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, 2018

  

HC GOVERNMENT REALTY TRUST, INC.

(Exact name of issuer as specified in its charter)

 

I.R.S. Employment Identification Number: 81-1867397

 

Maryland		81-1867397
(State or other jurisdiction of incorporation or organization)		(I.R.S. No.)
390 S. Liberty Street, Suite 100 Winston-Salem, NC		27101
(Address of principal executive offices)		(Zip Code)

 

(336) 477-2535

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:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

 

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 elected 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 to 50,000 rentable square feet, and in their first 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.

 

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, 2018, our portfolio consisted of:

 

 

 

 

 

 

 

 

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.

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. 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, or our Manager. Despite being externally managed, as a result of the Recapitalization Transaction, our internal management team will make all investment decisions for us. The officers of our Company are Mr. Steven A. Hale II as our Chief Executive Officer, Ms. Jacqlyn Piscetelli as our Chief Financial Officer, Treasurer and Secretary and Mr. Robert R. Kaplan Jr. as our President. Our management team will be overseen by our Board of Directors. For more information on our management team and directors please see "Item 3. Directors and Executive Officers” below.

 

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.

We primarily make direct acquisitions of GSA Properties, but we may also invest in GSA Properties through indirect investments, such as joint ventures, 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 Investment Company Act of 1940, as amended.

Our Competitive Strengths and Strategic Opportunities

 

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

 

 

 

 

Credit Quality of Tenant

 

 

 

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.

 

We target GSA Properties that are LEED® certified or energy star rated. Of our portfolio of 16 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 subject to broad investment policies adopted by our board of directors, as may be amended by the board of directors from time to time.

 

1 The weighted-average age of the properties in our portfolio is based on the later of (i) the date upon which the property was built or (ii) the date upon which the property was fully renovated.

 

Description of Our Properties

 

The following table presents an overview of our properties as of December 31, 2018.

 

Property	Current Occupant	Rentable Sq. Ft (RSF)	% of Portfolio 1	% Leased	Effective Annual Rent	Effective Annual Rent per RSF	Effective Annual Rent % of Portfolio
Our Portfolio
Port Saint Lucie, Florida	U.S Drug Enforcement Administration (DEA)	24,858	7.27%	100%	$571,824	$23.00	5.48%
Jonesboro, Arkansas	U.S Social Security Administration (SSA)	16,439	4.81%	100%	$621,144	$37.78	5.95%
Lorain, Ohio	SSA	11,607	3.40%	100%	$443,714	$38.23	4.25%
Cape Canaveral, Florida	U.S. Customs and Border Protection (CBP)	14,704	4.30%	100%	$670,729	$45.62	6.42%
Johnson City, Tennessee	U.S Federal Bureau of Investigation (FBI)	10,115	2.96%	100%	$395,613	$39.11	3.79%
Fort Smith, Arkansas	U.S. Citizenship and Immigration Services (CIS)	13,816	4.04%	100%	$425,672	$30.81	4.08%
Silt, Colorado	U.S. Bureau of Land Management (BLM)	18,813	5.50%	100%	$387,677	$20.61	3.71%
Lakewood, Colorado	U.S. Department of Transportation (DOT)	19,241	5.63%	100%	$464,660	$24.15	4.45%
Moore, Oklahoma	SSA	15,445	4.52%	100%	$530,659	$34.36	5.08%
Lawton, Oklahoma	SSA	9,298	2.72%	100%	$284,075	$30.55	2.72%
Norfolk, Virginia	SSA	53,917	15.78%	100%	$1,308,070	$24.26	12.53%
Montgomery, Alabama	CIS	21,420	6.27%	76%	$576,798	$26.93	5.52%
San Antonio, Texas	U.S. Immigration and Customs Enforcements (ICE)	38,756	11.34%	100%	$1,090,140	$28.13	10.44%
Knoxville, Iowa	U.S. Department of Veterans Affairs (VA)	12,833	3.76%	100%	$649,984	$50.65	6.22%
Champaign, Illinois	FBI	11,180	3.27%	100%	$370,240	$33.12	3.55%
Sarasota, Florida	U.S. Department of Agriculture (USDA)	28,210	8.25%	100%	$906,951	$32.15	8.68%
Total - Our Portfolio		320,652	93.82%	100%	$9,697,950	$30.24	92.86%
Our Pipeline
Monroe, Louisiana		21,124	6.18%	100%	$745,592	$35.30	7.14%
Total - Our Pipeline		21,124	6.18%	100%	$745,592	$35.30	7.14%
Total - Our Portfolio and Pipeline		341,776	100%	100%	$10,443,542	$30.56	100%

 

1By rentable square footage.

2The early termination date, if any, for each lease generally represents the commencement of the time period during which our tenant may exercise its right to terminate the lease, in whole or in part, at any time effective on or after such date by providing us with sufficient prior written notice.  The prior written notice required for early termination under each lease ranges from 60 to 180 days. If our tenant exercises its early termination rights with respect to any lease, we cannot guarantee that we will be able to re-lease the premises on comparable terms, if at all. The lease expiration date is the date the applicable lease will terminate if the early termination is not exercise or if no early termination right exists. As of December 31, 2018, the weighted average remaining lease term of our portfolio and pipeline is 10.4 years if none of the early termination rights are exercised and six years if all of the early termination rights are exercised.

 

A description of our portfolio of GSA Properties and the terms of their acquisition or contribution, including the closing of our anticipated acquisition of the Monroe Property which such closing date has been extended to May 1, 2019 upon our payment of an additional nonrefundable deposit of $1,000,000, is incorporated by reference herein from the post-qualification amendment to our Offering Statement on Form 1-A located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495418012065/hcgov_1apos.htm under the caption “DESCRIPTION OF OUR PROPERTIES—Our Portfolio and the Pipeline;” provided, that, the chart set forth therein has been updated above.

 

Recent Recapitalization Transaction

 

On March 19, 2019, we consummated a recapitalization transaction (the “Recapitalization Transaction”) with Hale Partnership Capital Management, LLC (“Hale”) and certain affiliated investors (each, an “Investor” and collectively, the “Investors”), pursuant to which (i) certain of such Investors provided a $10,500,000 mezzanine loan to us through our Operating Partnership, (ii) certain of such Investors purchased 1,050,000 shares of our 10.00% Series B Cumulative Preferred Stock (the “Series B Preferred Stock”) and (iii) an Investor purchased 300,000 shares of our newly issued common stock (the “Common Stock”).

 

 

 

Amended and Restated Bylaws

 

In connection with the Recapitalization Transaction, on March 13, 2019, the Board of Directors of our Company (the “Board of Directors”) adopted amended and restated bylaws of our Company (the “Bylaws”). The Bylaws were effective immediately and included, among other things, the following changes:

 

 

Articles Supplementary

 

In connection with the Recapitalization Transaction, on March 14, 2019, we filed Articles Supplementary with the Maryland State Department of Assessments and Taxation (the “Series B Articles Supplementary”) to classify 2,050,000 shares of our preferred stock, a portion of which are shares of Series B Preferred Stock to be purchased by Hale pursuant to the Recapitalization Transaction. The Series B Articles Supplementary became effective upon filing on March 14, 2019.

 

Holders of shares of the Series B Preferred Stock are entitled to receive cumulative cash dividends on the Series B Preferred Stock when, as and if authorized by the Board and declared by us, payable quarterly in arrears on each January 5th, April 5th, July 5th and October 5th of each year. From the date of original issue, we will pay dividends at the rate of 10.00% per annum of the $10.00 liquidation preference per share. Dividends on the Series B Preferred Stock will accrue and be cumulative from the end of the most recent dividend period for which dividends have been paid. With respect to priority of payment of dividends, the Series B Preferred Stock will rank on a parity with the Series A Preferred Stock.

 

If our Company liquidates, dissolves or winds-up, holders of shares of the Series B Preferred Stock will have the right to receive $10.00 per share of the Series B Preferred Stock, plus an amount equal to all accrued and unpaid dividends (whether or not authorized or declared) to and including the date of payment. With respect to priority of payment of distributions upon our Company’s voluntary or involuntary liquidation, dissolution or winding up, the Series B Preferred Stock will rank on a parity with the Series A Preferred Stock.

 

The Series B Preferred Stock will automatically convert into common stock upon the occurrence of our initial listing of our common stock on any national securities exchange. As of the date of the listing event, a holder of shares of Series B Preferred Stock will receive a number of shares of common stock in accordance with the conversion formula set forth in the Series B Articles Supplementary. Pursuant to the conversion formula, one share of the Series B Preferred Stock will convert to a number of shares of common stock equal to the original issue price of the Series B Preferred Stock (plus any accrued and unpaid dividends) divided by the lesser of $9.10 or the fair market value of the common stock. If the listing event has not occurred on or prior to March 31, 2020, then holders of the Series B Preferred Stock, at their option, may, at any time and from time to time after such date, convert all, but not less than all, of their outstanding shares of Series B Preferred Stock into common stock. Upon exercise of this optional conversion right, a holder of Series B Preferred Stock will receive a number of shares of common stock in accordance with the same conversion formula referenced above.

 

 

 

Subject to the preferential voting rights described below, the Series B Preferred Stock have identical voting rights as our common stock, with each share of Series B Preferred Stock entitling its holder to vote on an as converted basis, on all matters on which our common stockholders are entitled to vote. The Series B Preferred Stock, the Series A Preferred Stock and the common stock vote together as one class. So long as any shares of Series B Preferred Stock remain outstanding, in addition to the voting rights described above, we will not, without the affirmative vote or consent of the holders of at least two-thirds of the outstanding shares of Series B Preferred Stock voting together as a single class, authorize, create or issue, or increase the number of authorized or issued shares of, any class or series of capital stock ranking senior to the Series B Preferred Stock with respect to payment of dividends or the distribution of assets upon our liquidation, dissolution or winding up, or reclassify any of our authorized capital stock into such capital stock, or create, authorize or issue any obligation or security convertible into or evidencing the right to purchase such capital stock.

 

In addition, the holders of the Series B Preferred Stock have registration rights that are substantially similar to those granted to the holders of the Series A Preferred Stock.

 

Change in Control

 

The Series B Articles Supplementary, filed by our Company on March 14, 2019 in connection with the Recapitalization Transaction, provides that a majority of the members of the Board of Directors will be elected by the holders of a majority of the outstanding shares of Series B Preferred Stock. Our Board of Directors currently has up to seven members. In connection with the closing of the Recapitalization Transaction, on March 19, 2019, each of Robert R. Kaplan, Scott A. Musil, William J. Fields and Leo Kiely resigned from his position as a director of our Board of Directors, and, upon issuance of an aggregate of 1,050,000 shares of the Series B Preferred Stock to the Investors at Closing, the Investors elected Steven A. Hale II, Brad G. Garner, Matthew A. Hultquist and Jeffrey S. Stewart to serve on our Company’s Board of Directors, effective as of March 19, 2019, to serve until their successors are duly elected and qualified. Following the closing of the Recapitalization Transaction, on March 20, 2019, each of Dr. Philip Kurlander and Mr. Edwin Stanton resigned from his position as a director of our Board of Directors. As of March 20, 2019, our Board of Directors is comprised of Messrs. Hale, Garner, Hultquist and Stewart. Mr. Hale was named Chairman of our Board of Directors.

 

Departure of Certain Officers

 

On March 13, 2019, in connection with the Recapitalization Transaction and upon approval from the Board of Directors, we terminated Mr. Edwin Stanton from his position as Chief Executive Officer of our Company and Dr. Philip Kurlander from his position as Treasurer of our Company, each effective as of March 13, 2019.

 

On March 19, 2019, the Company accepted the resignation of Mr. Jason D. Post from his position as Vice President of Finance and Corporate Controller of our Company, effective as of March 19, 2019. 

 

Mr. Robert R. Kaplan resigned as Secretary of our Company on March 19, 2019.

 

Appointment of Officers

 

On March 21, 2019, Mr. Steven A. Hale II was appointed to serve as our new Chief Executive Officer and Chairman of the Board of Directors, and Ms. Jacqlyn Piscetelli was appointed to serve as our new Chief Financial Officer, Treasurer and Secretary.

 

Notice of Nonrenewal of Manager and Adoption of New Investment Guidelines

 

In connection with the Recapitalization Transaction, on March 14, 2019, we provided notice to our Manager, that the Board of Directors resolved to amend and restate our Company’s investment guidelines pursuant to the terms of our management agreement with the Manager (the “Management Agreement”). As a result, our management team, under the supervision of our Board of Directors, shall make all strategic decisions on behalf of our Company, including all acquisition, financing and dispositions.

 

In addition, on March 14, 2019, we provided notice to the Manager that we are electing not to renew the Management Agreement under its terms, effective March 31, 2020, pursuant to the resolve of the Board of Directors. Until the termination of the Management Agreement, our Manager will continue to be involved in our day-to-day operations, including back office and accounting functions, as we transition from an externally-managed to an internally-managed REIT.

 

 

 

Securities Issuances

 

In connection with the Recapitalization Transaction, we sold to the Investors (1) 1,050,000 shares of our Series B Preferred Stock for an aggregate purchase price of $10,500,000 and (2) 300,000 shares of our common stock for an aggregate purchase price of $3,000,000.

 

Both securities sales were with respect to a private offering of securities exempt from registration under the Securities Act of 1933, as amended, pursuant to Rule 506 of Regulation D promulgated thereunder.

 

Loan Agreement

 

In connection with the Recapitalization Transaction, on March 19, 2019, we, through our Operating Partnership, the Investors and HCM Agency, LLC (the “Agent”), an affiliate of Hale and the collateral agent, entered into a Loan Agreement (the “Loan Agreement”) pursuant to which certain of the Investors, as lenders (the “Lenders”), provided a $10,500,000 senior secured term loan to our Company (the “Loan”), with an option to fund up to an additional $10,000,000 in term loans, subject to customary terms and conditions, pursuant to which all such debt will accrue interest and mature on the same terms (the “Mezzanine Debt”).

 

The Loan is not evidenced by a promissory note. However, pursuant to the Loan Agreement, promissory notes evidencing the Loan and/or the Mezzanine Debt may be issued in the future at the request of the Lenders.

 

The Mezzanine Debt will accrue interest at a rate of fourteen percent (14%) per annum. Such interest will be paid in monthly, interest-only cash payments payable in arrears at a rate of twelve percent (12%) per annum plus (i) a cash payment at a rate of two percent (2%) per annum, (ii) an increase in the principal of the Mezzanine Debt equal to two percent (2%) per annum or (iii) a combination of both (i) and (ii) above, which such combined amount will be equal to two percent (2%) per annum. We are required to repay all outstanding principal and any accrued but unpaid interest on or before March 19, 2022. All outstanding principal and any accrued but unpaid interest shall become immediately due and payable upon certain events including, but not limited to, an initial public offering of our common stock.

 

The Mezzanine Debt is secured by a security interest in the accounts receivable and other personal property of our Operating Partnership, our Company and its subsidiaries, including our Operating Partnership’s ownership interest in its subsidiaries. We and Holmwood Portfolio Holdings, LLC, a limited partner in the Operating Partnership (the “LP”), also entered into customary guaranty agreements related to the payment by and performance of our Operating Partnership of its obligations under the Loan Agreement.

 

The Loan Agreement also includes customary representations, warranties, covenants and terms and conditions for transactions of this type, including a minimum fixed charge coverage ratio, limitations on incurrence of debt, liens, investments and mergers and asset dispositions, covenants to preserve corporate existence and comply with laws, covenants on the use of proceeds of the Mezzanine Debt and default provisions, including defaults for non-payment, breach of representations and warranties, insolvency, non-performance of covenants, failure to pay other outstanding debt and our failure to maintain our REIT status. The occurrence of an event of default under the Loan Agreement could result in all loans and other obligations becoming immediately due and payable and allow the Agent to exercise all rights and remedies available to it as collateral agent including the foreclosure of all liens granted under the Loan Agreement.

 

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 to 50,000 rentable square feet, and are in 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 December 31, 2018, the Company owned 16 GSA Properties, comprised of 13 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 320,652 rentable square feet located in 11 states with one additional GSA Property under contract, or our pipeline, for an additional 21,124 rentable square feet. As of December 31, 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, our portfolio has a weighted average remaining lease term of 10.0 years if none of the early termination rights are exercised and 6.2 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 30, 2019, on a fully diluted basis, we owned approximately 59.54% 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 elected to be taxed as a REIT for federal income tax purposes.

 

Our Predecessor

 

The term, “our predecessor”, refers to Holmwood and its three, remaining, 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

 

For the year ended December 31, 2018

 

At December 31, 2018, we owned 13 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, 2018 consisted of the following:

 

 

 

 

 

 

 

 

 

 

The portfolio contains 320,652 rentable square feet located in 11 states and is 100% leased to the United States and either administered by the GSA or occupying department or agency.

 

We earned revenues of $8,431,607 and incurred operating costs of $3,767,800, excluding depreciation and amortization of $3,102,762 and equity-based compensation of $193,119, for the year ended December 31, 2018. Our net loss was $2,104,526, and after allocating $569,904 of net loss to the noncontrolling interest in our operating partnership and deducting Series A Preferred Stock dividends of $252,875, our net loss attributed to our common shareholders was $1,787,497.

 

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:

 

 

 

 

 

 

 

The portfolio contained 263,045 rentable 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.

 

Our operating activity includes the operating activity of the seven properties contributed to us from the period May 26, 2017 through December 31, 2017. 

 

We earned revenues of $4,764,562 and incurred operating costs of $2,377,368, excluding depreciation and amortization of $1,675,079 and equity-based compensation of $181,031, for the year ended December 31, 2017. Our net loss was $1,459,774 and after allocating $244,844 of net loss to the noncontrolling interest in our operating partnership and deducting Series A Preferred Stock dividends of $316,095 our net loss attributed to our common shareholders was $1,531,025.

 

 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, interest expense, and asset management fees. 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.

 

 

 

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.

 

	For the year ended December 31
	2018	2017
Revenues	$8,431,607	$4,764,562
Less:
Operating expenses	2,572,811	1,353,452
Management fee	224,652	153,183
Total expenses	2,797,463	1,506,635
Net operating income	5,634,144	3,257,927
Less:
Asset management fee	328,053	150,299
Corporate expenses	835,403	901,465
Depreciation and amortization	3,102,762	1,675,079
Interest expense	3,529,982	1,990,858
Gain on asset disposition	(57,530)	-
Net loss	(2,104,526)	(1,459,774)
Less: Net (loss) income attributable to noncontrolling interest	(569,904)	(244,844)
Net loss attributed to HC Gov Realty Trust, Inc.	(1,534,622)	(1,214,930)
Less: Preferred stock dividends	(252,875)	(316,095)
Net (loss) income attributed to HC Gov Realty Trust, Inc. available to common shareholders	$(1,787,497)	$(1,531,025)

 

Liquidity and Capital Resources

 

Our business model is intended to drive growth through acquisitions. Our Recapitalization Transaction provided us with liquidity through both debt and cash investments. This allowed us to reduce our outstanding debt and provided us with additional capital to continue pursuing our acquisition strategies. In addition, 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, consistent with our Investment Guidelines and Investment Policies.

 

We currently have one GSA Property under contract which will require $4,150,000 of funding, as of April 30, 2019, through a combination of cash and secured debt financing.

  

Capital Resources

 

Our capital resources are substantially related to our recent Recapitalization Transaction which is described in detail above under “Item 1. Business—Recent Recapitalization Transaction.” In connection with the Recapitalization Transaction, we received $10,500,000 in mezzanine debt, $10,500,000 through the issuance of our Series B Preferred Stock and $3,000,000 through the issuance of our common stock. This capital was primarily used to pay off existing debt, including accrued interest, in the aggregate amount of $20,139,316 comprised of $9,708,581 to pay off various debt affiliated with our former directors and officers or their affiliates, see “Item 5. Interest of Management and Others in Certain Transactions,” $1,439,557 of unsecured promissory notes payable to accredited investors, and $8,991,178 to pay off a loan cross-collateralized by four of our properties. The remaining $3,860,684 received from the Recapitalization Transaction was used to pay transaction-related expenses and past due accounts payable, with the balance reserved for general working capital purposes including pursuing and making acquisitions.

 

 

 

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.

 

Prior to our Recapitalization Transaction, our Company had been capital constrained, which 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, we believe the Recapitalization Transaction will 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.

 

 Item 3. Directors and Officers

 

In connection with the Recapitalization Transaction, we experienced many changes in those who serve as our directors and officers. Information regarding our directors and officers is incorporated herein by reference to the Current Report on Form 1-U filed by our Company at: https://www.sec.gov/Archives/edgar/data/1670010/000165495419002955/hcgrt_1u.htm under the captions “Item 6. Changes in Control of Issuer” and “Item 9. Other Events.”

 

Following the closing of the Recapitalization Transaction, on March 20, 2019, each of Dr. Philip Kurlander and Mr. Edwin Stanton resigned from his position as a director of our Board of Directors. As of March 20, 2019, our Board of Directors is comprised of Messrs. Hale, Garner, Hultquist and Stewart. Mr. Hale was named Chairman of our Board of Directors.  

 

Item 4. Security Ownership of Management and Certain Security Holders

 

The table below sets forth, as of April 30, 2019, 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		50,000 Shares		N/A			3.6	%
Common Stock		HG Holdings, Inc.2		300,000 Shares		N/A			21.3	%
Series A Preferred Stock		Baker Hill Holding, LLC3		26,000 Shares		N/A			18.0	%
Series B Preferred Stock		All Executive Officers and Directors1		500,000 Shares4		N/A			47.6	%
Series B Preferred Stock		Hale Partnership Capital Management5, 6		500,000 Shares		N/A			47.6	%
Series B Preferred Stock		HG Holdings, Inc.2		200,000 Shares		N/A			19.0	%
Series B Preferred Stock		The Foursquare Foundation7		212,500 Shares		N/A			20.2	%

 

 

1 The address of each beneficial owner is 390 S Liberty Street, Suite 100, Winston-Salem, NC 27101.

2 The address of HG Holdings, Inc. is 2115 E. 7th Street, Suite 101, Charlotte, NC 27804.

3 The address of Baker Hill Holding, LLC is 54 Phipps Lane, Plainview, NY 11803.

4 Includes the shares directed by Hale Partnership Capital Management (“HPCM”).

5 The address of HPCM is 3675 Marine Drive, Greenville, NC 27834.

6 HPCM serves as investment manager or adviser to commingled funds, group trusts and separate accounts (such investment companies, funds, trusts and accounts, collectively referred to as the “Funds”). In certain cases, certain subsidiaries of HPCM may act as an adviser or sub-adviser to certain Funds. In its role as investment adviser, sub-adviser and/or manager, HPCM or its subsidiaries may possess voting and/or investment power over the securities of the Company owned by the Funds and may be deemed to be the beneficial owner of these shares. However, all securities reported on the table are owned by the Funds, and HPCM and its subsidiaries disclaim beneficial ownership of all of the shares shown.

7 The address of The Foursquare Foundation is 1910 W. Sunset Boulevard, Suite 200, Los Angeles, CA 90026.

 

 Item 5. Interest of Management and Others in Certain Transactions

 

The information included above under the caption “Item 1. Business—Recent Recapitalization Transaction” is hereby incorporated by reference into this Item 5. The information contained in the post-qualification amendment to our Offering Statement on Form 1-A located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495418012065/hcgov_1apos.htm under the caption “INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS” is incorporated herein by reference.

 

The following information has changed since the date of our post-qualification amendment to our Offering Statement on Form 1-A:

 

Norfolk Interim Loans

 

On March 31, 2017, the Company borrowed $2,770,000 from BH and $300,000 from Mr. Robert R. Kaplan. These loans were repaid in full in the aggregate amount of $3,070,000 with proceeds from our Recapitalization Transaction.

 

 

 

Additional Affiliated Loans and Advances

 

In July 2018, Messrs. Kaplan, Kaplan Jr., and Stanton, and BH, each advanced $60,000 to our Company to fund working capital and distributions. As of the date of this annual report, these amounts remain outstanding.

 

In October 2018, BH made two unsecured loans to our company in the amounts of $78,000 and $150,000 to fund distributions to our stockholders. These loans were repaid in full in the aggregate amount of $228,000 with proceeds from our Recapitalization Transaction.

 

Promissory Notes

 

On December 11, 2017, the Company borrowed $1,500,000 in aggregate principal amount pursuant to multiple unsecured promissory notes payable to accredited investors. With respect to these notes, $500,000 in principal amount was loaned by BH, and $250,000 was loaned by a member of the Company’s predecessor. These loans were repaid in full in the aggregate amount of $1,500,000 with proceeds from our Recapitalization Transaction.

 

BH Notes

 

On July 27, 2018, our Operating Partnership borrowed $1,700,000 from BH, pursuant to an unsecured promissory note. Also, on August 30, 2018, our Operating Partnership borrowed $800,000 from BH, pursuant to an unsecured promissory note. In addition, on October 12, 2018, our Operating Partnership borrowed $2,470,000 from BH, pursuant to an unsecured promissory note. These loans were repaid in full, including principal and interest make-whole payment, in the amount of $1,801,150, $856,933 and $2,705,336, respectively, with proceeds from our Recapitalization Transaction.

 

Predecessor Payables

 

Our Company had outstanding payables to our predecessor for various expenses paid on our behalf by our predecessor in the amount of $408,514. As of the date of this annual report, this amount remains outstanding.

 

Item 6. Other Information

 

None

 

 

 

 

 Item 7. Financial Statements

 

Report of Independent Registered Public Accounting Firm

 

 

 

To the Board of Directors and Stockholders

HC Government Realty Trust, Inc.

Winston-Salem, North Carolina

 

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, 2018 and 2017, the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the years in the two-year period ended December 31, 2018 and 2017, 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, 2018 and 2017, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2018 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 30, 2019

 

 

 

 

 

HC Government Realty Trust, Inc.

Consolidated Balance Sheets

December 31, 2018 and 2017

 

	December 31, 2018	December 31, 2017
ASSETS
Investment in real estate, net	$79,786,230	$61,922,635
Cash and cash equivalents	1,444,172	695,719
Restricted cash	1,718,676	1,676,152
Rent and other tenant receivables, net	1,073,881	757,752
Leasehold intangibles, net	8,024,729	5,635,435
Deposits on properties under contract	224,069	58,000
Prepaid expenses and other assets	235,005	307,840
Total Assets	$92,506,762	$71,053,533
LIABIILTIES
Mortgages payable, net of unamortized debt costs	$65,503,177	$49,573,683
Notes payable - related party	9,518,000	4,150,000
Notes payable	1,180,000	1,179,610
Declared dividends and distributions	378,687	344,842
Accrued interest payable	417,141	248,352
Accounts payable	422,162	267,232
Accrued expenses	483,879	357,981
Deferred revenue	452,313	-
Tenant improvement obligation	1,224,923	1,315,366
Acquisition fee payable - related party	505,239	274,345
Below-market leases, net	868,786	1,001,754
Related party payable, net	722,465	461,858
Total Liabilities	81,676,772	59,175,023
COMMITMENTS AND CONTINGENCIES (Note 14)	-	-
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, 1,107,041 and 895,307 common shares issued and outstanding at December 31, 2018 and 2017, respectively)	1,107	895
Additional paid-in capital	11,314,818	8,948,713
Offering costs	(1,459,479)	(1,459,479)
Accumulated deficit	(2,875,596)	(1,340,974)
Accumulated dividends and distributions	(1,536,708)	(690,963)
Total Stockholders' Equity	5,444,286	5,458,336
Noncontrolling interest in operating partnership	5,385,704	6,420,174
Total Equity	10,829,990	11,878,510
Total Liabilities and Stockholders' Equity	$92,506,762	$71,053,533

 

The following table presents the assets and liabilities of the Company's three consolidated variable interest entities as of December 31, 2018 and 2017 which are included on the consolidated balance sheets above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated variable interest entities. The liabilities in the table below include third-party liabilities of the consolidated variable interest entities 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	$11,627,603	$12,007,437
Intangible assets, net	397,582	530,626
Prepaids and other assets	122,777	457,096
Total Assets	$12,147,962	$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	$9,633,590	$9,796,972
Intangible liabilities, net	123,985	168,733
Accounts payable and accrued expenses	255,205	242,284
Total liabilities	$10,012,780	$10,207,989

 

The accompanying notes are an integral part of the consolidated financial statements

 

HC Government Realty Trust, Inc.

Consolidated Statements of Operations

For the years ended December 31, 2018 and 2017

 

	For the years ended December 31,
	2018	2017
Revenues
Rental revenues	$8,145,067	$4,595,560
Real estate tax reimbursments and other revenues	286,540	169,002
Total revenues	8,431,607	4,764,562
Operating expenses
Depreciation and amortization	3,102,762	1,675,079
General and administrative	441,029	405,824
Ground leases	91,545	45,954
Insurance	100,359	58,373
Janitorial	389,552	208,618
Management fees	552,705	303,482
Professional expenses	468,263	482,070
Real estate and other taxes	849,546	357,143
Repairs and maintenance	435,631	248,900
Equity-based compensation	193,119	181,031
Utilities	439,170	267,004
Total operating expenses	7,063,681	4,233,478
Other (income) expense
Interest expense	3,529,982	1,990,858
Gain on disposition of property	(57,530)	-
Net other (income) expense	3,472,452	1,990,858
Net loss	(2,104,526)	(1,459,774)
Less: Net loss attributable to noncontrolling interest in operating partnership	(569,904)	(244,844)
Net loss attributed to HC Government Realty Trust, Inc.	(1,534,622)	(1,214,930)
Preferred stock dividends	(252,875)	(316,095)
Net loss attributed to HC Government Realty Trust, Inc. available to common shareholders	$(1,787,497)	$(1,531,025)
Basic and diluted loss per share	$(1.70)	$(3.03)
Basic and diluted weighted-average common shares outstanding	1,048,495	504,486

 

The accompanying notes are an integral part of the consolidated financial statements

HC Government Realty Trust, Inc.

Consolidated Statements of Changes in Stockholders’ Equity

For the years ended December 31, 2018 and 2017

 

					Additional			Cumulative Dividends	Total	Non-controlling Interst in
	Preferred Series A		Common Stock		Paid-in	Offering	Accumulated	and	Stockholders'	Operating	Total
	Shares	Par Value	Shares	Par Value	Capital	Costs	Deficit	Distributions	Equity	Partnership	Equity
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
Equity-based compensation - restricted stock	-	-	16,000	16	98,651	-	-	-	98,667	-	98,667
Equity-based compensation 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
Proceeds from issuing common shares, net of issuances costs	-	-	211,734	212	1,947,443	-	-	-	1,947,655	-	1,947,655
Issuance of OP Units in connection with property closing	-	-	-	-	-	-	-	-	-	400,000	400,000
Equity-based compensation - restricted stock	-	-	-	-	61,333	-	-	-	61,333	-	61,333
Equity-based compensation long-term incentive plan shares	-	-	-	-	-	-	-	-	-	131,786	131,786
Dividends and distributions	-	-	-	-	-	-	-	(845,745)	(845,745)	(639,023)	(1,484,768)
Allocation of NCI in operating partnership	-	-	-	-	357,329	-	-	-	357,329	(357,329)	-
Net loss	-	-	-	-	-	-	(1,534,622)	-	(1,534,622)	(569,904)	(2,104,526)
Balance, December 31, 2018	144,500	$144	1,107,041	$1,107	$11,314,818	$(1,459,479)	$(2,875,596)	$(1,536,708)	$5,444,286	$5,385,704	$10,829,990

 

The accompanying notes are an integral part of the consolidated financial statements

 

HC Government Realty Trust, Inc.

Consolidated Statements of Cash Flows

For the years ended December 31, 2018 and 2017

 

	For the Years Ended December 31,
	2018	2017
Cash flows from operating activities:
Net loss	$(2,104,526)	$(1,459,774)
Adjustments to reconcile net loss to net cash provided from (used in) operating activities:
Depreciation	2,385,819	1,299,191
Amortization of acquired lease-up costs	322,446	178,296
Amortization of in-place leases	394,497	197,592
Amortization of above/below-market leases	101,008	24,639
Amortization of debt issuance costs	243,223	97,387
Equity-based compensation - long-term incentive plan units	131,786	82,364
Equity-based compensation - restricted shares	61,333	98,667
Gain on disposition of property	(57,530)	-
Change in assets and liabilities
Restricted cash	(42,524)	(174,271)
Rent and other tenant receivables, net	(316,129)	(482,217)
Prepaid expense and other assets	72,835	(130,470)
Deposits on properties under contract	(166,069)	-
Related party receivables, net	-	525,397
Accrued interest payable	244,789	212,973
Accounts payable and other accrued expenses	272,335	(90,454)
Deferred revenue	452,313	-
Tenant improvement obligation	(90,443)	-
Related party payable, net	20,607	461,858
Net cash provided from operating activities	1,925,770	841,178
Cash flows from investing activities:
Restricted cash	-	(1,315,366)
Capital improvements	(133,101)	(8,495)
Sale of property	98,879	-
Property acquisitions	(22,858,488)	(26,198,647)
Net cash used in investing activities	(22,892,710)	(27,522,508)
Cash flows from financing activities:
Debt issuance costs	(345,762)	(372,317)
Dividends paid	(1,450,923)	(632,354)
Mortgage principal payments	(1,107,967)	(3,673,038)
Mortgage proceeds	17,140,000	24,146,250
Notes principal repayments	(99,610)	(136,211)
Notes principal repayments - related party	(330,000)	-
Offering costs	-	(384,994)
Proceeds from advances - related party	765,000	-
Proceeds from notes payable	100,000	1,204,000
Proceeds from notes payable - related party	5,622,000	4,150,000
Proceeds from sale of common stock, net of issuance costs	1,947,655	6,141,926
Repayment of advances - related party	(525,000)	-
Repayment of seller note payable	-	(1,992,140)
Repayment of assumed notes payable	-	(1,321,210)
Net cash provided from financing activities	21,715,393	27,129,912
Net increase in cash and cash equivalents	748,453	448,582
Cash and cash equivalents, beginning of period	695,719	247,137
Cash and cash equivalents, end of period	$1,444,172	$695,719
Supplemental cash flow information:
Cash paid for interest	$3,117,970	$1,645,119
Cash paid for income taxes	$-	$-
Non cash investing and financing activities:
Accrued interest added to note payable - related party	$76,000	$-
Assumed liabilities (See Note 3)	$-	$24,670,469
Capitalized acquisition fees	$230,894	$274,345
Common units issued in connection with contribution transaction	$-	$6,068,182
Common units issued in connection with property acquisition	$400,000	$-
Contributed assets (See Note 3)	$-	$30,738,651
Mortgage principal refinanced	$6,781,386	$-
Refinance costs added to mortgage	$52,907	$-

The accompanying notes are an integral part of the consolidated financial statements

 

 

HC Government Realty Trust, Inc.

Notes to the Consolidated Financial Statements

For the years ended December 31, 2018 and 2017

 

 

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 to 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 the Operating Partnership subsidiary and related SPEs and the accounts of the REIT. As of December 31, 2018, the financial statements reflect the operations of 16 properties representing 320,652 rentable square feet located in eleven states. The properties are 100% leased to the government of the United States of America and based on annualized net operating income as of December 31, 2018, have a weighted average remaining lease term of 10.0 years if none of the early termination rights are exercised and 6.2 years if all of the early termination rights are exercised. 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 own an aggregate 43.54% of the common units of Operating Partnership as of December 31, 2018. The CEO of HCA and Holmwood served as the Company’s CEO until March 13, 2019 and as a board member of the Company until March 20, 2019. In addition, two other beneficial owners of HCA and Holmwood served as board members of the Company until March 20, 2019. The Company operates as an UPREIT and has elected 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.

 

 

Basis of Accounting and Consolidation Basis - The accompanying consolidated financial statements include the accounts of the Operating Partnership and 16 SPEs as of December 31, 2018. Of the SPEs, 13 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.

 

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, 2018, two accounts had a combined $1,773,591 in excess of insured 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.

 

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. Amortization relating to above (below) market leases for the years ended December 31, 2018 and 2017 was $101,008 and $24,639, respectively, and was recorded as a reduction to rental revenues.

 

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.

 

Management utilizes independent third-parties to assist with the determination of fair value of the various tangible and intangible assets that are acquired.

 

The cost of tenant improvements are capitalized and amortized over the non-cancelable term of each specific lease.

 

Maintenance and repair costs are expensed as incurred while costs incurred that extend the useful life of the real estate investment are capitalized.

 

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 and site improvements				5- 40 years
Tenant improvements				Shorter of remaining life of the lease or useful life

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 base 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 intangibles 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 revenue over the term of the lease.

 

Impairment – Real 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, 2018 and 2017, 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, 2018 and 2017, organizational and offering costs totaled $1,459,479.

 

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, 2018 and 2017.

 

Income Taxes – The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and applicable Treasury regulations relating to REIT qualification beginning with 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, 2018 and 2017.

 

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 is calculated by multiplying the noncontrolling interest ownership percentage at the balance sheet date by the Operating Partnership’s equity. The noncontrolling interest ownership percentage is calculated by dividing the Operating Partnership common units not owned by the Company by the total Operating Partnership 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 as a reduction of the mortgages payable carrying value within the consolidated balance sheets.

  

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.

  

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,
	2018	2017
Potentially dilutive securities outstanding
Convertible common units	1,118,416	1,078,416
Convertible long-term incentive plan units	72,215	66,056
Convertible preferred stock	433,500	433,500
Unvested restricted stock	-	16,000
Total potential dilutive securities	1,624,131	1,593,972