Inland Real Estate Income Trust, Inc.: Form 10-Q for the period ended Sep 30, 2023

Certain statements in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Words such as “may,” “could,” “should,” “expect,” “intend,” “plan,” “goal,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “variables,” “potential,” “continue,” “expand,” “maintain,” “create,” “strategies,” “likely,” “will,” “would” and variations of these terms and similar expressions, or the negative of these terms or similar expressions, are intended to identify forward-looking statements.

These forward-looking statements are not historical facts but reflect the intent, belief or current expectations of the management of Inland Real Estate Income Trust, Inc. (which we refer to herein as the “Company,” “we,” “our” or “us”) based on their knowledge and understanding of the business and industry, the economy and other future conditions. These statements are not guarantees of future performance, and we caution stockholders not to place undue reliance on forward-looking statements. Actual results may differ materially from those expressed or forecasted in the forward-looking statements due to a variety of risks, uncertainties and other factors, including but not limited to the factors listed and described under “Risk Factors” in this Quarterly Report on Form 10-Q, our Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, as filed with the Securities and Exchange Commission on August 9, 2023, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, as filed with the Securities and Exchange Commission on May 10, 2023 and in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the Securities and Exchange Commission on March 23, 2023, some of which are summarized below:

• Our strategic plan, which is discussed further below, may continue to evolve or change over time, and there is no assurance we will be able to successfully achieve our board's objectives under the strategic plan as it exists at any given time, including making strategic sales or purchases of properties, redeveloping properties or completing a liquidity event, within the timeframe we expect or would prefer or at all;
• The use of the internet by consumers to shop may continue to expand which could result in a further downturn in the business of certain of our current tenants in their “brick and mortar” locations and could affect their ability to pay rent and their demand for space at our retail properties;
• We may pursue redevelopment activities, which are subject to a number of risks, including, but not limited to: expending resources to determine the feasibility of the project or projects that are then not pursued or completed; construction delays or cost overruns; failure to meet anticipated occupancy or rent levels within the projected time frame, if at all; exposure to fluctuations in the general economy due to the significant time lag between commencing and completing the project; and reduced rental income during the period of time we are redeveloping an asset or assets;
• Our Business Manager and its affiliates face conflicts of interest caused by, among other things, their compensation arrangements with us, and the simultaneous overlapping leadership roles our executive officers have at the Business Manager and its affiliates, which could result in actions that are not in the long-term best interests of our stockholders;
• Market disruptions resulting from any future disruptions from a global pandemic, the war in Ukraine and the Israeli-Hamas war, high inflation, increases in interest rates, banking crises, supply chain shortages that affect our tenants or other disruptions caused by events beyond our control may adversely impact our results and financial condition, including our ability to service our debt obligations, borrow additional monies or pay distributions;
• We incurred net losses on a GAAP basis for the three and nine months ended September 30, 2023 and 2022, and for the year ended December 31, 2022, and future net losses could have a material adverse impact on our financial condition, operations, cash flow, and our ability to service our indebtedness or pay distributions to our stockholders;
• Our Sponsor may face a conflict of interest in allocating personnel and resources between its affiliates, our Business Manager and our Real Estate Manager;
• We do not have arm’s-length agreements with our Business Manager, our Real Estate Manager or any other affiliates of our Sponsor;
• We pay fees, which may be significant, to our Business Manager, Real Estate Manager and other affiliates of our Sponsor;
• Our properties may compete with the properties owned by other programs sponsored by our Sponsor or Inland Private Capital Corporation for, among other things, tenants;
• Our Business Manager is under no obligation, and may not agree, to forgo or defer its business management fee; and
• If we fail to continue to qualify as a REIT, our operations and distributions to stockholders, if any, will be adversely affected.

Forward-looking statements in this Quarterly Report on Form 10-Q reflect our management’s view only as of the date of this Quarterly Report, and may ultimately prove to be incorrect or false. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results except as required by applicable law. We intend for these forward-looking statements to be covered by the applicable safe harbor provisions created by Section 27A of the Securities Act and Section 21E of the Exchange Act.

The following discussion and analysis relates to the three and nine months ended September 30, 2023 and 2022 and as of September 30, 2023 and December 31, 2022. You should read the following discussion and analysis along with our consolidated financial statements and the related notes included in this report.

We routinely post important information about us and our business, including financial and other information for investors, on our website. We encourage investors to visit our website at inland-investments.com/inland-income-trust from time to time, as information is updated and new information is posted.

Overview

We were formed as a Maryland corporation on August 24, 2011 and elected to be taxed as a real estate investment trust for U.S. federal income tax purposes (“REIT”) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with the year ended December 31, 2013. We have no employees. We are managed by our business manager, IREIT Business Manager & Advisor, Inc., referred to herein as our “Business Manager.”

We are primarily focused on acquiring and owning retail properties and intend to target a portfolio substantially all of which would be comprised of grocery-anchored properties as described below. We have invested in joint ventures and, to the extent we have available capital, may invest again in additional joint ventures or acquire other real estate assets such as office and medical office buildings, multi-family properties and industrial/distribution and warehouse facilities if management believes the expected returns from those investments exceed that of retail properties. We also may invest in real estate-related equity securities of both publicly traded and private real estate companies, as well as commercial mortgage-backed securities.

On March 2, 2023, our board of directors determined an estimated per share net asset value of our common stock of $19.86 as of December 31, 2022, compared to the previous estimated value of $20.20 as of December 31, 2021. At September 30, 2023, we had total assets of $1.4 billion on our balance sheet and owned 52 properties located in 24 states containing 7.2 million square feet. On May 17, 2022, we acquired eight retail shopping center properties (the “IRPF Properties”) from certain subsidiaries of Inland Retail Property Fund, LP. The IRPF Properties are located across seven states and aggregate approximately 686,851 square feet. We acquired the IRPF Properties for an aggregate purchase price of $278 million, excluding closing costs. A majority of our properties are multi-tenant, necessity-based retail shopping centers primarily located in major regional markets and growing secondary markets throughout the United States. At September 30, 2023, grocery-anchored or grocery shadow-anchored shopping center properties represented 88% of our annualized base rent. A grocery shadow-anchored shopping center is a shopping center which we own that is located near a grocery store that we do not own but that we believe generates traffic for the shopping center. As of September 30, 2023, the portfolio properties have an economic occupancy of 91.9% and staggered lease maturity dates. Grocery tenants accounted for 17% of our annualized base rent (“ABR”) as of September 30, 2023.

Inflation and Interest Rates

Inflationary pressures and rising interest rates could result in reductions in consumer spending and retailer profitability that impacts the Company’s ability to grow rents and tenant demand for new and existing store locations. Regardless of accelerating inflation levels, base rent under most of the Company’s long-term anchor leases will remain constant (subject to tenants’ exercise of renewal options at pre-negotiated rent increases) until the expiration of their lease terms. While many of these leases require tenants to pay their share of shopping center operating expenses (including common area maintenance, real estate tax and insurance expenses), the Company’s ability to collect the expense increases passed through to tenants is dependent on their ability to absorb and pay these increases. Inflation may also impact other aspects of the Company’s operating costs, including fees paid to service providers, the cost to complete redevelopments and build-outs of recently leased vacancies and interest rate costs relating to variable rate loans and refinancing of lower fixed-rate indebtedness. While the Company has not been significantly impacted by any of these items to date, no assurances can be provided that these inflationary pressures will not have a material adverse effect on the Company’s business in the future.

Company Update – Strategic Plan

The Company has a strategic plan that includes the goals of providing a future liquidity event to investors and creating long-term stockholder value. The strategic plan centers around owning a portfolio of grocery-anchored properties with lower exposure to big box retailers. As part of this strategy, our management team continually evaluates possibilities for the opportunistic sale of certain assets with the goal of redeploying capital into the acquisition of strategically located grocery-anchored centers. Of the Company’s 953 leasable spaces, there are 122 non-grocery big box (anchor spaces of at least 10,000 square feet) in the portfolio, and of those twelve are vacant, and zero are dark (meaning that the tenant is still obligated by their lease to pay rent but has vacated the space and left it unused) as of

October 31, 2023. We are not actively marketing any properties for sale as of the date of this quarterly report on Form 10-Q. We believe increasing the size and profitability of the Company would enhance our ability to complete a successful liquidity event. On May 17, 2022, we acquired seven grocery-anchored retail shopping center properties and one additional retail shopping center, collectively referred to as the IRPF Properties, from certain subsidiaries of Inland Retail Property Fund, LP, for approximately $278 million. Although we are not actively pursuing any new acquisitions as of the date of this Quarterly Report, we may seek and evaluate potential acquisitions and, if we have the requisite capital and financing available to us, opportunistically acquire retail properties that we believe complement our existing portfolio in terms of relevant characteristics such as tenant mix, demographics and geography and are consistent with our plan to try to own a portfolio substantially all of which is comprised of grocery-anchored or shadow-anchored properties. We may also consider other transactions, such as redeveloping certain of our properties or portions of certain of our properties, for example, big-box spaces, to repurpose them for alternative commercial or multifamily residential uses. We expect to consider liquidity events, such as listing our common stock on a national securities exchange, but given current market conditions, we do not know when we will complete such a transaction. Our consideration of a liquidity event is influenced by our intention to opportunistically grow the portfolio, execute redevelopment opportunities and execute strategic sales and acquisitions. Likewise, we are continually impacted by (i) evolving retail market conditions and other complex factors such as (ii) competition for our tenants from evolving internet businesses, (iii) the state of the commercial real estate market and financial markets, (iv) our ability to raise capital or borrow on terms that are acceptable to the Company in light of the use of the proceeds and (v) changes in general economic conditions such as high interest rates, among other factors. The timing of the completion of the strategic plan has already extended beyond our original expectations and cannot be predicted with certainty. There is no assurance that the Company will be able to successfully implement its strategic plan, for example by making strategic sales or purchases of properties or listing the Company’s common stock, within the timeframe we would prefer or at all.

SELECT PROPERTY INFORMATION (All dollar amounts in thousands, except per square foot amounts)

Investment Properties

(a) Weighted average remaining lease term is based on a weighting by ABR as of September 30, 2023.

The table below presents information for each of our investment properties as of September 30, 2023.

(a) Property is included in the pool of unencumbered properties under our Credit Facility.

(b) Portfolio total is equal to the weighted average interest rate.

Tenancy Highlights

The following table presents information regarding the top ten tenants in our portfolio based on annualized base rent for leases in-place as of September 30, 2023.

The following table sets forth a summary of our tenant diversity for our entire portfolio and is based on leases in-place at September 30, 2023.

The following table sets forth a summary, as of September 30, 2023, of the percent of total annualized base rent and the weighted average lease expiration by size of tenant.

24

With respect to our locations affected by the Bed, Bath and Beyond bankruptcy, we have executed a lease for one out of our four locations that closed and are in active negotiations with national tenants to re-lease the remaining three spaces.

With respect to our locations affected by the Rite Aid bankruptcy, one of our two locations was already dark and is included on the initial closure list from Rite Aid. Our other location is still open and operating and is not on the initial closure list.

Lease Expirations

The following table sets forth a summary, as of September 30, 2023, of lease expirations scheduled to occur during the remainder of 2023 and each of the calendar years from 2024 to 2032 and thereafter, assuming no exercise of renewal options or early termination rights for leases commenced on or prior to September 30, 2023. Annualized base rent represents the rent in-place of the applicable property at September 30, 2023. The table below includes ground leases. If ground leases are excluded, annualized base rent would equal $99,991 or $19.48 per square foot for total expiring leases.

25

Liquidity and Capital Resources

General

Our primary uses and sources of cash are as follows:

*We cannot provide any assurance that we will be able to sell properties or issue new securities to raise capital when we would like, for example, to increase the proportion of grocery-anchored or shadow-anchored properties or increase the size of our portfolio of properties, or under terms that would be acceptable to us considering factors such as the anticipated use of the proceeds. Because the Company's common stock is not listed on a national securities exchange, our ability to access the public or private market, particularly for equity capital, is limited.

At September 30, 2023, we had $134 million outstanding under the Revolving Credit Facility and $575 million outstanding under the Term Loan. During the nine months ended September 30, 2023, the net borrowings from the Revolving Credit Facility were $32 million, which we used to fund the payoff of the Coastal North Town Center property mortgage. At September 30, 2023 the interest rates on the Revolving Credit Facility and the Term Loan were 7.33% and 4.39%, respectively. At September 30, 2022 the interest rates on the Revolving Credit Facility and the Term Loan were 4.56% and 4.11%, respectively. On February 3, 2022, we extended the Revolving Credit Facility maturity date to February 3, 2026 plus a twelve month extension, at the Company’s option. We also increased the Term Loan outstanding balance to $275 million which now matures on February 3, 2027. On May 17, 2022, we amended our Credit Agreement to increase the size of the Term Loan to $575 million and modify several covenants to fund our acquisition of a portfolio of eight retail shopping center properties from Inland Retail Property Fund, LP, a Delaware limited partnership. As of November 8, 2023, we had $66 million available for borrowing under the Revolving Credit Facility, subject to the terms and conditions, including compliance with the covenants, of the Credit Agreement that governs the Credit Facility. Although $66 million is the maximum available, covenant limitations affect what we can actually draw, and we expect to have substantially less than $66 million actually available to draw or otherwise undertake as additional debt as a result of, among other things, completing the aforementioned acquisition of the eight properties and increasing the amount of the Term Loan. By “additional debt,” we mean debt in addition to existing debt such as existing mortgages. The properties comprising the borrowing base for the Credit Facility are not available to be used as collateral for other debt unless removed from the borrowing base, which would shrink availability under the Credit Facility.

As of September 30, 2023, we had total debt outstanding of $847 million, excluding unamortized debt issuance costs, which bore interest at a weighted average interest rate of 4.79% per annum. As of September 30, 2023, the weighted average years to maturity for our debt was 3.0 years. As of September 30, 2023 and December 31, 2022, our borrowings were 52% and 53%, respectively, of the purchase price of our investment properties. At September 30, 2023, our cash and cash equivalents balance was $9.3 million.

As of November 8, 2023, in the next twelve months, we do not have any mortgage loans maturing.

During the nine months ended September 30, 2023, we repurchased $4.3 million of shares of common stock.

We delayed making non-essential capital improvements and other non-essential capital expenditures at our properties at the onset of the pandemic in 2020 and into 2021, where possible, to preserve cash. As rent collections increased during 2021 and 2022, we increased our funding of capital expenditures at our properties to levels similar to pre-pandemic periods, and we do not expect the prior delay in making these capital expenditures to have any material effect on our tenants or our ability to lease space. In the nine months ended September 30, 2023, we spent $7.0 million on capital expenditures and tenant improvements, which is approximately $0.7 million less than we did in the nine months ended September 30, 2022. Additionally, we expect to materially increase spending on tenant improvements in connection with new or renewed leases and capital expenditures during 2023 but do not anticipate a material effect on our liquidity from this increase, assuming the businesses of our tenants, including those that were negatively affected by the COVID-19 pandemic, remain steady or improve or they otherwise continue to pay their rent and fulfill their lease obligations.

As of September 30, 2023, we have paid all interest and principal amounts when due, and are in compliance with all financial covenants under the Credit Facility as amended.

Cash Flow Analysis

(Dollar amounts in thousands)

Operating activities

The decrease in cash from operating activities during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to higher interest payments, the timing of payments to related parties and a decrease in prepaid rent.

Investing activities

(Dollar amounts in thousands)

The decrease in cash used for investing activities during the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 was primarily due to the acquisition of the IRPF properties that occurred during the second quarter of 2022.

Financing activities

(Dollar amounts in thousands)

During the nine months ended September 30, 2023, changes in total debt decreased $263.5 million from the nine months ended September 30, 2022 primarily due to the acquisition of the IRPF properties during the nine months ended September 30, 2022. During the nine months ended September 30, 2023, we generated proceeds from the sale of shares pursuant to the DRP of $5.3 million. For the nine months ended September 30, 2023, share repurchases were $4.3 million. During the nine months ended September 30, 2023, we paid $14.7 million in distributions.

Distributions

Distributions when declared are paid quarterly in arrears. A summary of the distributions declared, distributions paid and cash flows provided by operations for the nine months ended September 30, 2023 and 2022 follows (Dollar amounts in thousands except per share amounts):

(1) Distributions were funded by cash flows from operating activities during the nine months ended September 30, 2023 and 2022.

Share Repurchases

Refer to “Part II. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - Share Repurchase Program” for details regarding our SRP. The SRP is funded by the proceeds from the DRP.

Results of Operations

This section describes and compares our results of operations for the three and nine months ended September 30, 2023 and 2022. Dollar amounts are stated in thousands.

We generate primarily all of our net operating income from property operations. In order to evaluate our overall portfolio, management analyzes the net operating income of properties that we have owned and operated for both periods presented. All 52 investment properties we currently own were held for the entirety of both the three months ended September 30, 2023 and 2022. A total of 44 investment properties that were acquired on or before January 1, 2022 represent our “same store” properties during the nine months ended September 30, 2023 and 2022. “Non-same store,” as reflected in the table below, consists of properties acquired after January 1, 2022. For the nine months ended September 30, 2023 and 2022, eight properties that were acquired on May 17, 2022 constituted non-same store properties.

Net operating income is a supplemental non-GAAP performance measure that we believe is useful to investors in measuring the operating performance of our property portfolio because our primary business is the ownership of real estate, and net operating income excludes various items included in GAAP net income that do not relate to, or are not indicative of, our property operating performance, such as depreciation and amortization and parent-level corporate expenses (including general and administrative expenses). Same store net operating income is useful because it eliminates differences in net operating income resulting from the acquisition or disposition of properties during the periods presented and therefore provides a better comparison of the operating performance of our properties between periods.

The following tables present the property net operating income prior to straight-line income (expense), net, amortization of intangibles, interest, and depreciation and amortization for the three and nine months ended September 30, 2023 and 2022, along with a reconciliation to net loss, calculated in accordance with GAAP.

Comparison of the three months ended September 30, 2023 and 2022

Net loss. Net loss was $3,710 and $2,900 for the three months ended September 30, 2023 and 2022, respectively.

Total property net operating income. During the three months ended September 30, 2023, property net operating income increased $425, total property income increased $704, and total property operating expenses including real estate tax expense increased $279.

The increase in total property income is primarily due to an increase in base rent and an increase in tenant recovery income due to increased recoverable expenses in 2023.

Straight-line income (expense), net. Straight-line income (expense), net increased $67 in 2023 compared to 2022. This increase is primarily due to a decrease in write-offs of straight-line balances during the third quarter of 2023.

Amortization of intangibles and lease incentives. Income from the amortization of intangibles and lease incentives decreased $338 in 2023 compared to 2022. The decrease is primarily due to write-offs of below market lease intangibles from early lease terminations during the third quarter of 2022.

General and administrative expenses. General and administrative expenses decreased $126 in 2023 compared to 2022. The decrease is primarily due to lower legal and stock administration costs partially offset by an increase in reimbursements for salaries during the three months ended September 30, 2023.

Business management fee. Business management fees decreased $401 in 2023 compared to 2022. The decrease is primarily due to an amendment to the agreement that reduced the base fee.

Depreciation and amortization. Depreciation and amortization decreased $444 in 2023 compared to 2022. The decrease is primarily due to a larger amount of fully amortized assets in 2023 compared to 2022.

Interest expense. Interest expense increased $2,006 in 2023 compared to 2022. The increase is primarily due to rising interest rates on the unhedged variable portion of the credit facility.

Interest and other income. Interest and other income decreased $71 in 2023 compared to 2022.

Comparison of the nine months ended September 30, 2023 and 2022

Net loss. Net loss was $11,274 and $6,790 for the nine months ended September 30, 2023 and 2022, respectively.

Total property net operating income. On a “same store” basis, comparing the results of operations of investment properties during the nine months ended September 30, 2023 with the results of the same investment properties owned during the full nine months ended September 30, 2022 property net operating income increased $1,788, total property income increased $3,147, and total property operating expenses including real estate tax expense increased $1,359.

The increase in “same store” total property income is primarily due to an increase in rental income and an increase in recovery income due to higher recoverable expenses during the nine months ended September 30, 2023.

“Non-same store” total property net operating income increased $6,078 during 2023 as compared to 2022. The increase is a result of acquiring eight retail properties on May 17, 2022. On a “non-same store” basis, total property income increased $9,334 and total property operating expenses increased $3,256 during the nine months ended September 30, 2023 as compared to 2022 as a result of this acquisition.

Straight-line income (expense), net. Straight-line income (expense), net increased $285 in 2023 compared to 2022. This increase is primarily due to scheduled rent increases during the nine months ended September 30, 2023.

Amortization of intangibles and lease incentives. Income from the amortization of intangibles and lease incentives increased $1,511 in 2023 compared to 2022. The increase is primarily due to the acquisition of IRPF Properties and write-offs of below market lease intangibles from early lease terminations during the nine months ended September 30, 2023.

General and administrative expenses. General and administrative expenses decreased $130 in 2023 compared to 2022. The decrease is primarily due to lower legal and stock administration costs partially offset by an increase in reimbursements for salaries during the nine months ended September 30, 2023.

Business management fee. Business management fees decreased $178 in 2023 compared to 2022. The decrease is primarily due to an amendment to the agreement that reduced the base fee, partially offset by the acquisition of IRPF Properties which increased the amount on which the base fee is determined.

Depreciation and amortization. Depreciation and amortization increased $4,053 in 2023 compared to 2022. The increase is primarily due to the acquisition of eight properties on May 17, 2022, partially offset by fully amortized assets in 2023 compared to 2022.

Interest expense. Interest expense increased $10,548 in 2023 compared to 2022. The increase is primarily due to an increase in average debt outstanding driven by the acquisition of IRPF Properties completed in May 2022 and rising interest rates on the unhedged variable portion of the credit facility.

Interest and other income. Interest and other income increased $147 in 2023 compared to 2022.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Leasing Activity

The following table sets forth leasing activity during the nine months ended September 30, 2023. Leases with terms of less than 12 months have been excluded from the table.

(a) Includes leases signed on units that were vacant for over 12 months, leases signed without fixed rent amounts and leases signed where the previous and current lease do not have similar lease structures.

Non-GAAP Financial Measures

Accounting for real estate assets in accordance with GAAP assumes the value of real estate assets is reduced over time due primarily to non-cash depreciation and amortization expense. Because real estate values may rise and fall with market conditions, operating results from real estate companies that use GAAP accounting may not present a complete view of their performance. We use Funds from Operations, or “FFO”, a widely accepted metric to evaluate our performance. FFO provides a supplemental measure to compare our performance and operations to other REITs. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or “NAREIT”, has promulgated a standard known as FFO, which it believes more accurately reflects the operating performance of a REIT. On November 7, 2018, NAREIT’s Executive Board approved the White Paper restatement, effective December 15, 2018. The purpose of the restatement was not to change the fundamental definition of FFO but to clarify existing guidance. The restated definition of FFO by NAREIT is net income (loss) computed in accordance with GAAP, excluding depreciation and amortization related to real estate, excluding gains (or losses) from sales of certain real estate assets, excluding impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate and excluding gains and losses from change in control. We have adopted the restated NAREIT definition for computing FFO. Previously presented periods were not impacted.

Under GAAP, acquisition related costs are treated differently if the acquisition is a business combination or an asset acquisition. An acquisition of a single property will likely be treated as an asset acquisition as opposed to a business combination and acquisition related costs will be capitalized rather than expensed when incurred. Publicly registered, non-listed REITs typically engage in a significant amount of acquisition activity in the early years of their operations, and thus incur significant acquisition related costs, during these initial years. Although other start up entities may engage in significant acquisition activity during their initial years, publicly registered, non-listed REITs are unique in that they typically have a limited timeframe during which they acquire a significant number of properties and thus incur significant acquisition related costs. Due to the above factors and other unique features of publicly registered, non-listed REITs, the Institute for Portfolio Alternatives, or “IPA”, an industry trade group, published a standardized measure known as Modified Funds from Operations, or “MFFO”, which the IPA has promulgated as a supplemental measure for publicly registered non-listed REITs and which may be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT. We believe it is appropriate to use MFFO as a supplemental measure of operating performance because we believe that, when compared year-over-year, both before and after we have deployed all of our Offering proceeds and are no longer incurring a significant amount of acquisition fees or other related costs, it reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income.

MFFO excludes expensed costs associated with investing activities, some of which are acquisition related costs that affect our operations only in periods in which properties are acquired, and other non-operating items that are included in FFO, such as straight-lining of rents as required by GAAP. By excluding costs that we consider more reflective of acquisition activities and other non-operating items, the use of MFFO provides another measure of our operating performance once our portfolio is stabilized. Because MFFO may be a recognized measure of operating performance within the non-listed REIT industry, MFFO and the adjustments used to calculate it may be useful in order to evaluate our performance against other non-listed REITs. Like FFO, MFFO is not equivalent to our net income or loss as determined under GAAP, as detailed in the table below, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we continue to acquire a significant amount of properties. MFFO should only be used as a measurement of our operating performance while we are acquiring a significant amount of properties because it excludes, among other things, acquisition costs incurred during the periods in which properties were acquired.

We believe our definition of MFFO, a non-GAAP measure, is consistent with the IPA's Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations, or the “Practice Guideline,” issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to straight-line rents and amortization of above and below market lease assets and liabilities, accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis.

Our presentation of FFO and MFFO may not be comparable to other similarly titled measures presented by other REITs. We believe that the use of FFO and MFFO provides a more complete understanding of our operating performance to stockholders and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs. Neither FFO nor MFFO is intended to be an alternative to “net income” or to “cash flows from operating activities” as determined by GAAP as a measure of our capacity to pay distributions. Management uses FFO and MFFO to compare our operating performance to that of other REITs and to assess our operating performance.

Our FFO and MFFO for the nine months ended September 30, 2023 and 2022 are calculated as follows:

(Dollar amounts in thousands)

Subsequent Events

For information related to subsequent events, reference is made to Note 15 – “Subsequent Events” which is included in our September 30, 2023 Notes to Consolidated Financial Statements in Item 1.

Market Risk

We are exposed to various market risks, including those caused by changes in interest rates and commodity prices. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and commodity prices. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We have entered into, and may continue to enter into, financial instruments to manage and reduce the impact of changes in interest rates. The counterparties are, and are expected to continue to be, major financial institutions.

Interest Rate Risk

We are exposed to interest rate changes primarily as a result of long-term debt used to purchase properties or other real estate assets and to fund capital expenditures.

As of September 30, 2023, we had outstanding debt of $847.1 million, excluding unamortized debt issuance costs, bearing interest rates ranging from 3.70% to 7.33% per annum. The weighted average interest rate was 4.79%, which includes the effect of interest rate swaps. As of September 30, 2023, the weighted average years to maturity for our mortgages and credit facility payable was 3.0 years.

As of September 30, 2023, our fixed-rate debt consisted of secured mortgage financings with a carrying value of $112.1 million and a fair value of $102.6 million. Changes in interest rates do not affect interest expense incurred on our fixed-rate debt until their maturity or earlier repayment, but interest rates do affect the fair value of our fixed rate debt obligations. If market interest rates were to increase by 1% (100 basis points), the fair market value of our fixed-rate debt would decrease by $2.1 million at September 30, 2023. If market interest rates were to decrease by 1% (100 basis points), the fair market value of our fixed-rate debt would increase by $2.1 million at September 30, 2023.

As of September 30, 2023, we had $184 million of debt or 21.7% of our total debt, excluding unamortized debt issuance costs, bearing interest at variable rates with a weighted average interest rate equal to 6.53% per annum. We had variable rate debt subject to swap agreements of $551 million, or 65.0% of our total debt, excluding unamortized debt issuance costs, at September 30, 2023.

If interest rates on all debt which bears interest at variable rates as of September 30, 2023 increased by 1% (100 basis points), the increase in interest expense would decrease earnings and cash flows by $1.8 million annually. If interest rates on all debt which bears interest at variable rates as of September 30, 2023 decreased by 1% (100 basis points), the decrease in interest expense would increase earnings and cash flows by the same amount.

With regard to variable rate financing, our Business Manager assesses our interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. Our Business Manager maintains risk management control systems to monitor interest rate cash flow risk attributable to both of our outstanding or forecasted debt obligations as well as our potential offsetting hedge positions.

We use derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our assets. Derivative instruments may include interest rate swap contracts, interest rate cap or floor contracts, futures or forward contracts, options or repurchase agreements. Our actual hedging decisions are determined in light of the facts and circumstances existing at the time of the hedge. We have used derivative financial instruments, specifically interest rate swap contracts, to hedge against interest rate fluctuations on variable rate debt, which exposes us to both credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. If the fair value of a derivative contract is positive, the counterparty will owe us, which creates credit risk for us because the counterparty may not perform. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We seek to manage the market risk associated with interest-rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. There is no assurance we will be successful.

In July 2017, the Financial Conduct Authority, the authority which regulates LIBOR, announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. As a result, the Federal Reserve Board and the Federal Reserve Bank of New York organized the Alternative Reference Rates Committee, which identified the SOFR as its preferred alternative to LIBOR in derivatives and other financial contracts. Subsequently, in November 2020, the Intercontinental Exchange (“ICE”) Benchmark Administration Limited (“IBA”), the administrator of LIBOR, announced that it would consult on its intention to cease the publication of the one-week and two-month USD LIBOR settings immediately following December 31, 2021 and the remaining USD LIBOR settings immediately following the LIBOR publication on June 30, 2023. The IBA has been compelled by the Financial Conduct Authority to publish the one-, three- and six-month USD LIBOR settings through September 30, 2024.

On February 3, 2022, we refinanced our Credit Facility and the interest rate benchmark used in this agreement changed from LIBOR to SOFR. On December 1, 2022, we amended our Credit Facility and the interest rate benchmark used in this agreement changed from LIBOR to SOFR. On the same date, we also amended the mortgage and associated interest swap agreements for one of the two remaining mortgages that was indexed to LIBOR to now be indexed to SOFR. The last remaining mortgage that was indexed to LIBOR was paid off on April 28, 2023 and the corresponding interest rate swap was also terminated on the same date.

Derivatives

For information related to our derivatives, reference is made to Note 7 – “Debt and Derivative Instruments” which is included in our September 30, 2023 Notes to Consolidated Financial Statements in Item 1.

Disclosure Controls and Procedures

Our management has evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the principal executive and principal financial officers have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) or Rule 15d-15(f)) during the three months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There are no material changes to the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2022, and our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2023.