based compensation, $29.0 million in depreciation and amortization primarily related to five properties held for sale, $1.2 million as a result of amortizing the identified intangible contract rights associated with the acquisition of Realty, partially offset by a $3.3 million increase in deferred taxes. Also contributing to this increase was cash used in net changes in other operating assets and liabilities of $36.3 million.

 

Net cash used in investing activities decreased $413.0 million to $73.9 million for the year ended December 31, 2008, compared to $486.9 million for the same period in 2007. This decrease in cash used in investing activities was primarily related to a decrease of $483.0 million of cash used in the acquisition and related improvements of office properties and asset purchases for GERI’s sponsored TIC Programs, partially offset by $92.9 million in proceeds from the sales of certain real estate assets in 2007.

 

Net cash provided by financing activities decreased $306.9 million to $93.6 million for the year ended December 31, 2008, compared to $400.5 million for the same period in 2007. The decrease was primarily due to a decrease of $443.7 million in borrowings on notes payable related to properties purchased for GERI’s sponsored TIC Programs in 2008, a decrease of $27.0 million in contributions from minority interests in 2008 offset by a decrease of $87.5 million in repayments of notes payable and capital lease obligations and an increase in advances on the line of credit of $55.0 million in 2008.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

Net cash provided by operating activities increased $16.2 million to $33.5 million for the year ended December 31, 2007, compared to $17.4 million for the same period in 2006. Net cash provided by operating activities included an increase in net income of $1.1 million adjusted for an increase in non-cash reconciling items, the most significant of which was $5.2 million in stock-based compensation, $6.6 million in depreciation and amortization primarily related to two properties purchased in 2007, $2.7 million as a result of amortizing the identified intangible contract rights associated with the acquisition of Realty, partially offset by a $1.0 million increase in deferred taxes. Also contributing to this increase was cash provided by net changes in other operating assets and liabilities of $6.1 million. This increase in cash from operating activities was partially offset by a $7.3 million increase in accounts receivable from related parties which consisted primarily of accrued management, leasing and transaction fees from the Company’s various sponsored programs.

 

Net cash used in investing activities increased $430.7 million to $486.9 million for the year ended December 31, 2007, compared to $56.2 million for the same period in 2006. This increase in cash used in investing activities was primarily related to $142.3 million of cash used in the acquisition and related improvements to two office properties held for investment and $462.8 million for asset purchases of GERI’s sponsored programs, to facilitate the reselling of such assets to its TIC Programs and REITs, partially offset by $92.9 million in proceeds from the sales of these assets and $117.5 million in proceeds from repayment of advances to related parties.

 

Net cash provided by financing activities increased $259.9 million to $400.5 million for the year ended December 31, 2007, compared to $140.5 million for the same period in 2006. The increase was primarily due to an increase of $426.3 million in borrowings on notes payable related to properties acquired in 2007 and an increase of $34.5 million in contributions from minority interests in 2007 and a decrease of $11.6 million in dividends paid in 2007. Partially offsetting the year-over-year increase in cash provided by financing activities was $146.0 million in net proceeds in November 2006 as a result of the issuance of NNN’s common stock through the 144A private equity offering, an increase of $47.9 million in principal repayments on notes payable in 2007 and $7.5 million in additional repayments under the Company’s line of credit in 2007.

 

Commitments, Contingencies and Other Contractual Obligations

 

Contractual Obligations

 

The Company leases office space throughout the country through non-cancelable operating leases, which expire at various dates through June 30, 2020.

 

The following table summarizes contractual obligations as of December 31, 2008 and the effect that such obligations are expected to have on the Company’s liquidity and cash flow in future periods. This table does not reflect any available extension options.

 

TIC Program Exchange Provisions.   Prior to the Merger, NNN entered into agreements in which NNN agreed to provide certain investors with a right to exchange their investment in certain TIC Programs for an investment in a different TIC program. NNN also entered into an agreement with another investor that provided the investor with certain repurchase rights under certain circumstances with respect to their investment. The agreements containing such rights of exchange and repurchase rights pertain to initial investments in TIC programs totaling $31.6 million. The Company deferred revenues relating to these agreements of $584,000, $393,000 and $986,000 for the years ended December 31, 2006, 2007 and 2008, respectively. Additional losses of $14.3 million related to these agreements were recorded in 2008 to reflect the impairment in value of properties underlying the agreements with investors. As of December 31, 2008 the Company had recorded liabilities totaling $18.6 million related to such agreements, consisting of $4.3 million of cumulative deferred revenues and $14.3 million of additional losses related to these agreements.

 

Off-Balance Sheet Arrangements.   From time to time the Company provides guarantees of loans for properties under management. As of December 31, 2008, there were 151 properties under management with loan guarantees of approximately $3.5 billion in total principal outstanding with terms ranging from one to 10 years, secured by properties with a total aggregate purchase price of approximately $4.8 billion. As of December 31, 2007, there were 143 properties under management with loan guarantees of approximately $3.4 billion in total principal outstanding with terms ranging from one to 10 years, secured by properties with a total aggregate purchase price of approximately $4.6 billion. In addition, the consolidated VIEs and unconsolidated VIEs are jointly and severally liable on the non-recourse mortgage debt related to the interests in the Company’s TIC investments totaling $277.8 million and $385.3 million as of December 31, 2008, respectively.

 

The Company’s guarantees consisted of the following as of December 31, 2008 and 2007:

 

 

 

 

Management evaluates these guarantees to determine if the guarantee meets the criteria required to record a liability in accordance with FASB Financial Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN No. 45”) Subsequent to the initial measurement under FIN No. 45, the Company evaluates the ongoing liability relating to these guarantees in accordance with SFAS No. 5. As of December 31, 2008, the Company recorded a liability of $9.1 million related to recourse guarantees of debt of properties under management which matured in January and April 2009. Any other such liabilities were insignificant as of December 31, 2008 and 2007.

 

 

Interest Rate Risk

 

Derivatives  — The Company’s Credit Facility debt obligations and mortgage loan obligations are floating rate obligations whose interest rate and related monthly interest payments vary with the movement in LIBOR and/or prime lending rates. As of December 31, 2008 and 2007, the outstanding principal balances on the Credit Facility debt obligations totaled $63.0 million and $8.0 million, respectively, and on the mortgage loan debt obligations totaled $216.0 million and $348.9 million, respectively. Since interest payments on any future obligation will increase if interest rate markets rise, or decrease if interest rate markets decline, the Company will be subject to cash flow risk related to these debt instruments. In order to mitigate this risk, the terms of

the Company’s Credit Facility required the Company to maintain interest rate hedge agreements that were in effect as of the date of the Third Amendment against variable interest debt obligations. To fulfill this requirement, the Company holds two interest rate cap agreements with Deutsche Bank Trust Company Americas, which provide for quarterly payments to the Company equal to the variable interest amount paid by the Company in excess of 6.00% of the underlying notional amounts. In addition, the terms of certain mortgage loan agreements required the Company to purchase two-year interest rate caps on 30-day LIBOR with a LIBOR strike price of 6.00%, thereby locking the maximum interest rate on borrowings under the mortgage loans at 7.70% for the initial two year term of the mortgage loans.

 

The Company’s earnings are affected by changes in short-term interest rates as a result of the variable interest rates incurred on its Credit Facility. The Company’s Credit Facility is secured by its assets, bears interest at the bank’s prime rate or LIBOR plus applicable margins based on compliance with covenants with respect to consummation of a recapitalization transaction in accordance with the Recapitalization Plan and currently matures on March 31 2010, subject to extension or early termination under certain circumstances.. Since interest payments on this obligation will increase if interest rate markets rise, or decrease if interest rate markets decline, the Company is subject to cash flow risk related to this debt instrument as amounts are drawn under the Line of Credit.

 

Additionally, the Company’s earnings are affected by changes in short-term interest rates as a result of the variable interest rate incurred on the portion of the outstanding mortgages on its real estate held for sale. As of December 31, 2008 and 2007, the outstanding principal balance on these variable rate debt obligations was $108.7 million and $169.3 million, respectively, with a weighted average interest rate of 3.78% and 8.23% per annum, respectively. Since interest payments on these obligations will increase if interest rates rise, or decrease if interest rates decline, the Company is subject to cash flow risk related to these debt instruments. As of December 31, 2008, for example, a 0.5% increase in interest rates would have increased the Company’s overall annual interest expense by approximately $390,000, or 3.67%. As of December 31, 2007, for example, a 0.8% increase in interest rates would have increased the Company’s overall annual interest expense by approximately $1.4 million, or 9.72%.This sensitivity analysis contains certain simplifying assumptions, for example, it does not consider the impact of changes in prepayment risk.

 

During the fourth quarter of 2006, GERI entered into several interest rate lock agreements with commercial banks aggregating to approximately $400.0 million, with interest rates ranging from 6.15% to 6.19% per annum. All rate locks were cancelled and all deposits in connection with these agreements were refunded to the Company in April 2008.

 

Except for the acquisition of Grubb & Ellis Alesco Global Advisors, LLC, as previously described, the Company does not utilize financial instruments for trading or other speculative purposes, nor does it utilize leveraged financial instruments.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Board of Directors and Shareholders of Grubb & Ellis Company

 

We have audited the consolidated balance sheets of Grubb & Ellis Company and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. Our audits also included the financial statement schedules listed in the index at Item 15. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the financial statements of Grubb & Ellis Securities, Inc. (f.k.a. NNN Capital Corp.), a wholly-owned subsidiary, which statements reflect total assets of $6,264,000 and $20,584,000 as of December 31, 2008 and 2007, respectively, and total revenues of $15,224,000 and $18,315,000 for the years then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Grubb & Ellis Securities, Inc. (f.k.a. NNN Capital Corp.), is based solely on the report of the other auditors.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.

 

In our opinion, based on our audit and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Grubb & Ellis Company and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

 

As discussed in Note 3, the accompanying 2007 consolidated financial statements have been restated.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Grubb & Ellis Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 27, 2009 expressed an adverse opinion thereon.

 

/s/ Ernst & Young LLP

 

Irvine, California

May 27, 2009

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors

Grubb & Ellis Securities, Inc. (f.k.a. NNN Capital Corp.)

Santa Ana, California

 

We have audited the accompanying statements of financial condition of Grubb & Ellis Securities, Inc. (f.k.a. NNN Capital Corp.) (the “Company”) (not separately included herein) as of December 31, 2008 and 2007, and the related statements of operations, changes in stockholder’s equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We have conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal controls over financial reporting. Our audits included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstance, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Grubb & Ellis Securities, Inc. (f.k.a. NNN Capital Corp.) as of December 31, 2008 and 2007 and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders Grubb & Ellis Company:

 

We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of Grubb & Ellis Company (formerly NNN Realty Advisors, Inc.) and subsidiaries (the “Company”) for the year ended December 31, 2006. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Grubb & Ellis Company and subsidiaries for the year ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

 

As discussed in Note 3, the accompanying 2006 consolidated financial statements have been restated.

 

 

Los Angeles, California

May 7, 2007 (May 27, 2009 as to the restatement discussed in Note 3 and of discontinued operations discussed in Note 19 )

GRUBB & ELLIS COMPANY

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)