UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 1-K
ANNUAL REPORT
  
ANNUAL REPORT PURSUANT TO REGULATION A OF THE SECURITIES ACT OF 1933
For the fiscal year ended December 31, 2017
  
HC GOVERNMENT REALTY TRUST, INC.
(Exact name of issuer as specified in its charter)
 
I.R.S. Employment Identification Number: 51-1867397
 
Maryland
 
32-0467957
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. No.)
 
 
 
 1819 Main Street, Suite 212 Sarasota, FL
 
 20036
(Address of principal executive offices)
 
(Zip Code)
 
 
(941) 955-7900
Issuer’s telephone number, including area code 
 
Common Stock
(Title of each class of securities issued pursuant to Regulation A)
 

 
 
 
Part II.
 
In this annual report, references to the “Company,” “we,” “us” or “our” or similar terms refer to HC Government Realty Trust, Inc. a Maryland corporation, together with its consolidated subsidiaries, including HC Government Realty Holdings, L.P., a Delaware limited partnership, which we refer to as our Operating Partnership. We refer to Holmwood Capital, LLC, a Delaware limited liability company, as Holmwood, and Holmwood Capital Advisors, LLC, a Delaware limited liability company, as our Manager. As used in this annual report on Form 1-K, an affiliate of, or person affiliated with, a specified person, is a person, who or which, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, the person specified.
 
STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
 
We make statements in this annual report on Form 1-K or this annual report, that are forward-looking statements within the meaning of the federal securities laws. The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek,” “may,” and similar expressions or statements regarding future periods are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results to differ materially from any predictions of future results, performance or achievements that we express or imply in this annual report or in the information incorporated by reference in this annual report.
 
The forward-looking statements included in this annual report are based upon our current expectations, plans, estimates, assumptions and beliefs that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve, among other things, judgments with respect to future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to:
 
our ability to effectively deploy the proceeds raised in our securities offering,
changes in economic conditions generally and in the real estate and securities markets specifically,
the ability of our Manager to source, originate and acquire suitable investment opportunities,
our expectation that there will be opportunities to acquire additional properties leased to the United States of America,
our expectations regarding demand by the federal government for leased space,
the GSA (acting for the United States as Tenant) renewing or extending one or more of the leases for one or more of our GSA Properties (as defined below), whether pursuant to early termination options or at lease-end, and if not renewed or extended that we will be successful in re-leasing the space.
the impact of changes in real estate needs and financial conditions of federal, state and local governments,
acts of terrorism and other disasters that are beyond our control,
legislative or regulatory changes impacting our business or our assets (including changes to the laws governing the taxation of real estate investment trust (“REITs”) and SEC guidance related to Regulation A or the JOBS Act,
our ability to raise equity or debt capital,
our compliance with applicable local, state and federal laws, including the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the Investment Company Act of 1940, as amended (the “40 Act”) and other laws, or
changes to generally accepted account principles, or GAAP.
 
Any of the assumptions underlying forward-looking statements could be inaccurate. You are cautioned not to place undue reliance on any forward-looking statements included in this annual report. All forward-looking statements are made as of the date of this annual report and the risk that actual results will differ materially from the expectations expressed in this annual report will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements after the date of this annual report, whether as a result of new information, future events, changed circumstances or any other reason. In light of the significant uncertainties inherent in the forward-looking statements included in this annual report, the inclusion of such forward-looking statements should not be regarded as a representation by us or any other person that the objectives and plans set forth in this annual report will be achieved.
 
 
2
 
 
Item 1. Business
 
The Company
 
We were formed in 2016 as a Maryland corporation, and incident to filing our federal income tax return for, and commencing with, our fiscal year ended December 31, 2017, we will elect to be taxed as a REIT for federal income tax purposes. We were formed primarily to source, acquire, own and manage built-to-suit or improved-to-suit, single-tenant properties leased by the United States of America and administered by the U.S General Services Administration or directly by the occupying agency, both of which are referred to as GSA Properties. We invest primarily in GSA Properties across secondary and smaller markets with sizes ranging from 5,000-50,000 rentable square feet, and in their listed lease term after construction or improvement to post-9/11 standards. We further emphasize GSA Properties that fulfill mission critical or citizen service functions. Leases associated with the GSA Properties in which our company invests are full faith and credit obligations of the United States of America.
 
We are currently offering up to $30,000,000 of our common stock for $10.00 per share (the “Initial Offering”) pursuant to a qualified offering statement on Form 1-A (File No.: 024-10563) and a Final Offering Circular dated December 18, 2017, as supplemented.
 
Our principal objective is the creation of value for stockholders by utilizing our relationships and knowledge of GSA Properties, specifically, the acquisition, management and disposition of GSA Properties. On December 31, 2017, our portfolio consisted of (i) our Initial Owned Properties, acquired by our company on June 10, 2016, for a purchase price of $11,050,596, financed with proceeds from the issuance of our 7.00% Series A Cumulative Convertible Redeemable Preferred Stock or Series A Preferred Stock, secured mortgage financing in the original principal amount of $7,225,00, unsecured seller financing in the original principal amount of $2,019,789 and $1,000,000 in original principal amount of our unsecured loan from Holmwood; (ii) our GSA Property acquired by our company on March 31, 2017, for a purchase price of $14,717,937, financed with proceeds from senior mortgage debt in the original principal amount of $10,875,000 and $3,842,937 in original aggregate principal amount of unsecured debt from two of our directors; (iii) seven properties contributed to us as of the initial closing by Holmwood, including three properties for which we received all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership for federal income tax purposes rather than a fee simple interest, each pursuant to the Contribution Agreement; (iv) our GSA Property acquired by our company on July 25, 2017, for a purchase price of $4,797,072, financed with secured mortgage financing in the original principal amount of $3,530,00, and proceeds from our Initial Offering of $1,179,458; and (v) our GSA Property acquired by our company on November 21, 2017, for a purchase price of $8,273,349, financed by secured mortgage debt in original principal amount of $6,991,250 and proceeds from our Initial Offering of $1,282,099.
 
A description of our portfolio of GSA Properties and the terms of their acquisition by us or contribution to us is incorporated by reference herein from the Final Offering Circular located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495417011730/hcgr_253g2.htm under the caption “DESCRIPTION OF OUR PROPERTIES.”
 
The GSA-leased, real estate asset class has a number of attributes that we believe will offer our stockholders significant benefits, including a highly creditworthy and very stable tenant base, long-term lease structures and low risk of tenant turnover. GSA leases are backed by the full faith and credit of the United States, and the GSA has never experienced a financial default. Payment of rents under GSA leases are funded through the Federal Buildings Fund and are not subject to direct federal appropriations, which can fluctuate with federal budget and political priorities. In addition to presenting reduced risk of default, GSA leases typically have long initial terms of ten to 20 years with renewal leases having terms of five to ten years, which limit operational risk. Upon renewal of a GSA lease, base rent typically is reset based on a number of factors at the time of renewal, including inflation and the replacement cost of the building, that generally we expect will increase over the life of the lease.
 
 
3
 
 
GSA-leased properties generally provide attractive investment opportunities but require specialized knowledge and expertise. Each U.S. Government agency has its own customs, procedures, culture, needs and mission, which results in different requirements for its leased space. Furthermore, the GSA-leased sector is highly fragmented with a significant amount of non-institutional owners, who lack our infrastructure and experience with GSA-leased properties. Moreover, while there are a number of national real estate brokers that hold themselves out as having GSA-leased property expertise, there are no national or regional clearing houses for GSA-leased properties. We believe this fragmentation can be ascribed particularly to the U.S. Government’s – including GSA’s – procurement policies, including policies of preference for small, female and minority owned businesses. As of August 2015, the largest owner of GSA-leased properties owned approximately 3.5% of the GSA-leased properties on a rent per square foot (RSF) basis, and the ten largest owners of GSA-leased properties collectively owned approximately 17% of the GSA-leased properties by RSF.1 Long-term relationships and specialized institutional knowledge regarding the agencies, their space needs and the hierarchy and importance of a property to its tenant agency are crucial to understanding which agencies and properties present the greatest likelihood of long-term agency occupancy, and, therefore, to identifying and acquiring attractive GSA-leased properties. Our portfolio is diversified among occupancy agencies, including a number of the largest and most essential agencies, such as the Drug Enforcement Administration, the Federal Bureau of Investigation, the Social Security Administration and the Department of Transportation.
 
We operate as an “UPREIT”, which means we own our GSA-leased properties through single-purpose entities that are wholly owned by our Operating Partnership. While we focus on investments in GSA Properties, in the future we also may invest in state and local government, mission critical single tenant properties or properties previously (but not exclusively) leased to the United States, the GSA or one or more occupying agencies. We are externally managed and advised by Holmwood Capital Advisors, LLC, a Delaware limited liability company. Our Manager will make all investment decisions for us. Our Manager is owned equally by Robert R. Kaplan and Robert R. Kaplan, Jr., individually, Stanton Holdings, LLC, which is controlled by Edwin M. Stanton, and by Baker Hill Holding LLC, which is controlled by Philip and Vickie Kurlander. The officers of our Manager are Messrs. Edwin M. Stanton, President, Robert R. Kaplan, Jr., Vice President, Philip Kurlander, Treasurer, and Robert R. Kaplan, Secretary. Our Manager will be overseen by our board of directors. For more information on our executive officers and directors please see "Item 3. Directors and Executive Officers” below.
 
We believe the extensive knowledge of U.S. Government properties and lease structures of each of our Manager, its principals and executive officers, allows us to execute transactions efficiently. Additionally, we believe that our ability to identify and implement building improvements increases the likelihood of lease renewal and enhances the value of our portfolio. Our Manager’s experienced team brings specialized insight into the mission and hierarchy of occupying agencies, so that we are able to gain a deep understanding of the U.S. Government’s long-term strategy for a particular agency and its resulting space needs. This allows us to target properties used by agencies that will have enduring criticality and the highest likelihood of lease renewal. Lease duration and the likelihood of renewal are further increased as properties are tailored to meet the specific needs of individual agencies, such as specialized environmental and security upgrades.
        
Our Manager and its principals and executive officers have a network of relationships with real estate owners, investors, operators and developers of all sizes and investment formats, across the United States and especially in relation to GSA Properties. We believe these relationships provide us with a competitive advantage, greater access to off-market transactions and flexibility in our investment choices to source and acquire GSA Properties.
 
We believe in the long-term there will be a consistent flow of GSA Properties in our target markets for purposes of acquisition, leasing and managing, which we expect will enable us to continue our platform into the foreseeable future. We acquire GSA Properties located across secondary and smaller markets throughout the United States. We do not anticipate making acquisitions outside of the United States or its territories.
 
 

1 Colliers International
 
4
 
 
We primarily make direct acquisitions of GSA Properties, but we may also invest in GSA Properties through indirect investments, such as joint ventures which may or may not be managed or affiliated with our Manager or its affiliates, and whereby we may own less than a 100% of the beneficial interest therein; provided, that in such event, we will acquire at least 50 percent of the outstanding voting securities in the investment, or otherwise comply with SEC staff guidance regarding majority-owned subsidiaries so that the investment meets the definition of “majority-owned subsidiary” under the 40 Act. While our Manager does not intend for these types of investments to be a primary focus, we may make such investments in our Manager’s sole discretion.
 
Our Competitive Strengths and Strategic Opportunities
 
We believe the experience of our Manager, its affiliates, principals and executive officers, as well as our investment strategies, distinguish us from other real estate companies. We believe that we will be benefitted by the alignment of the following competitive strengths and strategic opportunities:
 
High Quality Portfolio Leased to Mission-Critical U.S. Government Agencies
 
We own a portfolio of 13 GSA Properties, comprised of ten GSA Properties we own in fee simple and three additional GSA Properties for which we have all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership included for federal income tax purposes, each of which is leased to the United States. As of the date of this annual report, based upon net operating income, the weighted average age of our portfolio was approximately 10 years, and the weighted average remaining lease term is approximately 9.3 years if none of the early termination rights are exercised and 5.9 years, if all of the early termination rights are exercised.
 
All of our GSA Properties are occupied by agencies that serve mission-critical or citizen service functions.
 
Our GSA Properties generally meet our investment criteria, which target GSA Properties across secondary or smaller markets with sizes ranging between 5,000-50,000 rentable square feet and in their first term after construction or improvement to post-9/11 standards.
 
Aligned Management Team
 
Upon completion of our Initial Offering, assuming we sell the maximum amount, our senior management team will own beneficially approximately 31.20% of our common stock on a fully diluted basis, which will help to align their interests with those of our stockholders. This amount does not include equity issuable to our Manager in payment of acquisition fees, which will equal 1% of acquisition costs for each property we acquire.
 
A significant portion of our Manager’s fees will be accrued and eventually paid in stock, which will be issued upon the earlier of listing on a national securities exchange or March 31, 2020, which will also align the interests of our Manager with those of our stockholders.
 
Asset Management
 
Considerable experience in developing, financing, owning, managing, and leasing real properties, including GSA Properties across the U.S. (transactions involving approximately $3 billion of GSA Properties and other government leased assets).
 
Relationships with real estate owners, developers, brokers and lenders should allow our company to source off-market or limited-competitive acquisition opportunities at attractive cap rates.
 
In-depth knowledge of the GSA procurement process, GSA requirements, and GSA organizational dynamics. The GSA build-to-suit lease process is detailed and requires significant process-specific expertise as well as extensive knowledge of GSA building requirements and leases.
 
 
5
 
 
Strong network of professional and advisory relationships, including BB&T Capital Markets, financial advisor to our Manager.
 
Property Management
 
Significant experience in property management and oversight of third party property managers, focusing on the day-to-day management of our portfolio, including cleaning, repairs, landscaping, collecting rents, handling compliance with zoning and regulations.
 
Credit Quality of Tenant
 
Leases are full faith and credit obligations of the United States and, as such, are not subject to the risk of annual appropriations.
 
High lease renewal rates for GSA Properties in first term (average of 93% for single-tenant properties, 95% for single-tenant, built-to-suit properties).2
 
Based on 2014 GSA statistics, since 2001 average duration of occupancy for federal agencies in the same leased building is 25 years.  From 2001 through 2010, the GSA exercised the right to terminate prior to the end of the full lease term at a rate of 1.73%, according to Colliers International research.3
 
Leases typically include inflation-linked rent increases associated with certain property operating costs, which the Company believes will mitigate expense variability.
 
Fragmented Market for Assets Within Company Acquisition Strategy
 
Our Manager has observed that the market of owners and developers of targeted assets appears highly fragmented with the majority of ownership distributed among small regional owners and developers.
 
Based on our research, newly constructed, first-generation, GSA Properties currently trade at an average cap rate of 6.75% compared to 4.5% - 5.5% for all investment grade-rated, single tenant, triple net lease properties4 and less than 2.5% for 10-year U.S. Treasury bonds.5
 
Large Inventory of Targeted Assets
 
Over 1,300 GSA Properties in our targeted size are spread throughout U.S.6
 
Company strategy of mitigating lease renewal risk by owning specialized, mission critical and customer service GSA Properties, plus portfolio diversification by agency and location and through careful acquisition of staggered lease expirations.
 
Investment Strategy
 
We believe there is a significant opportunity to acquire and build a portfolio consisting of high-quality GSA Properties at attractive risk-adjusted returns. We seek primarily to acquire “citizen service” GSA Properties, or GSA Properties that are “mission critical” to an agency’s function. Further, we primarily target GSA Properties located in secondary or smaller markets, with sizes ranging from 5,000 to 50,000 rentable square feet, and in their first term after construction or to post-9/11 standards.
 

2 GSA
3 Colliers International GSA-X-CHANGE 2014 GSA Industry Data.
4 RCAnalytics
5 As of November 7, 2017
6 GSA
 
6
 
 
We target GSA Properties that are LEED® certified or energy star rated. Of our portfolio of 13 GSA Properties, six are LEED® certified and another GSA Property is in the LEED® certification process.
 
We believe the subset of GSA Properties on which we focus is highly fragmented and often overlooked by larger investors, which can provide opportunities for us to buy at more attractive pricing compared to other properties within the asset class. We also believe selection based on agency function, building use and location in these smaller markets will help to mitigate risk of non-renewal. While we intend to focus on this subset of GSA Properties, we are not limited in the properties in which we may invest. We have the flexibility to expand our investment focus as market conditions may dictate and, as determined in the sole discretion of our Manager, subject to broad investment guidelines or our Investment Guidelines, and investment policies or our Investment Policies, adopted by our board of directors, as either may be amended by the board of directors from time to time.
 
Our Investment Policies are more specifically described in “Policies with Respect to Certain Activities - Investment Policies.” Our Investment Policies provide our Manager with substantial discretion with respect to the selection, acquisition and management of specific investments, subject to the limitations in the Management Agreement. Our Manager may revise our Investment Policies without the approval of our board of directors or stockholders; provided, however, that our Manager may not acquire properties falling outside our Investment Guidelines without the approval of our board of directors. Our board also may adjust our Investment Policies and will review them at least annually to determine whether the policies are in the best interests of our stockholders. 
 
Growth Strategy
 
Value-Enhancing Asset Management
 
Our management team focuses on the efficient management of our GSA Properties and on improvements to our GSA Properties that enhance their value for our occupancy agency and improve the likelihood of lease renewal.
 
We also seek to reduce operating costs at all of our GSA Properties, often by implementing energy efficiency programs that help the U.S. Government achieve its conservation and efficiency goals.
 
Our asset management team also conducts frequent audits of each of our GSA Properties in concert with the GSA and the occupying agency in order to keep each facility in optimal condition, allowing the agency to better perform its stated mission and helping to position us as a “GSA partner of choice.”
 
Renew Existing Leases at Positive Spreads
 
We intend to renew leases of GSA Properties at positive spreads.
 
Upon lease renewal, GSA rental rates typically are reset based on a number of factors, including inflation, the replacement cost of the building at the time of renewal and enhancements to the property since the date of the prior lease.
 
During the term of a GSA lease, we work in close partnership with the GSA to implement improvements at our GSA Properties to enhance the occupying agency’s ability to perform its stated mission, thereby increasing the importance of the building to the occupying agency and the probability of an increase in rent at lease renewal.
 
Reduce Property-Level Operating Expenses
 
We manage our GSA Properties to increase our income by continuing to reduce property-level operating costs.
 
We manage our GSA Properties in a cost-efficient manner so as to eliminate any excess spending and streamline our operating costs.
 
When we acquire a GSA Property, we review all property-level operating expenditures to determine whether and how the GSA Property can be managed more efficiently.
 
 
7
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
We are an externally-managed real estate company, formed to grow our business of acquiring, developing, financing, owning and managing properties leased primarily to the United States of America, acting either through the GSA or directly through the federal government agencies or departments occupying such properties, including such properties owned by special purpose entities contributed to our operating partnership by Holmwood, our accounting predecessor. We invest primarily in GSA Properties across secondary and smaller markets, in sizes that range from 5,000-50,000 rentable square feet, these are their first term after construction or improvement to post-9/11 standards. We further emphasize GSA Properties that fulfill mission critical or direct citizen service functions.  We intend to grow our portfolio primarily through acquisitions of single-tenanted, federal government-leased properties in such markets; although, at some point in the future we may elect to develop, or joint venture with others in the development of, competitively bid, build-to-suit, single-tenant, federal government-leased properties, or buy facilities that are leased to credit-worthy state or municipal tenants.
 
As of April 27, 2018, the Company owned 13 GSA Properties, comprised of ten GSA Properties that we own in fee simple and three additional GSA Properties for which we have all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership including for federal income tax purposes, each of which is leased to the United States. Our portfolio of GSA Properties, or our portfolio, contains approximately 263,045 rentable square feet located in nine states with three additional GSA Properties under contract for an additional 56,121 rentable square feet, or our pipeline. As of April 27, 2018 our portfolio and pipeline properties are 100% leased to the United States of America and occupied, or to be occupied on completion, by federal government agencies. Based on net operating income of each property, the properties have a weighted average remaining lease term of 9.3 years if none of the early termination rights are exercised and 5.9 years if the early termination right are exercised.
 
Our Operating Partnership holds substantially all of our assets and conducts substantially all of our business. As of April 27, 2018, on a fully diluted basis, we owned approximately 53.73% of the aggregate common limited partnership interests in our Operating Partnership. We were formed in 2016 as a Maryland corporation and incident to filing our federal income tax return and commencing with our fiscal year ended December 31, 2017, we will elect to be taxed as a REIT for federal income tax purposes.
 
Our Predecessor
 
The term, “our predecessor”, refers to Holmwood and its three, remaining, consolidated, single purpose, wholly owned subsidiaries. Each such remaining subsidiary holds the fee interest in a GSA Property, the rights to the profits from, the leases for, any distributed cash flow from, and all of the benefits and burdens of ownership, including for federal income tax purposes, of which were contributed to our Operating Partnership by Holmwood.
  
Operating Results – HC Government Realty Trust, Inc.
 
For the year ended December 31, 2017
 
At December 31, 2017, we owned ten properties and all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership including for federal income tax purposes for three other properties. Our portfolio of properties at December 31, 2017 consisted of the following: (i) three GSA Properties, or our Initial Owned Properties, acquired by our company on June 10, 2016, for a purchase price of $11,050,596, financed with proceeds from the issuance of our 7.00% Series A Cumulative Convertible Redeemable Preferred Stock or Series A Preferred Stock, secured mortgage financing in the original principal amount of $7,225,00, unsecured seller financing in the original principal amount of $2,019,789 and $1,000,000 in original principal amount of our unsecured loan from Holmwood; (ii) our GSA Property acquired by our company on March 31, 2017, for a purchase price of $14,717,937, financed with proceeds from senior mortgage debt in the original principal amount of $10,875,000 and $3,842,937 in original aggregate principal amount of unsecured debt from two of our directors; (iii) seven properties contributed to us as of the initial closing by Holmwood, including three properties for which we received all of the rights to the profits, losses, any distributed cash flow and all of the other benefits and burdens of ownership for federal income tax purposes rather than a fee simple interest, each pursuant to the Contribution Agreement; (iv) our GSA Property acquired by our company on July 25, 2017, for a purchase price of $4,797,072, financed with secured mortgage financing in the original principal amount of $3,530,00, and proceeds from our Initial Offering of $1,179,458; and (v) our GSA Property acquired by our company on November 21, 2017, for a purchase price of $8,273,349, financed by secured mortgage debt in original principal amount of $6,991,250 and proceeds from our Initial Offering of $1,282,099. The portfolio contains 263,045 square feet located in nine states and is 100% leased to the United States and either administered by the GSA or occupying department or agency.
 
 
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Our operating activity includes the operating activity of the seven properties contributed to us from the period May 26, 2017 though December 31, 2017. 
 
We earned revenues of $4,764,562 and incurred operating costs, excluding depreciation and amortization, of $2,558,399 for the year ended December 31, 2017. Our net operating income was $2,206,163 and after deducting depreciation and amortization of $1,675,079, interest expense of $1,990,858 and Series A Preferred Stock dividends of $316,095, our net loss attributed to our common shareholders was $1,531,025.
 
For the period from of March 11, 2016 (date of inception) to December 31, 2016
 
On June 10, 2016, the company acquired three properties containing 43,984 square feet located in two states. The properties are 100% leased to the United States, administered by the GSA and occupied by the Social Security Administration in the instance of two of the properties and by the Department of Transportation in the instance of the third property. Total costs for the properties were $11,050,596 and were financed with $1,805,807 of proceeds from our Series A Preferred Stock, $2,019,789 of seller financing and a $7,225,000 bank loan. For the period from March 11, 2016 (date of inception) to December 31, 2016, we earned revenues from operations of $747,477 and incurred operating costs, excluding depreciation and amortization, of $314,866. Our net operating income was $432,611 and after deducting depreciation and amortization of $302,484, interest expense of $256,171 and Series A Preferred Stock dividends of $104,636, our net loss attributed to our common shareholders was $230,680. The aforementioned activity represents the financial results of our Initial Owned Properties.
 
Operating Results – Predecessor
 
For the period from January 1, 2017 to May 26, 2017.
 
Immediately prior to our predecessor contributing its portfolio of properties to us on May 26, 2017, our predecessor owned seven properties, containing 110,352 square feet located in five states. All of our predecessor’s properties are 100% leased to the United States of America, six of them are administered by the GSA, the seventh being administered by the occupying agency. For the period from January 1, 2017 to May 26, 2017 our predecessor earned revenues of $1,433,437 from its property portfolio. Operating costs, excluding depreciation and amortization, totaled $503,390 and net operating income was $930,047 for the period from January 1, 2017 to May 26, 2017.  After deducting depreciation and amortization of $478,377 and interest expense of $474,471 from our operating income, our predecessor incurred a net loss of $22,801 for the period from January 1, 2017 to May 26, 2017.
 
For the year ended December 31, 2016
 
At December 31, 2016, our predecessor owned seven properties, containing 110,352 square feet located in five states. All of our predecessor’s properties are 100% leased to the United States of America, six of them are administered by the GSA, the seventh being administered by the occupying agency. In this period from its property portfolio our predecessor earned revenues of $3,711,168. Operating costs, excluding depreciation and amortization, totaled $1,166,623 and net operating income was $2,544,545 for the year ended December 31, 2016.  After deducting depreciation and amortization of $1,228,064 and interest expense of $1,224,717 from our predecessor’s operating income, our predecessor’s net income was $91,764 for the year ended December 31, 2016.
 
Calculating Net Operating Income
 
We believe that our net operating income, or NOI, a non-GAAP measure, is a useful measure of our operating performance. We define NOI as total property revenues less total property operating expenses, excluding depreciation and amortization and interest expense. Other REITs may use different methodologies for calculating NOI, and accordingly, our NOI may not be comparable to the NOI of other REITs. We believe that NOI as we calculate it, provides an operating perspective not immediately apparent from GAAP operating income or net income. We use NOI to evaluate our performance on a property-by-property basis, because NOI more meaningfully reflects the core operations of our properties as well as their performance by excluding items not related to property operating performance and by capturing trends in property operating expenses. However, NOI should only be used as an alternative measure of our financial performance.
 
 
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The following table reflects GSA Property contributions to combined NOI together with a reconciliation of NOI to net income (loss) as computed in accordance with GAAP for the periods presented.
 

 
 
HC Gov Realty Trust, Inc.
 
 
Predecessor
 
 
 
For the year ended December 31, 2017
 
 
March 11, 2016 (date of inception) to December 31, 2016
 
 
January 1, 2017to May 26, 2017
 
 
For the year ended December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 $4,764,562 
 $747,477 
 $1,433,437 
 $3,711,168 
Less:
    
    
    
    
Operating expenses
  2,254,917 
  257,557 
  424,385 
  973,971 
Management fee
  303,482 
  57,309 
  79,005 
  192,652 
Total expenses
  2,558,399 
  314,866 
  503,390 
  1,166,623 
 
    
    
    
    
Net operating income
  2,206,163 
  432,611 
  930,047 
  2,544,545 
Less:
    
    
    
    
Depreciation and amortization
  1,675,079 
  302,484 
  478,377 
  1,228,064 
Interest expense
  1,990,858 
  256,171 
  474,471 
  1,224,717 
Net loss
  (1,459,774)
  (126,044)
 $(22,801)
 $91,764 
Less: Net loss attributable to noncontrolling interest
  (244,844)
  - 
    
    
Net loss loss attributed to HC Gov Realty Trust, Inc.
  (1,214,930)
  (126,044)
    
    
Less: Preferred stock dividends
  (316,095)
  (104,636)
    
    
Net (loss) income attributed to HC Gov Realty Trust, Inc.
    
    
    
    
available to common shareholders
 $(1,531,025)
 $(230,680)
    
    
 
Liquidity and Capital Resources
 
Our business model is intended to drive growth through acquisitions. Access to the capital markets is an important factor for our continued success. We expect to continue to issue equity in our company with proceeds being used to acquire other single tenanted properties leased to the United States of America or buy facilities that are leased to credit-worthy state or municipal tenants.
 
Liquidity General. 
 
Our need for liquidity will be primarily to fund (i) operating expenses and cash dividends; (ii) property acquisitions; (iii) deposits and fees associated with long-term debt financing for our GSA Properties; (iv) capital expenditures; (v) payment of principal of, and interest on, outstanding indebtedness; and (vi) other investments, consonant with our Investment Guidelines and Investment Policies.
 
We currently have three GSA Properties under contract for $21,655,000, which will require funding through a combination of secured debt financing and equity.
  
Capital Resources
 
As of April 27, 2018, the Company has sold 859,591 cumulative shares for net proceeds of $7,886,332 in the Initial Offering. We have used, and will continue to use, net proceeds from the Initial Offering to pay down debt, fund acquisitions, provide working capital, fund a portion of our targeted dividend and otherwise improve our capital structure, enabling us to further implement our acquisition strategy, and increase cash flows.
 
On March 31, 2017, the Company borrowed an aggregate amount of $3,400,000 pursuant to multiple promissory notes payable. The notes are unsecured, require monthly interest-only payments payable in arrears at an interest rate of 12% per annum. By agreement with the holders of these notes, the maturity date of such notes has been extended to May 1, 2019. The notes are pre-payable without penalty. Of these notes, $3,070,000 in aggregate principal were loaned by a director of the Company and by an affiliate of another Company director, all of whom or which also are affiliates of the Asset Manager and the Company’s predecessor. As of December 31, 2017, the outstanding principal balance of these notes was $3,400,000.
 
 
10
 
 
On December 11, 2017, our company borrowed $330,000 from an affiliated entity of our Company’s CEO. The loan accrues interest at 3.25% per annum and both principal and accrued interest is payable on demand. This note was paid in full on February 26, 2018.
 
On December 11, 2017, the Company borrowed $1,500,000 in aggregate principal amount pursuant to multiple promissory notes payable to accredited investors. The notes are unsecured, require monthly interest-only payments payable in arrears at an interest rate of 8% per annum. By agreement with the holders of these notes, the maturity date of such notes has been extended to May 1, 2019. With respect to these notes, $500,000 in principal amount was loaned by an affiliate of a director of the Company, the Asset Manager and the Company’s predecessor, and $250,000 was loaned by a member of the Company’s predecessor. As of December 31, 2017, the outstanding principal balance of these notes was $1,500,000.
 
On November 30, 2017, our Company incurred indebtedness of $124,000 to finance certain insurance premiums. The loan bears interest at a fixed annum rate of 4.98% and requires 10 payments, including principal and interest, of $12,685. As of December 31, 2017, the outstanding balance was $99,609.
 
Trend Information
 
Our company, through our operating partnership is engaged primarily in the acquisition, leasing and disposition of single-tenanted, mission critical or customer facing properties, leased to the United States of America and that are situated in secondary and tertiary markets throughout the country. As full faith and credit obligations of the United States these leases offer risk-adjusted returns that are attractive, inasmuch as there continues to be no appreciable yield of comparable credit quality in the marketplace. Conversely, these market dynamics have caused upward pressure on sales prices, offset by management’s deep knowledge and contacts in the sector and the paucity of buyers which will consider smaller properties in smaller markets, frequently enabling our company to lock-up transactions directly with sellers, avoiding brokerage commissions to either party. Short-term interest rates are rising, but while any increase in interest rates will tend to result in some downward pressure on sales prices, if they become sustained, conversely, if long-term interest rates rise, our cost of capital to fund acquisitions can be expected to rise as well, increasing our operating costs and decreasing net income.
 
To date our company has been capital constrained, which has affected liquidity adversely from an operating perspective and the ability of our company to manage several viable acquisition opportunities at the same time. While there can be no assurance, completion of our offering should enable management to accelerate acquisition plans, provide liquidity to recruit and retain qualified personnel to support growth and enhance purchasing power for goods and services in connection with the operation of our properties.
 
 
11
 
 
Item 3. Directors and Officers
 
Information regarding our directors and officers is incorporated herein by reference to the Final Offering Circular located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495417011730/hcgr_253g2.htm under the captions “DIRECTORS, EXECUTIVE OFFICERS, AND SIGNIFICANT EMPLOYEES” and “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS.”
 
The following officers and/or directors ages have changed since the date of the Final Offering Circular:
 
Robert R. Kaplan, Jr. – 47
Philip Kurlander – 54
Robert R. Kaplan – 71
Scott Musil – 50
William Robert Fields – 68
Leo Kiely – 71
 
On January 25, 2018, Elizabeth Watson, who served as our Chief Financial Officer and both our principal financial and accounting officer for purposes of Regulation A, Tier II reporting requirements, and the Company agreed that she would be resigning from the foregoing positions effective as of January 31, 2018.
 
On January 31, 2018, our Manager hired Jason D. Post as our Vice President of Finance and Corporate Controller. The following disclosure should be read in conjunction with “DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES” and any other relevant section contained in the Offering Circular or any supplement to the Offering Circular.
 
Name
 
Position
 
Age
 
Term of Office
 
Hours/Year
Jason D. Post
 
Vice President of Finance and Corporate Controller, Principal Accounting Officer
 
43
 
January 2018 - Present
 
N/A
 
Mr. Post is responsible for our company’s financial management, including corporate accounting, regulatory and financial reporting, budgeting, as well as internal control policies, particularly as they relate to financial risk management.
 
Prior to joining the Company, Mr. Post was the Principal Financial Officer of As Seen On TV, Inc. (OTCBB: ASTV), a direct marketing company. Before that he operated Jason D. Post CPA, PA, a consulting firm offering financial and controller services for pre-IPO and listed companies. Previously he was CFO of Amacore Group (OTCCQB: ACGI), a marketer of health, life and dental insurance plans, and Zurvita (OTCQB: ZRVT), a distributor of health and wellness products. Mr. Post began his career at Deloitte & Touche, an international accounting and auditing firm and then was associated with Cherry, Bekaert & Holland, a southeast regional accounting and auditing firm, and prior thereto at Arthur Anderson, at the time an international accounting and auditing firm. He is a Certified Public Accountant as well as a Certified Fraud Examiner and holds a Bachelor of Science degree, cum laude, from the University of South Florida.
 
 
12
 
 
Item 4. Security Ownership of Management and Certain Security Holders
 
The table below sets forth, as of April 27, 2018, certain information regarding the beneficial ownership of our stock for (1) each person who is expected to be the beneficial owner of 10% or more of our outstanding shares of any class of voting stock and (2) each of our directors and named executive officers, if together such group would be expected to be the beneficial owners of 10% or more of our outstanding shares of any class of voting stock. Each person named in the table has sole voting and investment power with respect to all of the shares of common stock shown as beneficially owned by such person.
 
The SEC has defined “beneficial ownership” of a security to mean the possession, directly or indirectly, of voting power and/or investment power over such security. A stockholder is also deemed to be, as of any date, the beneficial owner of all securities that such stockholder has the right to acquire within 60 days after that date through (1) the exercise of any option, warrant or right, (2) the conversion of a security, (3) the power to revoke a trust, discretionary account or similar arrangement or (4) the automatic termination of a trust, discretionary account or similar arrangement. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, our shares of common stock subject to options or other rights (as set forth above) held by that person that are exercisable as of the completion of this offering or will become exercisable within 60 days thereafter, are deemed outstanding, while such shares are not deemed outstanding for purposes of computing percentage ownership of any other person.
 
Title of Class
 
Name and Address of Beneficial Owner
 
Amount and Nature of Beneficial Ownership
 
Amount and Nature of Beneficial Ownership Acquirable
 
 
Percent
of Class
 
Common Stock
 
All Executive Officers and Directors1
 
216,000 Shares
 
N/A
 
 
20.10
%
Series A Preferred Stock
 
All Executive Officers and Directors1
 
44,000 Shares2
 
N/A
 
 
30.45
%2
Series A Preferred Stock
 
Philip Kurlander1
 
26,000 Shares
 
N/A
 
 
17.99
%
 

1 The address of each beneficial owner is 1819 Main Street, Suite 212, Sarasota, Florida 34236.
2 Includes the 26,000 shares owned by Philip Kurlander disclosed in the table.
3 Address of beneficial owner is 191 Fox Lane, Northport, New York 11763.
 
13
 
 
Item 5. Interest of Management and Others in Certain Transactions
 
On March 31, 2017, the Company borrowed an aggregate amount of $3,400,000 pursuant to multiple promissory notes payable. The notes are unsecured, require monthly interest-only payments payable in arrears at an interest rate of 12% per annum. By agreement with the holders of these notes, the maturity date of such notes has been extended to May 1, 2019. The notes are pre-payable without penalty. Of these notes, $3,070,000 in aggregate principal was loaned by a director of the Company and by an affiliate of another Company director, all of whom or which also are affiliates of the Asset Manager and the Company’s predecessor. As of December 31, 2017, the outstanding principal balance of these notes was $3,400,000.
 
On December 11, 2017, our company borrowed $330,000 from an affiliated entity of our Company’s CEO. The loan accrues interest at 3.25% per annum and both principal and accrued interest is payable on demand. This note was paid in full on February 26, 2018.
 
On December 11, 2017, the Company borrowed $1,500,000 in aggregate principal amount pursuant to multiple promissory notes payable to accredited investors. The notes are unsecured, require monthly interest-only payments payable in arrears at an interest rate of 8% per annum. By agreement with the holders of these notes, the maturity date of such notes has been extended to May 1, 2019. With respect to these notes, $500,000 in principal amount was loaned by an affiliate of a director of the Company, the Asset Manager and the Company’s predecessor, and $250,000 was loaned by a member of the Company’s predecessor. As of December 31, 2017, the outstanding principal balance of these notes was $1,500,000.
 
The information contained in the Final Offering Circular located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495417011730/hcgr_253g2.htm under the caption “INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS” is incorporated herein by reference.
 
 
14
 
 
Item 6. Other Information
 
None
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15
 
 
Item 7. Financial Statements
 
Report of Independent Registered Public Accounting Firm
 
 
 
To the Board of Directors and Stockholders
HC Government Realty Trust, Inc.
Sarasota, Florida
 
Opinion on the Consolidated Financial Statements
 
We have audited the accompanying consolidated balance sheets of HC Government Reality Trust, Inc. and subsidiaries (collectively, “the Company”) as of December 31, 2017 and 2016, the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the year ended December 31, 2017 and for the period from March 11, 2016 (date of inception) to December 31, 2016, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the year ended December 31, 2017 and for the period from March 11, 2016 (date of inception) to December 31, 2016 in conformity with accounting principles generally accepted in the United States of America.
 
Basis for Opinion
 
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audits in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
 
 
/s/ Cherry Bekaert LLP
 
We have served as the Company’s auditor since 2016.
 
Richmond, VA
April 27, 2018
 
 
16
 
 
HC Government Realty Trust, Inc.
Consolidated Balance Sheets
December 31, 2017 and 2016
 
 
 
December 31,
 
 
December 31,
 
 
 
2017
 
 
2016
 
ASSETS
 
 
 
 
 
 
Investment in real estate, net
 $61,922,635 
 $10,435,991 
Cash and cash equivalents
  695,719 
  247,137 
Restricted cash
  1,676,152 
  51,656 
Rent and other tenant receivables, net
  757,752 
  126,590 
Related parties receivable, net
  - 
  525,397 
Leasehold intangibles, net
  5,635,435 
  743,010 
Prepaid expenses and other assets
  365,840 
  182,376 
Total Assets
 $71,053,533 
 $12,312,157 
 
  (8,272,194.6)
    
LIABIILTIES
    
    
Mortgages payable, net of unamortized debt costs
 $49,573,683 
 $7,068,067 
Notes payable
  1,179,610 
  2,103,961 
Notes payable - related party
  4,150,000 
  - 
Declared dividends and distributions
  344,842 
  - 
Accrued interest payable
  248,352 
  35,379 
Accounts payable
  267,232 
  138,998 
Accrued expenses
  357,981 
  239,686 
Tenant improvement obligation
  1,315,366 
  - 
Acquisition fee payable - related party
  274,345 
  - 
Below-market leases, net
  1,001,754 
  416,731 
Related parties payable, net
  461,858 
  - 
Total Liabilities
  59,175,023 
  10,002,822 
 
    
    
STOCKHOLDERS' EQUITY
    
    
Preferred stock ($0.001 par value, 750,000,000 shares authorized
    
    
and 144,500 shares issued and outstanding)
  144 
  144 
Common stock ($0.001 par value, 250,000,000
    
    
shares authorized, 895,307 and 200,000 common shares issued
    
    
and outstanding at December 31, 2017 and 2016, respectively)
  895 
  200 
Additional paid-in capital
  8,948,713 
  3,614,156 
Offering costs
  (1,459,479)
  (1,074,485)
Accumulated deficit
  (1,340,974)
  (126,044)
Accumulated dividends and distributions
  (690,963)
  (104,636)
Total Stockholders' Equity
  5,458,336 
  2,309,335 
Noncontrolling interest in operating partnership
  6,420,174 
  - 
Total Equity
  11,878,510 
  2,309,335 
Total Liabilities and Stockholders' Equity
 $71,053,533 
 $12,312,157 
 
The accompanying notes are an integral part of the consolidated financial statements
 
17
 
 
HC Government Realty Trust, Inc.
Consolidated Balance Sheets (continued)
December 31, 2017 and 2016
 
The following table presents the assets and liabilities of the Company's consolidated variable interest entities as of December 31, 2017 which are included on the consolidated balance sheet above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated variable interest entity. The Liabilities in the table below include third-party liabilities of the consolidated variable interest entity only, and for which creditors or beneficial interest holders do not have recourse to the Company, and exclude intercompany balances that eliminate in consolidation.
 
ASSETS OF CONSOLIDATED VARIABLE INTEREST ENTITIES THAT CAN ONLY BE USED TO SETTLE THE OBLIGATIONS OF CONSOLIDATED VARIABLE INTEREST ENTITIES:
 
 
 
 
Buildings and improvements, net
 $12,007,437 
Intangible assets, net
  530,626 
Prepaids and other assets
  457,096 
Total Assets
 $12,995,159 
 
LIABILITIES OF CONSOLIDATED VARIABLE INTEREST ENTITIES FOR WHICH CREDITORS OR BENEFICIAL INTEREST HOLDERS DO NOT HAVE RECOURSE TO THE COMPANY.
 
 
 
 
Mortgages payable
 $9,796,972 
Intangible liabilities, net
  168,733 
Accounts payable and accrued expenses
  242,284 
Total liabilities
 $10,207,989 
 
The accompanying notes are an integral part of the consolidated financial statements
 
 
18
 
 
HC Government Realty Trust, Inc.
Consolidated Statements of Operations
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
 
 
For the year ended December 31, 2017
 
 
March 11, 2016 (date of inception) to December 31, 2016
 
Revenues
 
 
 
 
 
 
Rental revenues
 $4,595,560 
 $720,850 
Real estate tax reimbursments and other revenues
  169,002 
  26,627 
Total revenues
  4,764,562 
  747,477 
 
    
    
Operating expenses
    
    
Depreciation and amortization
  1,675,079 
  302,484 
General and administrative
  405,824 
  71,522 
Ground lease
  45,954 
  - 
Insurance
  58,373 
  32,510 
Janitorial
  208,618 
  27,298 
Management fees
  303,482 
  57,309 
Professional expenses
  482,070 
  3,864 
Real estate and other taxes
  357,143 
  50,723 
Repairs and maintenance
  248,900 
  36,373 
Equity-based compensation
  181,031 
  - 
Utilities
  267,004 
  35,267 
Total operating expenses
  4,233,478 
  617,350 
Interest expense
  1,990,858 
  256,171 
Net loss
  (1,459,774)
  (126,044)
Less: Net loss attributable to nonconrolling interest in operating partnership
  (244,844)
  - 
Net loss attributed to HC Government Realty Trust, Inc.
  (1,214,930)
  (126,044)
Preferred stock dividends
  (316,095)
  (104,636)
Net loss attributed to HC Government Realty Trust, Inc. available to common shareholders
 $(1,531,025)
 $(230,680)
 
    
    
Basic and diluted loss per share
 $(3.03)
 $(1.44)
 
    
    
Basic and diluted weighted-average common shares outstanding
  504,486 
  160,000 
 
The accompanying notes are an integral part of the consolidated financial statements
 
19
 
 
HC Government Realty Trust, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
 
 
       
 
 
       
 
 
       
 
 
       
 
 
       
 
 
       
 
 
       
 
 
       
 
 
       
 
 
Non-Controling
 
 
       
 
 
 
       
 
 
       
 
 
       
 
 
       
 
 
Additional
 
 
       
 
 
       
 
 
Cumulative
 
 
Total
 
 
Interest in
 
 
       
 
 
 
Preferred Series A      
 
 
Common Stock      
 
 
Paid-in
 
 
Offering
 
 
Accumulated
 
 
Dividends and
 
 
Stockholders'
 
 
 Operating
 
 
Total
 
 
 
Shares
 
 
Par Value
 
 
Shares
 
 
Par Value
 
 
Capital
 
 
Costs
 
 
Deficit
 
 
Distributions
 
 
Equity
 
 
Partnership
 
 
Equity
 
Balance, March 11, 2016
  - 
 $- 
  - 
 $- 
 $- 
 $- 
 $- 
 $- 
 $- 
 $- 
 $- 
 
    
    
    
    
    
    
    
    
    
    
    
Proceeds from issuance of stock
  144,500 
  144 
  200,000 
  200 
  3,614,156 
  - 
  - 
  - 
  3,614,500 
  - 
  3,614,500 
 
    
    
    
    
    
    
    
    
    
    
    
Offering costs
  - 
  - 
  - 
  - 
  - 
  (1,074,485)
  - 
  - 
  (1,074,485)
  - 
  (1,074,485)
 
    
    
    
    
    
    
    
    
    
    
    
Dividends and distributions
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  (104,636)
  (104,636)
  - 
  (104,636)
 
    
    
    
    
    
    
    
    
    
    
    
Net loss
  - 
  - 
  - 
  - 
  - 
  - 
  (126,044)
  - 
  (126,044)
  - 
  (126,044)
 
    
    
    
    
    
    
    
    
    
    
    
Balance, December 31, 2016
  144,500 
  144 
  200,000 
  200 
  3,614,156 
  (1,074,485)
  (126,044)
  (104,636)
  2,309,335 
  - 
  2,309,335 
 
    
    
    
    
    
    
    
    
    
    
    
Proceeds from issuing common shares, net of issuances costs
  - 
  - 
  679,307 
  679 
  6,141,247 
  - 
  - 
  - 
  6,141,926 
  - 
  6,141,926 
 
    
    
    
    
    
    
    
    
    
    
    
Contribution of Holmwood Capital properties for common units
  - 
  - 
  - 
  - 
  (1,316,740)
  - 
  - 
  - 
  (1,316,740)
  7,384,922 
  6,068,182 
 
    
    
    
    
    
    
    
    
    
    
    
Grant of restricted stock
  - 
  - 
  16,000 
  16 
  98,651 
  - 
  - 
  - 
  98,667 
  - 
  98,667 
 
    
    
    
    
    
    
    
    
    
    
    
Grant of long-term incentive plan shares
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  82,364 
  82,364 
 
    
    
    
    
    
    
    
    
    
    
    
Dividends and distributions
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  (586,327)
  (586,327)
  (390,869)
  (977,196)
 
    
    
    
    
    
    
    
    
    
    
    
Offering costs
  - 
  - 
  - 
  - 
  - 
  (384,994)
  - 
  - 
  (384,994)
  - 
  (384,994)
 
    
    
    
    
    
    
    
    
    
    
    
Allocation of NCI in operating partnership
  - 
  - 
  - 
  - 
  411,399 
  - 
  - 
  - 
  411,399 
  (411,399)
  - 
 
    
    
    
    
    
    
    
    
    
    
    
Net loss
  - 
  - 
  - 
  - 
  - 
  - 
  (1,214,930)
  - 
  (1,214,930)
  (244,844)
  (1,459,774)
 
    
    
    
    
    
    
    
    
    
    
    
 
    
    
    
    
    
    
    
    
    
    
    
Balance, December 31, 2017
  144,500 
 $144 
  895,307 
 $895 
 $8,948,713 
 $(1,459,479)
 $(1,340,974)
 $(690,963)
 $5,458,336 
 $6,420,174 
 $11,878,510 
 
The accompanying notes are an integral part of the consolidated financial statements
 
20
 
 
HC Government Realty Trust, Inc.
Consolidated Statements of Cash Flows
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
 
 
For the Year Ended December 31, 2017
 
 
March 11, 2016 (date of inception) to December 31, 2016
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 $(1,459,774)
 $(126,044)
Adjustments to reconcile net loss to net cash used in operating activities:
    
    
Depreciation
  1,299,191 
  244,029 
Amortization of acquired lease-up costs
  178,296 
  23,862 
Amortization of in-place leases
  197,592 
  34,593 
Amortization of above/below-market leases
  24,639 
  (14,158)
Amortization of debt issuance costs
  97,387 
  19,584 
Amortization of long-term incentive plan units
  82,364 
  - 
Amortization of equity-based compensation
  98,667 
  - 
Change in assets and liabilities
    
    
Restricted cash
  (174,271)
  (51,656)
Rent and other tenant receivables, net
  (482,217)
  (126,590)
Prepaid expense and other assets
  (130,470)
  (182,376)
Related party receivables, net
  525,397 
  (525,397)
Accrued interest payable
  212,973 
  35,379 
Accounts payable and other accrued expenses
  (90,454)
  378,684 
Related party payable, net
  461,858 
  - 
Net cash provided (used) in operating activities
  841,178 
  (290,090)
 
    
    
Cash flows from investing activities:
    
    
Restricted cash
  (1,315,366)
  - 
Investment property acquisitions
  (26,207,142)
  (11,050,596)
Net cash used in investing activities
  (27,522,508)
  (11,050,596)
 
    
    
Cash flows from financing activities:
    
    
Debt issuance costs
  (372,317)
  (105,072)
Dividends paid
  (632,354)
  (104,636)
Mortgage principal payments
  (3,673,038)
  (71,445)
Mortgage proceeds
  24,146,250 
  7,225,000 
Notes principal repayments
  (136,211)
  (39,828)
Offering costs
  (384,994)
  (1,074,485)
Proceeds from notes payable
  1,204,000 
  124,000 
Proceeds from notes payable - related party
  4,150,000 
  - 
Proceeds from sale of common stock, net of issuance costs
  6,141,926 
  2,000 
Proceeds from sale of preferred stock
  - 
  3,612,500 
Proceeds from seller note payable
  - 
  2,019,789 
Repayment of assumed notes payable
  (1,321,210)
  - 
Repayment of seller note payable
  (1,992,140)
  - 
Net cash provided from financing activities
  27,129,912 
  11,587,823 
 
    
    
Net increase in cash and cash equivalents
  448,582 
  247,137 
Cash and cash equivalents, beginning of period
  247,137 
  - 
Cash and cash equivalents, end of period
 $695,719 
 $247,137 
 
    
    
Supplemental cash flow information:
    
    
Cash paid for interest
 $1,645,119 
 $201,208 
Cash paid for income taxes
 $- 
 $- 
Non cash investing and financing activities:
    
    
Contributed assets (See Note 3)
 $30,738,651 
 $- 
Assumed liabilities (See Note 3)
 $24,670,469 
 $- 
Common units issued in connection with contribution transaction
 $6,068,182 
 $- 
 
The accompanying notes are an integral part of the consolidated financial statements
 
21
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
1.
Organization
 
HC Government Realty Trust, Inc. (the “REIT”), a Maryland corporation, was formed on March 11, 2016 to primarily source, acquire, own and manage built-to-suit and improved-to-suit, single-tenant properties leased by the United States of America through the U.S General Services Administration (“GSA Properties”). The REIT focuses primarily on GSA Properties across secondary and smaller markets, within size ranges of 5,000-50,000 rentable square feet, and in their first term after construction or retrofit to post-9/11 standards. Further, the REIT selects GSA Properties that fulfill mission critical or citizen service functions. Leases associated with the GSA Properties are full faith and credit obligations of the United States of America and are administered by the U.S. General Services Administration or directly through the occupying federal agencies, or collectively the GSA.
 
The REIT owns its properties through the REIT’s subsidiary, HC Government Realty Holdings, L.P., a Delaware limited partnership (“Operating Partnership”, and together with the REIT, the “Company”). The Operating Partnership invests through wholly-owned special purpose limited liability companies, or special purpose entities (“SPEs”), primarily in properties across secondary or smaller markets.
 
The consolidated financial statements include the accounts of its Operating Partnership subsidiary and related SPEs and the accounts of the Company. As of December 31, 2017, the financial statements reflect the operations of 13 properties representing 263,045 rentable square feet located in seven states. The properties are 100% leased to the government of the United States of America and based on net operating income, have a weighted average remaining lease term of 9.5 years if none of the early termination rights are exercised and 6.2 years if all of the early termination rights are exercised as of December 31, 2017. The Company and its assets are managed externally by Holmwood Capital Advisors, LLC and its subsidiary Holmwood Capital Management, LLC (collectively “HCA” or “Asset Manager”).  The owners of HCA, or their respective affiliates, principally own and control Holmwood Capital, LLC (“predecessor” or “Holmwood”). Holmwood and HCA collectively own 46% of the common shares of the Company outstanding, on a fully diluted basis as of December 31, 2017. The CEO of HCA and Holmwood serves as the CEO and board member of the Company. In addition, two other beneficial owners of HCA and Holmwood serve as board members of the Company. The Company operates as an UPREIT and has elect to be treated as a real estate investment trust, or REIT, for federal income tax purposes under the Internal Revenue Code of 1986, as amended, or the Code, beginning with the taxable year ended December 31, 2017.
 
2.
Significant Accounting Policies
 
Basis of Accounting and Consolidation Basis - The accompanying consolidated financial statements include the accounts of the Operating Partnership and 13 SPEs as of December 31, 2017. Of the SPEs, ten are wholly-owned entities that are consolidated based upon the Company having a controlling financial interest, and three SPEs are consolidated variable interest entities based upon management’s determination that the Operating Partnership has a variable interest in the entities and is the primary beneficiary. All other significant intercompany balances and transactions have been eliminated in consolidation.
 
Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.
 

 
22
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016

Cash and Cash Equivalents - Cash and cash equivalents include all cash and liquid investments with an initial maturity of three months or less when purchased. At times, the Company’s cash and cash equivalents balance deposited with financial institutions may exceed federally insurable limits. The Company maintains separate cash balances at the operating partnership and SPE level. At December 31, 2017 one account had a $318,919 balance in excess of FDIC limits, all others were below the insurable limits. The Company mitigates this risk by depositing funds with major financial institutions. The Company has not experienced any losses in connection with such deposits.
 
Restricted Cash Restricted cash consists of amounts escrowed for future real estate taxes, insurance, and capital expenditures, as required by certain of the Company’s mortgage debt agreements.
 
Purchase Accounting for Acquisitions of Real Estate Subject to a Lease - In accordance with the Financial Accounting Standards Board (“FASB”) guidance on business combinations, the Company determines the fair value of the real estate assets acquired on an “as if vacant” basis. The difference between the purchase price and the fair value of the real estate assets on an “as if vacant” basis is first allocated to the fair value of above- and below-market leases, and then allocated to in-place leases and lease-up costs.
 
Management estimates the “as if vacant” value considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows, and valuation assumptions consistent with current market conditions. The “as if vacant” fair value is allocated to land and buildings and improvements based on relevant information obtained in connection with the acquisition of the property, including appraisals and property tax assessments. Above-market and below-market lease values are determined on a lease-by-lease basis based on the present value (using an interest rate that reflects the risk associated with the leases acquired) of the difference between (a) the contractual amounts to be paid under the lease and (b) management’s estimate of the fair market lease rate for the corresponding space over the remaining non-cancelable terms of the related leases. Above (below) market lease values are recorded as leasehold intangibles and are recognized as an increase or decrease in rental income over the remaining non-cancelable term of the lease.
 
Additionally, in-place leases are valued in consideration of the net rents earned that would have been foregone during an assumed lease-up period; and lease-up costs are valued based upon avoided brokerage fees. The Company has not recognized any value attributable to customer relationships. The difference between the total of the calculated values described above, and the actual purchase price plus acquisition costs, is allocated pro-ratably to each component of calculated value. In-place leases and lease-up costs are amortized over the remaining non-cancelable term of the leases. Real estate values were determined by independent accredited appraisers.
 
Depreciation of an asset begins when it is available for use and is calculated using the straight-line method over its estimated useful life. Range of useful lives for depreciable assets are as follows:
 
Category
 
 
Term
Buildings
 
 
40 years
Building improvements
 
 
5 - 40 years
Tenant improvements
 
 
Shorter of remaining life of the lease or useful life
 
Construction expenditures for building improvements and tenant improvements are capitalized and amortized over the terms of each specific lease.
 
 
 
23
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
Maintenance and repair expenditures are charged to expense as incurred while expenditures that extend the useful life of the real estate investment are capitalized.
 
Tenant Improvements - As part of the leasing process, the Company may provide the lessee with an allowance for the construction of leasehold improvements. These leasehold improvements are capitalized and recorded as tenant improvements and depreciated over the shorter of the useful life of the improvements or the remaining lease term. If the allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements, the allowance is considered to be a lease incentive and is recognized over the lease term as a reduction of minimum rent revenue. Factors considered during this evaluation include, among other things, who holds legal title to the improvements as well as other controlling rights provided by the lease agreement and provisions for substantiation of such costs (e.g. unilateral control of the tenant space during the build-out process). Determination of the appropriate accounting for the payment of a tenant allowance is made on a lease-by-lease basis, considering the facts and circumstances of the individual tenant lease.
 
Leases - The Company’s real estate is leased to tenants on a modified gross lease basis. The leases provide for a minimum rent which normally is flat during the firm term of the lease. The minimum rent payment may include payments to pay for lessee requests for tenant improvements or to cover the cost for extra security. The tenant is required to pay increases in property taxes over the first year and an increase in operating costs based on the consumer price index of the lease’s base year operating expenses. Operating costs includes repairs and maintenance, cleaning, utilities and other related costs. Generally, the leases provide the tenant with renewal options, subject to generally the same terms and conditions of the base term of the lease. The Company accounts for its leases using the operating method. Such method is described below:
 
Operating method – Properties with leases accounted for using the operating method are recorded at the cost of the real estate. Revenue is recognized as rentals are earned and expenses (including depreciation and amortization) are charged to operations as incurred. Buildings are depreciated on the straight-line method over their estimated useful lives. Leasehold interests are amortized on the straight-line method over the terms of their respective leases. When scheduled rentals vary during the lease term, income is recognized on a straight-line basis so as to produce a constant periodic rent over the term of the lease.
 
ImpairmentReal Estate - The Company reviews investments in real estate for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. To determine if impairment may exist, the Company reviews its properties and identifies those that have experienced either a change or an event or circumstance warranting further assessment of recoverability (such as a decrease in occupancy). If further assessment of recoverability is needed, the Company estimates the future net cash flows expected to result from the use of the property and its eventual disposition, on an individual property basis. If the sum of the expected future net cash flows (undiscounted and without interest charges) is less than the carrying amount of the property on an individual property basis, the Company will recognize an impairment loss based upon the estimated fair value of such property. For the year ended December 31, 2017 and the period from March 11, 2016 to December 31, 2016, the Company has not recorded any impairment charges.
 
Organizational, Offering and Related Costs - Organizational and offering costs of the Company are presented as a reduction of shareholders’ equity within the consolidated balance sheets and statements of changes in stockholders’ equity. Organizational and offering costs represent expenses incurred in connection with the formation of the Company and the filing of the Company’s securities offering pursuant to Regulation A. As of December 31, 2017 and December 31, 2016, organizational and offering costs totaled $1,459,479 and $1,074,485 respectively.
 
24
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
Revenue Recognition - Minimum rents are recognized when due from tenants; however, minimum rent revenues under leases which provide for varying rents over their terms, if any, are straight lined over the term of the leases. In the case of expense reimbursements due from tenants, the revenue is recognized in the period in which the related expense is incurred.
 
Rents and Other Tenant Receivables net - Rents and other tenant receivables represent amounts billed and due from tenants. When a portion of the tenants’ receivable is estimated to be uncollectible, an allowance for doubtful accounts is recorded. Due to the high credit worthiness of the tenants, there were no allowances as of December 31, 2017 and December 31, 2016, respectively.
 
Income Taxes The Company will elect to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and applicable Treasury regulations relating to REIT qualification for its fiscal year ending December 31, 2017. In order to maintain this REIT status, the regulations require the Company to distribute at least 90% of its taxable income to shareholders and meet certain other asset and income tests, as well as other requirements. If the Company fails to qualify as a REIT, it will be subject to tax at regular corporate rates for the years in which it fails to qualify. If the Company loses its REIT status it could not elect to be taxed as a REIT for five years unless the Company’s failure to qualify was due to reasonable cause and certain other conditions were satisfied.
 
Management analyzes its tax filing positions in the U.S. federal, state and local jurisdictions where it is required to file income tax returns for all open tax years. If, based on this analysis, management determines that uncertainties in tax positions exist, a liability is established along with an estimate for interest and penalty. Management has determined that there were no uncertain tax positions, and accordingly no associated interest and penalties were required to be accrued at December 31, 2017 and December 31, 2016, respectively.
 
Noncontrolling Interest - Noncontrolling interest represents the portion of equity in the Company’s Operating Partnership not attributable to the Company. The value of the noncontrolling interest of the Operating Partnership is calculated by multiplying the noncontrolling interest ownership percentage at the balance sheet date by the Operating Partnership’s equity. The noncontrolling interest percentage is calculated by dividing the number of common units not owned by the Company by the total number of common units outstanding. The noncontrolling interest ownership percentage will change as additional common units are issued or as common units are exchanged for the Company’s common stock. Subsequent changes in the noncontrolling interest value are recorded to additional paid-in capital. Accordingly, the value of the noncontrolling interest is included in the equity section of the consolidated balance sheets but presented separately from the Company’s equity.
 
Debt Issuance Costs – Debt issuance costs incurred in connection with the Company’s mortgages payable have been deferred and are being amortized over the term of the respective loan agreements using the effective interest method. As applicable, the unamortized balance of debt issuance costs is presented under mortgages payable within the consolidated balance sheet.
 
Earnings (Loss) Per Share
 
Basic earnings (loss) per share is based on the weighted effect of all common shares issued and outstanding and is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares, if any, that would be issued assuming conversion of all potentially dilutive securities outstanding.
 
25
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
The following securities were not included in the computation of the Company’s diluted net loss per share as their effect would be anti-dilutive.
 
 
 
 
As of December 31,
 
 
 
2017
 
 
2016
 
Potentially dilutive securities outstanding at end of period: 
    
   
 
Convertible common units
  1,078,416 
  -
 
Convertible long-term incentive plan units
  74,450
 
  -
 
Convertible preferred stock
  433,500
 
  433,500
 
Unvested restricted stock
  16,000
 
  -
 
Total potential dilutive securities
  1,602,366
 
  433,500 

Reclassifications – Certain prior year amounts have been reclassified for consistency with the current year presentation. Accordingly, $416,731 has been reclassified from leasehold intangibles, net to below-market leases, net, on the consolidated balance sheets as of December 31, 2016, in order to present the below-market lease intangibles separately from the above-market lease intangibles. This reclassification has no effect on the reported total partners’ capital or results of operations as of and for the period ended December 31, 2016.
 
Recent Accounting Pronouncements - In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements of Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” and most industry-specific guidance on revenue recognition throughout the ASC. The new standard is principles based and provides a five-step model to determine when and how revenue is recognized. The core principle of the new standard is that revenue should be recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also requires disclosure of qualitative and quantitative information surrounding the amount, nature, timing and uncertainty of revenues and cash flows arising from contracts with customers. The new standard will be effective for the Company for the year ending December 31, 2019 and can be applied either retrospectively to all periods presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is permitted beginning for the year ending December 31, 2017. The Company is currently evaluating the impact of adoption of the new standard on its consolidated financial statements.
 
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 is intended to improve financial reporting about leasing transactions.  The ASU will require organizations that lease assets referred to as “Lessees” to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with lease terms of more than 12 months. An organization is to provide disclosures designed to enable users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements concerning additional information about the amounts recorded in the consolidated financial statements.  
 
The leasing standard will be effective for the year ended December 31, 2020. Early adoption will be permitted upon issuance of the standard and a modified retrospective approach must be applied. The Company is currently evaluating the impact of ASU 2016-02 on its financial statements.
 
26
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” ASU 2016-15 is intended to improve cash flow statement classification guidance. The standard will be effective for fiscal years beginning after December 15, 2018. The Company is currently evaluating the impact of ASU 2016-15 on its financial statements.
 
In January 2017, the FASB issued ASU 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business.” ASU 2017-01 is intended to help companies evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard will be effective for fiscal years beginning after December 15, 2018. The Company is currently evaluating the impact of ASU 2017-01 on its financial statements.
 
The Company has adopted reporting standards and disclosure requirements as a “smaller reporting company” as defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K as amended September 13, 2017. This rule provides scaled disclosure accommodations, the purpose of which is to provide general regulatory relief to qualifying entities.
 
Other accounting standards that have been issued or proposed by the FASB or other standard-setting bodies are not currently applicable to the Company or are not expected to have a significant impact on the Company’s financial position, results of operations and cash flows.
 
3.
Contribution Transaction
 
On May 26, 2017, Holmwood and the Operating Partnership closed on a transaction that resulted in Holmwood contributing its entire membership interest in four SPEs to the Operating Partnership and assigning to the Operating Partnership all its rights, title and interest in and to any and all profits, losses and distributed cash flow for three other SPEs as well as all of the other benefits and burdens of ownership for federal income tax purposes (the “Contribution Transaction”). In exchange for the aforementioned, the Operating Partnership issued 1,078,416 of its common units (“OP Units”). The agreed upon value of the transaction between the parties was $10,784,161. However, the Company recognized value of $6,068,182 with respect to the issuance of the OP Units based upon the net identifiable assets received. This issuance was recorded as a non-cash transaction in the consolidated statement of changes in stockholders equity for the year ended December 31, 2017.
 
The Contribution Transaction was accounted for as a commonly controlled transaction whereby the contributed assets and assumed liabilities are acquired at their historical book values, rather than at the agreed upon value. The historical book value of the net identifiable assets contributed was $6,068,182.
 
 
 
27
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
A summary of the Company’s contributed assets and assumed liabilities as of May 26, 2017 is as follows:
 
Assets contributed
 
 
 
Buildings and improvements, net
 $28,748,079 
Intangible assets, net
  1,653,771 
Prepaid and other assets
  336,801 
Total assets contributed, net
 $30,738,651 
 
    
Liabilities assumed
    
Mortgages payable
 $22,307,335 
Notes payable
  1,321,210 
Intangible liabilities, net
  704,941 
Accounts payable and accrued expenses
  336,983 
Total liabilities assumed
 $24,670,469 
 
    
Net identifiable assets contributed
 $6,068,182 
 
As part of the Contribution Transaction, the Company and Holmwood entered into a tax protection agreement indemnifying Holmwood for any taxes resulting from a sale for a period of ten years after the date of the Contribution Transaction.
 
4.
Variable Interest Entities
 
With respect to the three SPEs where Holmwood assigned to the Operating Partnership all its rights, title and interest in and to any and all profits, losses and distributed cash flow, management determined these SPEs to be variable interest entities (“VIE”) in which the Operating Partnership has a variable interest and that Holmwood equity holders lacked the characteristics of a controlling financial interest. The Company determined in accordance with ASC Topic 801 “Consolidation” to consolidate these SPEs.
 
A summary of the VIE’s assets and liabilities that are included within the Company’s consolidated balance sheet at December 31, is as follows:
 
 
 
28
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
Assets:
 
 
 
Buildings and improvements, net
 $12,007,437 
Intangible assets, net
  530,626 
Prepaids and other assets
  457,096 
Total assets
 $12,995,159 
 
    
Liabilities:
    
Mortages payable
 $9,796,972 
Intangible liabilities, net
  168,733 
Accounts payable and accrued expenses
  242,284 
Total liabilities
 $10,207,989 
 
    
Net identifiable assets
 $2,787,170 
 
5.
Investment in Real Estate
 
The following is a summary of the Company’s investment in real estate, net as of December 31, 2017 and December 31, 2016, respectively:
 
 
 
2017
 
 
2016
 
Land
 $6,065,137 
 $841,155 
Buildings and improvements
  52,699,106 
  8,420,511 
Tenant improvements
  4,701,613 
  1,418,354 
 
  63,465,856 
  10,680,020 
Accumulated depreciation
  (1,543,221)
  (244,029)
Investments in real estate, net
 $61,922,635 
 $10,435,991 
 
Depreciation expense for the year ended December 31, 2017 and 2016 was $1,299,192 and $244,029, respectively.
 
The Company capitalized building improvements in the amount of $49,475 and $0 for the year ended December 31, 2017 and for the period from March 11, 2016 (date of inception) to December 31, 2016, respectively.
 
During the year ended December 31, 2017 the Company acquired three properties located in Virginia, Alabama and Texas with rentable square footage of 53,917, 16,036 and 38,756 respectively. The acquisitions were financed with a combination of cash and first mortgage loans. All 3 properties were acquired with leases in place with the United States of America with remaining firm terms between 4.3 and 9.5 years at the time of acquisition. A summary of the allocated purchase price for each acquired property, based on estimated fair values, is as follows:
 
 
 
29
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
 
 
Norfolk, VA
 
 
Montgomery, AL
 
 
San Antonio, TX
 
 
 
 
2017 Acquisitions:
 
March 31, 2017
 
 
July 25, 2017
 
 
November 21, 2017
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land
 $1,542,290 
 $549,664 
 $273,588 
 $2,365,542 
Buildings and improvements
  11,115,690 
  2,751,204 
  5,968,136 
  19,835,030 
Tenant improvements
  - 
  504,350 
  1,324,340 
  1,828,690 
Acquired In-place leases
  418,856 
  174,905 
  394,907 
  988,668 
Acquired lease-up costs
  562,611 
  167,501 
  193,487 
  923,599 
Above market leases
  1,078,490 
  649,448 
  118,891 
  1,846,829 
Tenant improvement obligation
  (1,315,366)
  - 
  - 
  (1,315,366)
Acquisition fees payable
  (145,000)
  (47,095)
  (82,250)
  (274,345)
Capitalized costs, other
  - 
  - 
  - 
  8,495 
 
 $13,257,571 
 $4,749,977 
 $8,191,099 
 $26,207,142 
 
In connection with the purchase of the Norfolk property and the assumption of its related lease agreement, the Company assumed an aggregate obligation in the amount of $1,315,366 relating to a build-out allowance and a building specific capital allowance. At closing, the seller provided the Company a credit of an equal amount. The credit was received in cash and is held in escrow until the capital projects begin. As of December 31, 2017, $1,315,366 remained in escrow and is classified as restricted cash on the consolidated balance sheet.
 
The Company during 2017 also capitalized certain costs in the amount of $8,495 related to its Lakewood Co. property.
 
During the period March 11, 2016 to December 31, 2016 the Company acquired three properties, two in Oklahoma and one in Colorado with rentable square footage of 15,445, 9,298 and 19,241 respectively. The acquisitions were financed with a combination of cash and first mortgage loans. All three properties were acquired with leases in place with the United States of America with remaining firm terms between 4.2 and 8.0 years at the time of acquisition. A summary of the allocated purchase price for each acquired property, based on estimated fair values, is as follows:
 
 
 
Moore, OK
 
 
Lawton, OK
 
 
Lakewood, CO
 
 
 
 
2016 Acquisitions:
 
June 10, 2016
 
 
June 10, 2016
 
 
June 10, 2016
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land
 $259,130 
 $169,458 
 $412,567 
 $841,155 
Buildings and improvements
  3,936,562 
  1,731,446 
  2,752,503 
  8,420,511 
Tenant improvements
  382,588 
  276,317 
  759,449 
  1,418,354 
Acquired In-place leases
  150,020 
  81,066 
  135,081 
  366,167 
Acquired lease-up costs
  102,235 
  39,919 
  125,973 
  268,127 
Above market leases
  184,887 
  - 
  - 
  184,887 
Below Market leases
  - 
  (10,519)
  (438,086)
  (448,605)
 
 $5,015,422 
 $2,287,687 
 $3,747,487 
 $11,050,596 
 
 
 
 
30
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
6.
Leasehold Intangibles, net
 
The following is a summary of the Company’s leasehold intangibles as of December 31, 2017 and December 31, 2016.
 
 
 
December 31,
2017
 
 
December 31,
2016
 
Acquired in-place leases
 $2,171,435 
 $366,167 
Acquired lease-up costs
  2,022,123 
  268,127 
Acquired above-market leases
  2,038,492 
  184,887 
 
  6,232,050 
  819,181 
Accumulated amortization
  (596,615)
  (76,171)
Leasehold intangibles, net
 $5,635,435 
 $743,010 
 
Amortization of in-place leases, lease-up costs and acquired above market leases was $520,444 and $76,171 for the year ended December 31, 2017 and for the period from March 11, 2016 (date of inception) to December 31, 2016, respectively.
 
Future amortization of acquired in-place lease value, acquired lease-up costs and acquired above market leases (collectively “Intangible Lease Costs”) is as follows:
 
 
 
Intangible
 
 
 
Lease
 
Year Ended
 
Costs
 
2018
 $804,784 
2019
  804,784 
2020
  794,016 
2021
  743,345 
2022
  565,945 
Thereafter
  1,922,561 
Total
 $5,635,435 
 
7.
Below-Market Leases, net
 
The Company’s intangible liabilities consist of acquired below-market leases. The following is a summary of the Company’s intangible liabilities, as of December 31, 2017 and 2016.

 
 
31
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
 
 
December 31,
2017
 
 
December 31,
2016
 
Acquired below-market leases
 $1,153,546 
 $448,605 
Accumulated amortization
  (151,792)
  (31,874)
Below-market leases, net
 $1,001,754 
 $416,731 
 
Amortization of below-market leases resulted in an increase in rental revenue of $119,918 and $31,874 for the year ended December 31, 2017 and for the period from March 11, 2016 (date of inception) to December 31, 2016, respectively.
 
The future amortization of acquired below market leases is as follows:
 
 
 
Below
 
 
 
Market
 
Year Ended
 
Leases
 
2018
 $163,305 
2019
  163,305 
2020
  162,356 
2021
  144,363 
2022
  104,499 
Thereafter
  263,926 
Total
 $1,001,754 
 
8.
Mortgages Payable
 
The following table outlines the mortgages payable as of December 31, 2017 and 2016:
 
 
 
Initial
 
 
Interest
 
 
 
  Outstanding Principal      
 
Issuance Date
 
Balance
 
 
Rate
 
Maturity
 
December 31, 2017
 
 
December 31, 2016
 
August-2013
 $10,700,000 
  5.27%
August-2023
 $9,976,722 
 $- 
April-2015
  7,600,000 
  3.72%
March-2018
  6,874,169 
  - 
June-2016
  9,675,000 
  3.93%
July-2019
  9,343,234 
  7,153,556 
July-2017
  10,875,000 
  4.00%
August-2022
  10,789,967 
  - 
July-2017
  3,530,000 
  4.00%
August-2022
  3,502,398 
  - 
September-2017
  2,750,000 
  4.00%
August-2022
  2,734,311 
  - 
November-2017
  6,991,250 
  4.25%
June-2019
  6,991,250 
  - 
Total principal
    
    
 
  50,212,051 
  7,153,556 
Debt issuance costs
    
    
 
  (755,338)
  (105,072)
Accumulated amortization
    
    
 
  116,970 
  19,583 
 
Mortgage payable net of unamortized debt costs
 
    
 
 $49,573,683 
 $7,068,067 
 
 
32
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
At December 31, 2017, and December 31, 2016, the Company had unamortized debt issuance costs of $638,368 and $85,489 net of $116,970, and $19,583 of accumulated amortization, respectively, in connection with its various mortgage payables.
 
Mortgage loan balances as of December 31, 2017 and 2016 totaled $50,212,051 and $7,153,556, respectively. Fixed rate loans before unamortized debt issuance costs totaled $43,337,882 and $7,153,556 as of December 31, 2017 and 2016, respectively. Variable rate loans before unamortized debt issuance costs totaled $6,874,169 and $0 for the same respective periods. The loans are payable to various financial institutions and are collateralized by specific properties.
 
The mortgage loan issued in August 2013 bears interest at a fixed rate of 5.27% per annum, has debt service payments based on principal amortization over 30 years, and matures in August 2023. This mortgage was assumed by the Company in connection with the Contribution Agreement. Outstanding principal balance as of December 31, 2017 was $9,976,722.
 
The mortgage loan issued in April 2015 has a variable interest rate equal to the one-month LIBOR rate plus 235 basis points. The interest rate was 3.72% for the year ended December 31, 2017. This mortgage was assumed by the Company in connection with the Contribution Agreement. The loan has required debt service payments based on principal amortization over 20 years and would have matured on March 25, 2017 in the event the predecessor had not exercised its option to extend the loan to March 25, 2018. The predecessor paid an extension fee in the amount of $11,400. The outstanding principal balance as of December 31, 2017 was $6,874,169. On or about March 25, 2018, management secured a 90-day extension to June 25, 2018 while negotiations were in process to procure a long-term refinance agreement. As a result of those negotiations, the Company entered into a loan modification agreement on April 27, 2018 which, among other things, extended the maturity date to April 27, 2020 (See Note 14 - Mortgage Payable for further discussion).
 
The mortgage loans issued in June 2016 bear interest at a fixed rate of 3.93% per annum with debt service payments based on principal amortization over 25 years and mature in July 2019. During the period from March 11, 2016 (date of inception) to December 31, 2016, there were three separate properties included in this financing, each with a separate mortgage payable. A fourth property financed on the same day with the same institution and with the same terms was acquired as a result of the Contribution Transaction. The aggregate original issue for the 4 loans outstanding at December 31, 2017, and the three loans outstanding at December 31, 2016 was $9,675,000 and $7,225,000, respectively. The outstanding principal balances were $9,343,234 and $7,153,566 as of December 31, 2017 and 2016, respectively.
 
The mortgage loan issued in July 2017, for a newly acquired property in Norfolk, VA., bears interest at a fixed rate of 4.00% per annum, has debt service payments based on principal amortization over 25 years, and matures in August 2022. The outstanding principal balance as of December 31, 2017 was $10,789,967.
 
The mortgage loan issued in July 2017, for a newly acquired property in Montgomery, AL., bears interest at a fixed rate of 4.00% per annum, has debt service payments based on principal amortization over 25 years, and matures in August 2022. The outstanding principal balance as of December 31, 2017 was $3,502,398.
 
The mortgage loan issued in September 2017, was to refinance a property acquired as a result of the Contribution Transaction. It bears interest at a fixed rate of 4.00% per annum, has debt service payments based on principal amortization over 25 years, and matures in August 2022. The outstanding principal balance as of December 31, 2017 was $2,734,311.
 
 
 
33
HC Government Realty Trust, Inc.
Notes to the Consolidated Financial Statements
For the year ended December 31, 2017 and from
March 11, 2016 (date of inception) to December 31, 2016
 
The mortgage loan issued in November 2017, for a newly acquired property in San Antonio, TX, is an interest only note that bears a fixed rate of 4.25% per annum and matures in June 2019. The outstanding principal balance as of December 31, 2017 was $6,991,250.
 
The carrying amount of the Company’s variable rate debt approximates its fair value as of December 31, 2017.
 
9.
Notes Payable
 
The following table outlines the notes payable as of December 31, 2017 and 2016:
 
 
 
 
 
 
 
 
 
 
Outstanding Principal
 
 
 
Initial
 
 
Interest
 
 
 
December 31
 
 
December 31
 
Issuance Date
 
Balance
 
 
Rate
 
Maturity
 
2017
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Related Parties
 
 
 
 
 
 
 
 
 
 
 
 
 
March-2017
  3,070,000 
  12.00%
March-2018
 $3,070,000 
 $- 
December-2017
  330,000 
  3.25%
February-2018
  330,000 
  - 
December-2017
  750,000 
  8.00%
June-2018
  750,000 
  - 
Total related parties notes payable
    
    
 
 $4,150,000 
 $- 
 
    
    
 
    
    
Third parties
    
    
 
    
    
June-2016
  2,019,789 
  7.00%
December-2017
 $- 
 $1,992,140 
December-2016
  124,000 
  4.78%
September-2017
  - 
  111,821 
March-2017
  330,000 
  12.00%
March-2018
  330,000 
  - 
November-2017
  124,000 
  4.98%
September-2018
  99,610 
  - 
December-2017
  750,000 
  8.00%
June-2018
  750,000 
  - 
Total third party notes payable
    
    
 
 $1,179,610 
 $2,103,961 
 
    
    
 
    
    
Total related and third party notes
    
    
 
 $5,329,610 
 $2,103,961