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, 2019

  

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 HCA. 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 on Form 1-K and the risk that actual results will differ materially from the expectations expressed in this annual report on Form 1-K 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 on Form 1-K, 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 on Form 1-K, 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 on Form 1-K will be achieved.

 

Item 1. Business

 

The Company

 

We are an internally-managed real estate investment trust, or REIT, formed to grow our business of acquiring, developing, financing, owning and managing build-to-suit or improved-to-suit, single-tenant properties leased primarily to the United States of America and administered by the U.S. General Services Administration (“GSA”) or directly by the federal government agencies or departments occupying such properties (referred to as “GSA Properties”). We invest primarily in GSA Properties with sizes ranging from 5,000 to 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.

 

On March 14, 2019, we provided notice of nonrenewal (the “Nonrenewal Notice”) of our Management Agreement with HCA to be effective as of March 31, 2020. While our Management Agreement has continued to be in place since the date of the Nonrenewal Notice, our Board amended and restated our investment guidelines as of the date of the Nonrenewal Notice. On March 31, 2020, the Management Agreement was terminated. We paid a total termination fee of $1,645,453, which was satisfied with $1,275,000 in cash and $370,453 in shares of common stock of the Company at a per share price of $7.17 for a total of 51,667 shares.

 

As of the filing of this report, our portfolio consists of 20 GSA Properties, comprised of 16 GSA Properties that we own in fee simple, one GSA Property that we own subject to a ground lease and three 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 (“Portfolio Properties”), which includes one property acquired on May 1, 2019 and three properties acquired on October 22, 2019, contains approximately 390,767 rentable square feet located in 13 states. Based on net operating income of our Portfolio Properties, our portfolio has a weighted average remaining lease term of 9.3 years if none of the early termination rights are exercised and 5.7 years if all of the early termination rights are exercised.

 

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 we generally 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. 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 occupying 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 Veterans Affairs.

  

 

We operate as an umbrella partnership REIT (“UPREIT”), which means that we conduct substantially all of our business through our Operating Partnership for which we serve as the general partner. Our GSA-leased properties are owned through single-purpose entities, 17 of which are wholly owned by our Operating Partnership and three of which 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. 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 believe in the long-term there will be a consistent flow of GSA Properties that meet our target investment criteria 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 with sizes ranging from 5,000 to 50,000 rentable square feet, and in their listed lease term after construction or improvement to post-9/11 standards 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 benefit from 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 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 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 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, subject to broad investment policies adopted by our board of directors, as may be amended by the board of directors from time to time.

  

Description of Our Properties

 

The following table presents an overview of our properties as of December 31, 2019.

 

Property	Current Occupant	Rentable Sq. Ft (RSF)	% of Portfolio 1	% Leased	Early Termination 2	Expiration Date	Effective Annual Rent	Effective Annual Rent per RSF	Effective Annual Rent % of Portfolio
Our Portfolio
Port Saint Lucie, Florida	DEA	24,858	6.4%	100%	5/31/2022	5/31/2027	$574,875	$23.13	4.7%
Jonesboro, Arkansas	SSA	16,439	4.2%	100%	1/11/2022	1/11/2027	$623,145	$37.91	5.1%
Lorain, Ohio	SSA	11,607	3.0%	100%	3/31/2021	3/31/2024	$445,892	$38.42	3.6%
Cape Canaveral, Florida	CBP	14,704	3.8%	100%	7/15/2022	7/15/2027	$673,653	$45.81	5.5%
Johnson City, Tennessee	FBI	10,115	2.6%	100%	8/20/2022	8/20/2027	$396,781	$39.23	3.2%
Fort Smith, Arkansas	CIS	13,816	3.5%	100%	10/30/2024	10/30/2029	$427,275	$30.93	3.5%
Silt, Colorado	BLM	18,813	4.8%	100%	9/30/2024	9/30/2029	$388,380	$20.64	3.1%
Lakewood, Colorado	DOT	19,241	4.9%	100%	No Early Termination	6/20/2024	$466,253	$24.23	3.8%
Moore, Oklahoma	SSA	15,445	3.9%	100%	4/9/2022	4/9/2027	$530,659	$34.36	4.3%
Lawton, Oklahoma	SSA	9,298	2.4%	100%	8/16/2020	8/16/2025	$285,044	$30.66	2.3%
Norfolk, Virginia	SSA	53,917	13.8%	100%	No Early Termination	6/26/2027	$1,314,322	$24.38	10.7%
Montgomery, Alabama	CIS	21,420	5.5%	76%	12/8/2026	12/8/2031	$578,848	$27.02	4.7%
San Antonio, Texas	ICE	38,756	9.9%	100%	4/30/2022	4/30/2027	$1,093,819	$28.22	8.9%
Knoxville, Iowa	VA	12,833	3.3%	100%	No Early Termination	1/11/2032	$687,427	$53.57	5.6%
Champaign, Illinois	FBI	11,180	2.9%	100%	4/12/2028	4/12/2033	$371,323	$33.21	3.0%
Sarasota, Florida	USDA	28,210	7.2%	100%	7/19/2028	7/19/2038	$919,223	$32.59	7.5%
Monroe, Louisiana	VA	21,124	5.4%	100%	No Early Termination	9/30/2023	$744,471	$35.24	6.1%
Ft. Lauderdale, Florida	ICE	16,000	4.1%	100%	4/9/2028	4/9/2033	$702,936	$43.93	5.7%
Lawrence, Kansas	USGS	16,000	4.1%	100%	No Early Termination	2/28/2033	$595,522	$37.22	4.8%
Oklahoma City, Oklahoma	ICE	16,991	4.3%	100%	12/27/2028	12/27/2033	$483,642	$28.46	3.9%
Total - Our Portfolio		390,767	100.00%	100%			$12,303,491	$31.49	100.00%

 

 

 

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”). Additional description of the Recapitalization Transaction can be found on our Current Report on Form 1-U located at: https://www.sec.gov/Archives/edgar/data/1670010/000165495419002955/hcgrt_1u.htm.

  

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are a real estate investment trust, or REIT, formed to grow our business of acquiring, developing, financing, owning and managing build-to-suit or improved-to-suit, single-tenant properties leased primarily to the United States of America and administered by the GSA or directly by the federal government agencies or departments occupying such properties (referred to as “GSA Properties”). We invest primarily in GSA Properties in sizes that range from 5,000 to 50,000 rentable square feet that 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.  Leases associated with the GSA Properties in which our company invests are full faith and credit obligations of the United States of America. 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, built-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, 2019, the Company owned 20 GSA Properties, comprised of 16 GSA Properties that we own in fee simple, one GSA Property that we own subject to a ground lease and three 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 390,767 rentable square feet located in 13 states. As of December 31, 2019, our portfolio properties are 100% leased to the United States of America and occupied by 11 different federal government agencies. Based on net operating income of each property, our portfolio has a weighted average remaining lease term of 9.3 years if none of the early termination rights are exercised and 5.7 years if the early termination right are exercised.

 

Our Operating Partnership, through wholly-owned special purpose entities or SPEs, holds substantially all of our assets and conducts substantially all of our business. As of December 31, 2019, we owned approximately 54.7% of the aggregate common limited partnership interests in our Operating Partnership, or common units. We also own all of the preferred limited partnership interests in our Operating Partnership. We were formed in 2016 as a Maryland corporation and we have elected to be taxed as a REIT for federal income tax purposes commencing with our fiscal year ended December 31, 2017.

 

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 on May 26, 2017.

 

 

Operating Results

 

For the year ended December 31, 2019

 

At December 31, 2019, we owned 17 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 comprises 390,767 rentable square feet located in 13 states and is 100% leased to the United States and either administered by the GSA or occupying department or agency.

 

During the year ended December 31, 2019, we earned revenues of $10,788,099 and incurred operating costs of $3,356,328, excluding asset management fees, depreciation and amortization and corporate expenses. Our net operating income for the period was $7,431,771; and, after deducting asset management fees of $485,813, corporate expenses of $3,649,756, depreciation and amortization of $4,046,413, interest expense of $5,045,639, loss on extinguishment of debt of $966,200, management termination fees of $1,900,002 and the recognition of a gain on involuntary conversion of $192,717, the Company’s net loss was $8,469,335 for the year ended December 31, 2019. Our net loss attributed to our common shareholders was $7,611,041 after allocating $2,020,305 of the Company’s net loss to the noncontrolling interest in our Operating Partnership and after deducting preferred stock dividends of $1,162,011. In connection with the Recapitalization Transaction, we incurred certain one-time expenses totaling $1,655,631 primarily for legal and professional services and make-whole premium on certain notes payable that were paid off at closing. During the year ended December 31, 2019, we recognized $584,553 to write-off debt issuance costs associated with the early repayment of certain mortgages and $1,900,002 of management termination fees comprised of (1) fees associated with the termination of certain property management agreements and (2) estimated fees expected to be paid to HCA in connection with the non-renewal of our asset management agreement, which formally terminated effective March 31, 2020. Excluding the impact of these one-time expenses, our net loss was $4,329,149 for the year ended December 31, 2019 and our net loss attributed to our common shareholders was $3,470,855.

 

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

 

During the year ended December 31, 2018, we earned revenues of $8,431,607 and incurred operating costs, excluding asset management fees, depreciation and amortization and corporate expenses, of $2,622,000. Our net operating income for the period was $5,809,607; and, after deducting asset management fees of $328,053, corporate expenses of $1,010,866, depreciation and amortization of $3,102,762, interest expense of $3,529,982 and after the recognition of a gain on an asset disposition of $57,530, the Company’s net loss was $2,104,526 for the year ended December 31, 2018. Our net loss attributed to our common shareholders was $1,787,497 after allocating $569,904 of the Company’s net loss to the noncontrolling interest in our Operating Partnership and after deducting preferred stock dividends of $252,875.

 

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 a reconciliation of NOI to net income (loss) as computed in accordance with GAAP for the periods presented.

 

	For the year ended December 31,
	2019	2018
Revenues	$10,788,099	$8,431,607
Less:
Operating expenses	3,087,487	2,397,348
Property management fee	268,841	224,652
Total expenses	3,356,328	2,622,000
Net operating income	7,431,771	5,809,607
Less:
Asset management fee	485,813	328,053
Corporate expenses	3,649,756	1,010,866
Depreciation and amortization	4,046,413	3,102,762
Interest expense	5,045,639	3,529,982
Loss on extinguishment of debt	966,200	-
Management termination fees	1,900,002	-
Gain on involuntary conversion	(192,717)	-
Gain on asset disposition	-	(57,530)
Net loss	(8,469,335)	(2,104,526)
Less: Net loss attributable to noncontrolling interest	(2,020,305)	(569,904)
Net loss attributed to HC Gov Realty Trust, Inc.	(6,449,030)	(1,534,622)
Less: Preferred stock dividends	(1,162,011)	(252,875)
Net loss attributed to HC Gov Realty Trust, Inc. available to common shareholders	$(7,611,041)	$(1,787,497)

 

Liquidity and Capital Resources

 

Our business model is intended to drive growth through acquisitions. Our Recapitalization Transaction and KeyBank Transaction (as defined below) provided us with liquidity through both debt and equity investments. This allowed us to refinance our existing 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 . In November 2019, our securities offering pursuant to Regulation A (the “Offering”) expired and we did not file a post-qualification amendment to extend the Offering. While we have currently elected to not continue to issue equity under Regulation A, we expect to continue to issue equity in our company with proceeds being used to acquire GSA Properties or buy facilities that are leased to credit-worthy state or municipal tenants. As of December 31, 2019, we had approximately $3,436,577 available in cash and cash equivalents.

 

Liquidity General 

 

Our need for liquidity will be primarily to fund (i) operating expenses and cash dividends and distributions; (ii) property acquisitions; (iii) capital expenditures; (iv) payment of principal of, and interest on, outstanding indebtedness; and (v) other investments, consistent with our Investment Guidelines and Investment Policies.

 

 

Capital Resources

 

Our capital resources are substantially related to our recent Recapitalization Transaction and KeyBank Transaction (as defined below). 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, $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.

 

The Recapitalization Transaction permitted the issuance of up to an additional $10,000,000 of Series B Preferred Stock and the borrowing of up to an additional $10,000,000 of mezzanine debt, which was later increased in October 2019 to an additional $13,500,000 of mezzanine debt in the aggregate. In May 2019, we issued an additional $1,300,000 of Series B Preferred Stock and borrowed an additional $1,300,000 in mezzanine debt to partially finance our acquisition of our Portfolio Property in Monroe, Louisiana. In June 2019, we borrowed an additional $2,000,000 of mezzanine debt to partially refinance the mortgage debt on our Portfolio Property in San Antonio, Texas. In October 2019, we borrowed an additional $7,000,000 of mezzanine debt to partially finance our acquisition of our Portfolio Properties in Ft. Lauderdale, Florida, Lawrence, Kansas and Oklahoma City, Oklahoma. As of December 31, 2019, we had approximately $8,700,000 in authorized but unissued shares of Series B Preferred Stock and $3,200,00 of mezzanine debt available.

 

In October 2019, we also entered into a senior secured revolving credit facility with KeyBanc Capital Markets, Inc., as sole bookrunner and lead arranger, and KeyBank National Association, as syndication agent and administrative agent, in connection with which we obtained commitments in an initial amount of $60,000,000 (the “KeyBank Transaction”) and borrowed an initial principal amount of $60,000,000 in order to refinance certain existing indebtedness and to partially finance our acquisition of our Portfolio Properties in Ft. Lauderdale, Florida, Lawrence, Kansas and Oklahoma City, Oklahoma. In December 2019, the senior secured revolving credit facility was increased to provide total availability of up to $100,000,000, subject to customary terms and availability conditions. The senior secured revolving credit facility includes an accordion feature that will permit the Company to further increase the amount of commitments available to the Company, up to $200,000,000, subject to customary terms and conditions. The Company intends to use the senior secured revolving credit facility to repay certain indebtedness, fund acquisitions and capital expenditures and provide working capital.

 

As of December 31, 2019, we had approximately $39,050,000 committed and undrawn under our senior secured revolving credit facility.

 

Trend Information

 

Our Company, through our Operating Partnership is engaged primarily in the acquisition, leasing and management of single-tenanted, mission critical or customer facing properties, leased to the United States of America 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. We believe the Recapitalization Transaction enabled management to accelerate its acquisition plans and provided much needed liquidity to our Company during 2019. While there can be no assurance, we believe our senior secured revolving credit facility will support our Company’s growth strategy, provide liquidity to recruit and retain qualified personnel, and enhance purchasing power for goods and services in connection with the operation of our properties.

 

 

 

 Item 3. Directors and Officers

 

The individuals listed below are our executive officers and directors. The following table and biographical descriptions set forth certain information with respect to the individuals who currently serve as our directors and the executive officers:

 

Name		Position		Age		Term of Office
Steven A. Hale II		Chairman and Chief Executive Officer		36		March 2019
Jacqlyn Piscetelli		Chief Financial Officer, Treasurer and Secretary		36		March 2019
Brad G. Garner		Director		37		March 2019
Matthew A. Hultquist		Director		41		March 2019
Jeffrey S. Stewart		Director		53		March 2019
Anthony J. Sciacca, Jr.		Director		49		September 2019

 

Steven A. Hale II. Mr. Hale has managed the Hale Partnership Fund LP, MGEN-II Hale Fund LP, Clark-Hale Fund LP, and Hale Medical Office Building Fund, LP, via Hale Partnership Capital Management, LLC, since September 2010. In November 2017, Mr. Hale was named Chairman of the Board for Stanley Furniture Company, Inc. (since renamed HG Holdings, Inc.). He has served as Chief Executive Officer of HG Holdings, Inc. since March 2018. Prior to founding Hale Partnership Capital Management, LLC, Mr. Hale worked for Babson Capital Management, LLC where he was responsible for primary coverage of distressed debt investments across a variety of industries including manufacturing commercial real estate, services, and casinos/gaming. Prior to joining Babson, Mr. Hale was a Leveraged Finance Analyst at Bank of America Securities. Mr. Hale graduated from Wake Forest University in 2005, where majored in economics, minored in psychology and religion, and was a 3-year letterman on the varsity football team.

 

Jacqlyn Piscetelli. Ms. Piscetelli served as Chief Financial Officer of Stanley Furniture Company, LLC (“Stanley Furniture”) from March 2018 until January 2019 where she directed all finance and accounting operations. Prior to joining Stanley Furniture, Ms. Piscetelli served as the Financial Executive – Governance for the Financial Management group at BB&T Corporation (“BB&T”) from 2016 to 2018 where she managed BB&T’s Sarbanes-Oxley Section 302 and 404 compliance programs. From 2013 to 2016, Ms. Piscetelli worked in BB&T’s Accounting Policy group where she was primarily responsible for monitoring the issuance of new accounting pronouncements and evaluating their impact on the financial institution. Ms. Piscetelli spent over 7 years in public accounting at Ernst & Young LLP (“EY”) in their Assurance practice. At EY, she served both public and private clients with domestic and foreign operations across a variety of industries including manufacturing and distribution, automotive, retail and financial services. Ms. Piscetelli graduated from Wake Forest University in 2006 with a B.S. and M.S. in Accountancy.

 

Brad G. Garner. Mr. Garner joined Hale Partnership Capital Management, LLC in 2015 as Chief Financial Officer and Partner. In April 2018, Mr. Garner was named Chief Financial Officer of HG Holdings, Inc. (formerly Stanley Furniture Company, Inc.). Mr. Garner leads Real Estate efforts and private equity investments for the Hale entities. He has also served as Chief Financial Officer of Best Bar Ever, Inc., a protein bar business from 2015-2017. Mr. Garner assisted in raising and structuring a capital investment and successful exit to a strategic partner while overseeing all financial reporting functions during a two-year time horizon. Prior to taking on that role, he spent 10 years in public accounting at Dixon Hughes Goodman LLP (“DHG”), the largest public accounting firm headquartered in the Southeast, as a Senior Tax Manager. At DHG, he served domestic closely held companies (specifically pass-through entities) and individuals. These clients represented a variety of industries including manufacturing and distribution, construction and real estate, and financial institutions. Mr. Garner earned B.S and M.S in Accounting from Wake Forest.

 

Matthew A. Hultquist. Mr. Hultquist has served as the Managing Member of Hillandale Advisors, a private investment and advisory firm that works with private businesses and their owners on strategic growth since January 2017. In June 2018, Matthew joined the Board of Directors of HG Holdings, Inc. (formerly Stanley Furniture Company, Inc.). From 2006 to 2016, Matt served on the investment team as Sasco Capital, Inc., a public equity asset management firm overseeing $4 billion + of assets for public funds, corporations and endowments. Sasco Capital invested in mid to large capitalization public companies across most industries, with jewel businesses, that are undergoing corporate restructuring, transformation, or management change. Matt earned B.S in Finance from Wake Forest University and M.B.A from Columbia Business School.

 

 

Jeffrey S. Stewart. Mr. Stewart has been the Chairman of the Foursquare Foundation Investment Committee since 2008. Mr. Stewart also currently sits on Morgan Stanley’s North Haven Credit Advisory Board. Mr. Stewart is a highly experienced portfolio manager with 24 years of experience investing and researching debt and equity, including equity research at IJL and fixed income at First Union, and portfolio management at Babson Capital Management, LLC. Jeff started his career as a United States Marine in 1985. Three time meritoriously promoted, he was awarded a NROTC scholarship in 1988 and attended UNC Chapel Hill, where he received a BSBA with a concentration in finance and a minor in history with distinction.

 

Anthony J. Sciacca, Jr. Mr. Sciacca serves as Head of Global Alternative Investments at Barings Real Estate Advisers LLC and Babson Capital Management LLC, Investment Arm. Mr. Sciacca is responsible for overseeing the group's investment activities across private equity, asset-based investments, and real assets. He serves as the Head of Barings Alternative Investments at Barings LLC. Previously, he served as a Managing Director, Head of Babson Capital Strategic Investors and Head of Global Business Development Group at the firm. In this capacity, he drove business development initiatives across Babson's investment strategies from fixed income to alternative asset markets and oversaw the management of Babson's institutional and retail relationships globally. He joined the firm in 2006. He also leads the middle-market bank loan business at the firm's U.S. bank loan team. Mr. Sciacca is also a member of the firm's Senior Management Team and the President of Babson Capital Securities. He was a Managing Director and the Head of Structured Credit Origination for the collateralized loan obligation and corporate collateralized debt obligation businesses at Wachovia Securities. Mr. Sciacca was employed at Wachovia Securities from April 2002 to April 2006. Before that, he was a Managing Director at Bear, Stearns & Co. where he was a structured credit market specialist. Mr. Sciacca was an Associate Director at Bank of America from October 1996 to September 2000. He served as a Consultant at Accenture from September 1993 till October 1996. He also worked in middle market senior lending as well as financial services consulting with Accenture. Mr. Sciacca serves as a member of Board of Managers of Cornerstone Real Estate Advisors LLC. He has worked in the industry since 1993. Mr. Sciacca has several years of industry experience, encompassing private equity, middle market finance and structured credit. He received a B.S. degree in Applied Economics from Cornell University in 1993.

 

Executive Compensation

 

The following table summarizes compensation to our executive officers for the year ended December 31, 2019:

 

Name	Salary	Stock-Based Compensation	Total Compensation
Steven A. Hale II, Chief Executive Officer	$175,625	$225,000	$400,625
Jacqlyn Piscetelli, Chief Financial Officer	117,083	50,000	167,083

 

Director Compensation

 

In 2019, we granted $35,000 of shared-based compensation in the form of restricted shares of our common stock to each of our non-employee directors, which vests in September 2020.

 

A description of our 2016 Equity Incentive Plan 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 “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS— HC Government Realty Trust 2016 Long Term Incentive Plan.”

 

Item 4. Security Ownership of Management and Certain Security Holders

 

The table below sets forth, as of the filing of this report, 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	31,424 Shares	N/A	2.2%
Common Stock	HG Holdings, Inc.2	300,000 Shares	N/A	20.9%
Series A Preferred Stock	Baker Hill Holding, LLC3	26,000 Shares	N/A	18.0%
Series B Preferred Stock	All Executive Officers and Directors1	730,000 Shares4	N/A	61.9%
Series B Preferred Stock	Hale Partnership Capital Management5, 6	730,000 Shares	N/A	61.9%
Series B Preferred Stock	HG Holdings, Inc.2	200,000 Shares	N/A	16.9%
Series B Preferred Stock	International Church of the Foursquare Gospel7	250,500 Shares	N/A	21.2%

 

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, HPCM may act as an adviser or sub-adviser to certain Funds. In its role as investment adviser, sub-adviser and/or manager, HPCM 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 disclaim beneficial ownership of all of the shares shown.

7 The address of International Church of the Foursquare Gospel 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 Baker Hill Holdings LLC (“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. These advances were repaid during 2019.

 

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 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. The principal balance of these loans were repaid in full along with $356,697 of make whole premium with proceeds from our Recapitalization Transaction.

 

Real Estate Notes

 

On May 1, 2019, one of our single-purpose entities that is wholly-owned by our Operating Partnership borrowed $2,550,000 from the Hale Partnership Fund, L.P. to partially finance the acquisition of our GSA Property located in Monroe, Alabama. The unsecured loan bears a variable interest rate based on one-month LIBOR plus 225 basis points. This loan was fully repaid with proceeds from the KeyBank Transaction. The loan was not subject to any prepayment penalty.

 

On June 5, 2019, one of our single-purpose entities that is wholly-owned by our Operating Partnership borrowed $5,000,000 from the Hale Partnership Fund, L.P. to partially refinance the mortgage on our GSA Property located in San Antonio, Texas. The unsecured loan bears interest at a fixed rate of 5.50%. This loan was fully repaid with proceeds from the KeyBank Transaction. The loan was not subject to any prepayment penalty.

 

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, 2019 and 2018, 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, 2019 and 2018, 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, 2019 and 2018, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2019 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 2, 2020

 

 

HC Government Realty Trust, Inc.

Consolidated Balance Sheets

December 31, 2019 and 2018

 

 

	December 31, 2019	December 31, 2018
ASSETS
Investment in real estate, net	$96,972,845	$79,786,230
Cash and cash equivalents	3,436,577	1,444,172
Restricted cash	120,166	1,718,676
Rent and other tenant receivables, net	1,136,496	1,073,881
Leasehold intangibles, net	9,319,030	8,024,729
Deposits on properties under contract	-	224,069
Deferred financing, net	2,023,844	-
Prepaid expenses and other assets	188,058	235,005
Total Assets	$113,197,016	$92,506,762
LIABILTIES
Revolving credit facility	$60,950,000	$-
Mezzanine debt	20,800,000	-
Mortgages payable, net of unamortized debt costs	9,459,291	65,503,177
Notes payable - related party	-	9,518,000
Notes payable	-	1,180,000
Declared dividends and distributions	721,733	378,687
Accrued interest payable	267,366	417,141
Accounts payable	591,791	422,162
Accrued expenses	1,289,450	483,879
Accrued management termination fee	1,650,000	-
Deferred revenue	-	452,313
Tenant improvement obligation	1,201,661	1,224,923
Acquisition fee payable	556,739	505,239
Below-market leases, net	753,515	868,786
Related party payable, net	-	722,465
Total Liabilities	98,241,546	81,676,772
COMMITMENTS AND CONTINGENCIES (Note 13)	-	-
STOCKHOLDERS' EQUITY
Preferred stock ($0.001 par value, 250,000,000 shares authorized and 1,324,500 and 144,500 shares issued and outstanding at December 31, 2019 and 2018, respectively)	1,324	144
Common stock ($0.001 par value, 750,000,000 shares authorized, 1,438,465 and 1,107,041 common shares issued and outstanding at December 31, 2019 and 2018, respectively)	1,438	1,107
Additional paid-in capital	24,463,133	11,314,818
Offering costs	(1,459,479)	(1,459,479)
Accumulated deficit	(9,324,626)	(2,875,596)
Accumulated dividends and distributions	(3,478,926)	(1,536,708)
Total Stockholders' Equity	10,202,864	5,444,286
Noncontrolling interest in operating partnership	4,752,606	5,385,704
Total Equity	14,955,470	10,829,990
Total Liabilities and Stockholders' Equity	$113,197,016	$92,506,762

 

The following table presents the assets and liabilities of the Company's three consolidated variable interest entities as of December 31, 2019 and 2018 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	$11,237,144	$11,627,603
Intangible assets, net	264,538	397,582
Prepaids and other assets	358,998	122,777
Total Assets	$11,860,680	$12,147,962

LIABILITIES OF CONSOLIDATED VARIABLE INTEREST ENTITIES FOR WHICH CREDITORS OR BENEFICIAL INTEREST HOLDERS DO NOT HAVE RECOURSE TO THE COMPANY.

Mortgages payable, net	$9,459,291	$9,633,590
Intangible liabilities, net	79,237	123,985
Accounts payable and accrued expenses	205,862	255,205
Total liabilities	$9,744,390	$10,012,780

 

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, 2019 and 2018

 

	For the years ended
	December 31, 2019	December 31, 2018
Revenues
Rental revenues	$10,441,958	$8,145,067
Real estate tax reimbursements and other revenues	346,141	286,540
Total revenues	10,788,099	8,431,607
Operating expenses
Depreciation and amortization	4,046,413	3,102,762
General and administrative - corporate	885,888	416,183
General and administrative - property	52,201	24,846
Ground leases	91,755	91,545
Insurance	172,129	100,359
Janitorial	498,423	389,552
Management fees	754,654	552,705
Management termination fees	1,900,002	-
Professional expenses	2,299,084	468,263
Real estate and other taxes	1,034,703	849,546
Repairs and maintenance	720,501	435,631
Equity-based compensation	492,654	193,119
Utilities	489,905	439,170
Total operating expenses	13,438,312	7,063,681
Other (income) expense
Interest expense	5,045,639	3,529,982
Loss on extinguishment of debt	966,200	-
Gain on involuntary conversion	(192,717)	-
Gain on sale of property	-	(57,530)
Net other (income) expense	5,819,122	3,472,452
Net loss	(8,469,335)	(2,104,526)
Less: Net loss attributable to noncontrolling interest in operating partnership	(2,020,305)	(569,904)
Net loss attributed to HC Government Realty Trust, Inc.	(6,449,030)	(1,534,622)
Preferred stock dividends	(1,162,011)	(252,875)
Net loss attributed to HC Government Realty Trust, Inc. available to common shareholders	$(7,611,041)	$(1,787,497)
Basic and diluted loss per share	$(5.64)	$(1.70)
Basic and diluted weighted-average common shares outstanding	1,348,958	1,048,495

 

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, 2019 and 2018

  

	Preferred Series A		Preferred Series B		Common Stock		Additional			Cumulative Dividends	Total	Non-controlling Interest in
		Par		Par		Par	Paid-in	Offering	Accumulated	and	Stockholders'	Operating	Total
	Shares	Value	Shares	Par Value	Shares	Value	Capital	Costs	Deficit	Distributions	Equity	Partnership	Equity
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
Proceeds from issuing common shares, net of issuances costs	-	-	-	-	300,000	300	2,999,700	-	-	-	3,000,000	-	3,000,000
Proceeds from issuing preferred shares	-	-	1,180,000	1,180	-	-	11,798,820	-	-	-	11,800,000	-	11,800,000
Equity-based compensation long-term incentive plan shares	-	-	-	-	-	-	-	-	-	-	-	144,499	144,499
Equity-based compensation - restricted stock	-	-	-	-	31,424	31	247,350	-	-	-	247,381	-	247,381
Dividends and distributions	-	-	-	-	-	-	-	-	-	(1,942,218)	(1,942,218)	(654,847)	(2,597,065)
Allocation of NCI in operating partnership	-	-	-	-	-	-	(1,897,555)	-	-	-	(1,897,555)	1,897,555	-
Net loss	-	-	-	-	-	-	-	-	(6,449,030)	-	(6,449,030)	(2,020,305)	(8,469,335)
Balance, December 31, 2019	144,500	$144	1,180,000	$1,180	1,438,465	$1,438	$24,463,133	$(1,459,479)	$(9,324,626)	$(3,478,926)	$10,202,864	$4,752,606	$14,955,470

 

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, 2019 and 2018

 

	For the years ended December 31,
	2019	2018
Cash flows from operating activities:
Net loss	$(8,469,335)	$(2,104,526)
Adjustments to reconcile net loss to net cash provided from (used in) operating activities:
Depreciation	3,074,466	2,385,819
Amortization of acquired lease-up costs	416,310	322,446
Amortization of in-place leases	555,637	394,497
Amortization of above/below-market leases, net	154,375	101,008
Amortization of debt issuance costs	864,927	243,223
Equity-based compensation - long-term incentive plan units	144,499	131,786
Equity-based compensation - restricted shares	247,381	61,333
Gain on disposition of property	-	(57,530)
Gain on involuntary conversion	(192,717)	-
Change in assets and liabilities
Rent and other tenant receivables, net	(62,615)	(316,129)
Prepaid expense and other assets	552,767	72,835
Deposits on properties under contract	224,069	(166,069)
Accrued interest payable	(149,775)	244,789
Accounts payable and other accrued expenses	(125,627)	272,335
Deferred revenue	-	452,313
Accrued management termination fee	1,650,000	-
Tenant improvement obligation	(23,262)	(90,443)
Related party payable, net	(73,951)	20,607
Net cash provided from (used in) operating activities	(1,212,851)	1,968,294
Cash flows from investing activities:
Capital improvements	(565,658)	(133,101)
Sale of property	-	98,879
Real estate acquisitions and deposits	(22,492,920)	(22,858,488)
Net cash used in investing activities	(23,058,578)	(22,892,710)
Cash flows from financing activities:
Debt issuance costs	(2,216,921)	(345,762)
Dividends paid	(2,254,019)	(1,450,923)
Proceeds from sale of common stock, net of issuance costs	3,000,000	1,947,655
Proceeds from sale of preferred stock	11,800,000	-
Borrowings under revolving credit facility	60,950,000	-
Mortgage proceeds	7,550,000	17,140,000
Mortgage principal payments	(64,265,736)	(1,107,967)
Proceeds from notes payable	20,934,000	100,000
Proceeds from notes payable - related party	-	5,622,000
Proceeds from advances - related party	-	765,000
Notes principal repayments	(1,314,000)	(99,610)
Notes principal repayments - related party	(9,518,000)	(330,000)
Advances repayments - related party	-	(525,000)
Net cash provided from financing activities	24,665,324	21,715,393
Net increase in Cash and cash equivalents and Restricted cash	393,895	790,977
Cash and cash equivalents and Restricted cash, beginning of period	3,162,848	2,371,871
Cash and cash equivalents and Restricted cash, end of period	$3,556,743	$3,162,848
Supplemental cash flow information:
Cash paid for interest	$4,439,279	$2,104,206
Cash paid for income taxes	$-	$-
Non cash investing and financing activities:
Capitalized acquisition fees	$51,500	$230,894
Accrued interest added to note payable - related party	$-	$76,000
Common units issued in connection with property acquisition	$-	$400,000
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, 2019 and 2018

 

 

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 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 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, (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”). As of December 31, 2019, the Company owned approximately 54.7% of the aggregate common limited partnership interests in our Operating Partnership, or common units, and all of the preferred limited partnership interests, preferred units.

 

The consolidated financial statements include the accounts of its Operating Partnership subsidiary and related SPEs and the accounts of the REIT. As of December 31, 2019, the financial statements reflect the operations of 20 GSA Properties representing 390,767 rentable square feet located in 13 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 as of December 31, 2019 of 9.3 years if none of the early termination rights are exercised and 5.7 years if all of the early termination rights are exercised. 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 are presented on the accrual basis of accounting in accordance with principles generally accepted in the United States of America (“GAAP”) and include the accounts of the REIT, the Operating Partnership and 20 SPEs as of December 31, 2019. Of the SPEs, 17 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. Intercompany accounts and transactions are eliminated in consolidation. The results of operations of companies or assets acquired are included from the dates of acquisition.

 

These statements include all adjustments necessary for a fair presentation of the results of all periods reported herein. All such adjustments are of a normal recurring nature.

 

Use of Estimates - The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

 

Cash, Cash Equivalents and Restricted Cash - Cash and cash equivalents include all cash and liquid investments that mature three months or less from when they are purchased. 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. The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the Consolidated Balance Sheets that sum to the totals of the same such amounts presented in the Consolidated Statements of Cash Flows:

 

 

	December 31, 2019	December 31, 2018
Cash and cash equivalents	$3,436,577	$1,444,172
Restricted cash	120,166	1,718,676
Cash, cash equivalents and restricted cash	$3,556,743	$3,162,848

 

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, 2019, one account had $2,756,885 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. 

 

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, 2019 and 2018 was $154,375 and $101,008, respectively, and was recorded as a reduction to rental revenues.

 

In-place leases are valued in consideration of the net rents earned that would have been foregone during an assumed lease-up period. Lease-up costs are valued based upon avoided brokerage fees. In-place leases and lease-up costs are amortized over the remaining non-cancelable term of the leases. The Company has not recognized any value attributable to customer relationships.

 

Management utilizes independent third parties to assist with the determination of fair value of the various tangible and intangible assets that are acquired. The difference between the total of the calculated values described above, and the actual purchase price plus acquisition costs, is allocated pro-rata to each component of calculated value.

 

The cost of tenant improvements is 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 non-cancelable 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 lease’s base year property taxes and an increase in operating costs based on the lease’s base year operating expenses multiplied by the annual percentage change in the consumer price index. Operating costs include repairs and maintenance, cleaning, utilities and other related costs. Generally, the leases provide the tenant with renewal options, subject to substantially the same terms and conditions of the non-cancelable term of the lease. The Company accounts for its leases using the 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, 2019 and 2018, 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 Consolidated 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, 2019 and 2018, organizational and offering costs totaled $1,459,479.

 

Revenue Recognition - Revenue includes base rent due from tenants in accordance with the terms of its respective lease. The Company recognizes rental income on a straight-line basis over the non-cancellable term of the respective lease. Revenue also includes reimbursement income from the recovery of all or a portion of operating expenses and real estate taxes and are recognized in the same periods as the related expenses are incurred. For newly acquired properties, the Company begins to recognize rental income from leases concurrently with the date of the property closing. Revenue also includes the amortization or accretion of acquired above (below) market leases over the remaining non-cancelable term of the lease.

 

 

On January 1, 2019, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) using the modified retrospective method and applied it to all contracts that were not completed as of January 1, 2019. The new guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and replaced the existing revenue recognition guidance.  The adoption of Topic 606 did not have an impact on the Company’s historical financial statements as the majority of the Company’s revenue does not fall under the scope of this guidance.

 

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, 2019 and 2018. The Company has a straight-line rent receivable of $3,000 as of December 31, 2019. There was no such receivable as of December 31, 2018.

 

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, 2019 and 2018.

 

Noncontrolling Interest - Noncontrolling interest represents the common units in the Company’s Operating Partnership not attributable to the Company. The noncontrolling interest is calculated by multiplying the noncontrolling interest ownership percentage at the balance sheet date by the Operating Partnership’s common 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. The Company’s noncontrolling interest was 45.3% and 51.8% at December 31, 2019 and 2018, respectively.

 

Deferred Costs – Deferred financing fees include costs incurred in obtaining debt. For debt other than a line-of credit arrangement, deferred financing fees are capitalized and presented as a direct reduction from the carrying amount of the associated debt liability within the Consolidated Balance Sheets. Deferred financing fees related to line-of-credit arrangements are capitalized and presented as an asset within the Consolidated Balance Sheets. Deferred financing fees are amortized through interest expense over the life of the respective loans on a basis which approximates the effective interest method for debt other than a line-of credit arrangement or straight-line over the contractual term of the arrangement for a line-of-credit arrangement. Any unamortized amounts upon early repayment of debt are written off in the period of repayment as a loss on extinguishment of debt.

 

Stock Based Compensation – The Company grants equity-based compensation awards to its officers, employees and non-employee directors in the form of restricted shares of common stock and long-term incentive plan units in the Operating Partnership (“LTIP units”). The Company recognizes compensation expense for non-vested restricted shares of common stock and LTIP units granted to officers, employees and non-employee directors on a straight-line basis over the requisite service and/or performance period based upon the fair market value of the shares on the date of grant, as adjusted for forfeitures.

  

 

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,
	2019	2018
Potentially dilutive securities outstanding
Convertible common units	1,118,416	1,118,416
Convertible long-term incentive plan units	72,215	72,215
Convertible preferred stock	2,079,246	433,500
Total potentially dilutive securities	3,269,877	1,624,131

 

Recently Adopted 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 Company adopted the standard on January 1, 2019. The Company’s revenue is based on real estate leasing transactions which are not within the scope of the new standard. The adoption of ASU 2014-09 did not have a material impact on its consolidated financial statements.

 

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 Company adopted this ASU on January 1, 2019 and applied the amendments using a retrospective transition method. The adoption of ASU 2016-15 did not have a material impact on its consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash” to address the diversity in practice with respect to the classification and presentation of changes in restricted cash on the statement of cash flows. ASU 2016-18 requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. The Company adopted this ASU on January 1, 2019 and applied the amendments using a retrospective transition method. The Company now reconciles both cash and cash equivalents and restricted cash in the accompanying Consolidated Statements of Cash Flows for all periods. For the year ended December 31, 2018, the effect of the change in accounting principle was an increase in cash provided from operating activities of $42,524 on the accompanying Consolidated Statements of Cash Flows.

 

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.

  

 

Recent Accounting Pronouncements Not Yet Adopted - 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 Company for the year ended December 31, 2021. Early adoption is permitted, and a modified retrospective approach must be applied. The Company is currently evaluating the impact of ASU 2016-02 on its financial statements. See Note 13 Commitments and Contingencies for the Company’s operating leases.

 

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.

 

 

On March 19, 2019, the Company 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 have provided a $10,500,000 mezzanine loan to the Company through the Operating Partnership, (ii) certain of such Investors purchased 1,050,000 shares of the Company’s 10.00% Series B Cumulative Preferred Stock (the “Series B Preferred Stock”) for proceeds of $10,500,000 and (iii) an Investor purchased 300,000 shares of the Company’s newly issued common stock (the “Common Stock”) for proceeds of $3,000,000.

 

The Company satisfied $10,698,000 of outstanding notes payable, $68,491 of accrued interest through March 19, 2019 and $381,647 of prepayment penalties on certain notes payable with proceeds from the Recapitalization Transaction. In addition, the Company satisfied four mortgages with an aggregate principal balance, net of escrows for property taxes and insurance, of $8,991,178.

 

Transaction costs of the Recapitalization Transaction totaled $1,273,984. Of the transaction costs, $252,100 was paid to the Company’s law firm where our former President is a partner and our former Secretary is employed.

 

 

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 810 “Consolidation” to consolidate these SPEs.

 

 

A summary of the VIE’s assets and liabilities that are included within the Company’s Consolidated Balance Sheets at December 31, 2019 and 2018 is as follows:

 

Assets:	December 31, 2019	December 31, 2018
Buildings and improvements, net	$11,237,144	$11,627,603
Intangible assets, net	264,538	397,582
Prepaids and other assets	358,998	122,777
Total assets	$11,860,680	$12,147,962
Liabilities:
Mortages payable, net	$9,459,291	$9,633,590
Intangible liabilities, net	79,237	123,985
Accounts payable and accrued expenses	205,862	255,205
Total liabilities	$9,744,390	$10,012,780
Net identifiable assets	$2,116,290	$2,135,182