One Liberty Properties Inc: Form 10-Q for the period ended Sep 30, 2023

Forward-Looking Statements

This Quarterly Report on Form 10-Q, together with other statements and information publicly disseminated by us, contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provision for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “will,” “could,” “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions or variations thereof and include, without limitations, statements regarding our future estimated rental income, funds from operations, adjusted funds from operations and our dividend. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect our results of operations, financial condition, cash flows, performance or achievements.

The uncertainties, risks and factors which may cause actual results to differ materially from current expectations include, but are not limited to:

• the financial failure of, or other default in payment by, tenants under their leases and the potential resulting vacancies;
• adverse changes and disruption in the retail, restaurant, theater and health and fitness sectors, which impacts our tenants’ ability to pay rent and expense reimbursement;
• loss or bankruptcy of one or more of our tenants, and bankruptcy laws that limits our remedies if a tenant becomes bankrupt and rejects its lease;
• the level and volatility of interest rates, which adversely affects our ability to acquire properties and refinance maturing mortgage debt;
• general economic and business conditions and developments, including those currently affecting or that affects our economy;
• general and local real estate conditions, including any changes in the value of our real estate;
• our ability to renew or re-lease space as leases expire;
• our ability to pay dividends;
• changes in governmental laws and regulations relating to real estate and related investments;
• compliance with credit facility and mortgage debt covenants;
• the availability of, and costs associated with, sources of capital and liquidity;
• competition in our industry;
• technological changes, such as autonomous vehicles, reconfiguration of supply chains, robotics, 3D printing or other technologies;
• natural disasters, epidemics, pandemics or outbreak of infectious disease, such as COVID-19, and other potentially catastrophic events such as acts of war and/or terrorism; and
• the other risks, uncertainties and factors described in the reports and documents we file with the SEC including the risks, uncertainties and factors described in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “Annual Report”) under the caption “Item 1A. Risk Factors” for a discussion of certain factors which may cause actual results to differ materially from current.

In light of the factors referred to above, the future events discussed or incorporated by reference in this report and other documents we file with the SEC may not occur, and actual results, performance or achievements could differ materially from those anticipated or implied in the forward-looking statements. Given these uncertainties, you should not rely on any forward-looking statements.

Except as may be required under the United States federal securities laws, we undertake no obligation to publicly update our forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make in our reports that are filed with or furnished to the SEC.

Challenges and Uncertainties Facing Certain Tenants and Properties

As more fully described in (i) our Annual Report, and in particular, the sections thereof entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and (ii) our Quarterly Reports on Form 10-Q for the periods ended March 31, 2023 and June 30, 2023, and in particular, the sections thereof entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (the “Quarterly Reports”; and together with the Annual Report, the “Reports”), we face challenges due to the volatile economic environment, and certain of our properties and tenants (including Regal Cinemas, our Manahawkin, New Jersey property (the “Manahawkin Property”), The Vue Apartments, LA Fitness, and Party City) face various challenges. Our cash flow and profitability will be adversely impacted if the issues with respect to the challenged tenants/properties identified in the Reports (including this Quarterly Report on Form 10-Q) are not resolved in a satisfactory manner. There have been no material changes to the status of such tenants/properties from that described in our Reports except as described below:

Manahawkin Property

On September 8, 2023, the joint venture (the “Venture”) in which we have a 50% interest and that owns a multi-tenant shopping center in Manahawkin, New Jersey entered into a contract to sell this property to an unaffiliated third-party for a sales price of approximately $36.5 million, subject to customary closing adjustments and prorations. We anticipate that the transaction will be completed in the quarter ending December 31, 2023, subject to the satisfaction of customary closing conditions (including the purchaser’s right to terminate the contract without penalty if it is not satisfied with the results of its due diligence investigation with respect to environmental and title matters), and that the net proceeds to us from the sale, ranging from approximately $6.0 million to $8.0 million (after giving effect to the repayment of our $10.4 million share of mortgage debt on this property), will be used to pay down our credit facility indebtedness. We expect to recognize a nominal gain from this sale when it is completed.

In connection with entering into this contract, the Venture recorded an impairment charge of $1.7 million, of which our 50% share was $850,000, which was recorded in Equity in loss from unconsolidated joint ventures for the three and nine months ended September 30, 2023.

During the nine months ended September 30, 2023, 2022 and 2021, we recognized $(889,000), $168,000 and $(77,000) of equity in earnings (loss) from the Venture, and the results for such periods included $51,000, $81,000 and $0, respectively, of repayments from Regal Cinemas of amounts previously deferred due to the COVID-19 pandemic.

No assurance can be provided that this sale will be completed, and if it is not completed, we will be adversely impacted.

LA Fitness

LA Fitness leases from us three properties pursuant to three separate leases, including a 38,000 square foot health and fitness facility in Hamilton, Ohio. Effective as of October 12, 2023, we and LA Fitness amended the lease at the Hamilton, Ohio property (which lease had been scheduled to expire in November 2023), which, effective as of December 1, 2023, provides (i) that the property will be leased on a month-to-month basis with a mutual right to terminate on 90 days’ notice; (ii) that we are responsible for, among other things, real estate taxes and common area maintenance expenses; and (iii) for a $30,000 monthly gross rent (compared to the monthly base rent of $66,000 paid during 2023). This property accounted, during the nine months ended September 30, 2023, for (i) $702,000 of rental income and (ii) $142,000, $144,000 and $157,000 of interest expense, real estate operating expense and depreciation and amortization expense, respectively. As a result of this lease amendment, our rental income from this property will be significantly reduced, our real estate expenses will increase, and there is uncertainty as to whether this property will generate positive cash flow.

At September 30, 2023, the unbilled rent receivable, tenant origination cost and mortgage debt with respect to this property was $7,000, $6,000 and $4.0 million, respectively. The mortgage debt is scheduled to mature in December 2023 and although we are in discussions with the lender for an extension of the maturity date, we can provide no assurance that the lender will agree to same. If the lender does not extend the maturity date and we do not have sufficient available cash, we will be adversely affected if we (i) pay off the mortgage debt with funds from our credit facility, or (ii) surrender the property to the lender.

If LA Fitness vacates this property, it may be difficult, due to the presence of another health and fitness facility located nearby, to re-lease this property to another health and fitness operator, and if we are unable to re-lease this property to such an operator, it may be costly to reconfigure the space for use other than as a fitness facility.

NYC

The City of New York is a tenant at a 66,000 square foot office building in Brooklyn, New York. Although the lease expired on or about October 15, 2023, we and representatives of the tenant have signed a term sheet to extend the lease through October 2028 with the tenant having the right to terminate the lease beginning October 2027 on six months’ notice. The extension would be at a base annual rent of approximately $1.3 million, slightly higher than the annual rent the tenant is currently paying. The term sheet is non-binding and subject to the execution of more formal documentation which we anticipate will take several months to complete. There is no mortgage debt on the property, and the tenant is generally responsible for the expenses of operating the property. We can provide no assurance that the proposed lease will be signed, and if it is not, we will be adversely affected by the loss of rental income and the expenses associated with maintaining the property.

Overview

We are a self-administered and self-managed real estate investment trust, or REIT. To qualify as a REIT, under the Internal Revenue Code of 1986, as amended, we must meet a number of organizational and operational requirements, including a requirement that we distribute currently at least 90% of ordinary taxable income to our stockholders. We intend to comply with these requirements and to maintain our REIT status.

We acquire, own and manage a geographically diversified portfolio consisting primarily of industrial and retail properties, and to a lesser extent, health and fitness, restaurant, theater, and other properties, many of which are subject to long-term net leases. As of September 30, 2023, we own 118 properties (including three properties owned by consolidated joint ventures and three properties owned by unconsolidated joint ventures) located in 31 states. Based on square footage, our occupancy rate at September 30, 2023 is approximately 97.5%.

We face a variety of risks and challenges in our business, including the possibility we will not be able to: acquire or dispose of properties on acceptable terms, lease our properties on terms favorable to us or at all, collect amounts owed to us by our tenants, renew or re-let, on acceptable terms, leases that are expiring or otherwise terminating.

We seek to manage the risk of our real property portfolio and the related financing arrangements by (i) diversifying among locations, tenants, scheduled lease expirations, mortgage maturities and lenders, and (ii) minimizing our exposure to interest rate fluctuations. Substantially all of our mortgage debt either bears interest at fixed rates or is subject to interest rate swaps, limiting our exposure to fluctuating interest rates on our outstanding mortgage debt.

We monitor the risk of tenant non-payments through a variety of approaches tailored to the applicable situation. Generally, based on our assessment of the credit risk posed by our tenants, we monitor a tenant’s financial condition through one or more of the following actions: reviewing tenant financial statements or other financial information, obtaining other tenant related information, regular contact with tenant’s representatives, tenant credit checks and regular management reviews of our tenants and their payment practices. We may sell a property if a tenant’s financial condition is unsatisfactory.

In acquiring and disposing of properties, among other things, we evaluate the terms of the leases, the credit of the existing tenants, the terms and conditions of the related financing arrangement (including any contemplated financing) and engage in a fundamental analysis of the real estate to be bought or sold. This fundamental analysis takes into account, among other things, the estimated value of the property, local demographics and the ability to re-rent or dispose of the property on favorable terms upon lease expiration or early termination. In addition, in evaluating property sales, we take into account, among other things, the property type (i.e., industrial, retail or other), our perception of the property’s long-term prospects

(including the likelihood for, and the extent of, any further appreciation or diminution in value), the term remaining on the related lease and mortgage debt, the price and other terms and conditions for the sale of such property and the returns anticipated to be generated from the reinvestment of the net proceeds to us from such property sale.

Our 2023 contractual base rent is approximately $71.0 million and represents, after giving effect to any abatements, concessions, deferrals or adjustments, the base rent payable to us during the twelve months ending September 30, 2024 under leases in effect at September 30, 2023. Included in such contractual rental income is an aggregate of $1.3 million related to five properties which we expect to sell by December 31, 2023 (see – Contracted and Contemplated Dispositions below). Excluded from such contractual rental income is an aggregate of $4.1 million comprised of: (i) subject to the property generating specified levels of positive operating cash flow, $1.3 million of estimated variable lease payments from The Vue, a multi-family complex which ground leases the underlying land from us and as to which there is uncertainty as to when and whether the tenant will resume paying rent, (ii) $1.3 million representing our share of the base rent payable to our joint ventures (which includes $1.1 million from the Manahawkin Property), and (iii) approximately $678,000 of straight-line rent and $837,000 of amortization of lease-related intangibles.

The following table sets forth scheduled expirations of leases for our properties as of September 30, 2023 for the periods indicated below:

(1) Lease expirations assume tenants do not exercise existing renewal or termination options.

(2) Excludes an aggregate of 132,685 square feet of vacant space.

ATM Program

In September 2023, we entered into a new at-the-market equity distribution agreement with B. Riley Securities, Inc. pursuant to which we may sell up to $50 million of shares of our common stock.

Property Transactions During the Three Months Ended September 30, 2023

On July 13, 2023, we acquired a multi-tenant industrial property located in Blythewood, South Carolina for a purchase price of $13.4 million, including the assumption of $4.3 million of mortgage debt with an interest rate of 4.60% and maturing in June 2029. This property contributed $268,000 and $251,000 to rental income and total operating expenses, respectively, in the nine months ended September 30, 2023.

On September 20, 2023, we sold a restaurant property in Greensboro, North Carolina for a gross sales price of $3.3 million and recognized a gain of $332,000 from this sale. This property contributed $180,000 and $188,000 to rental income and $29,000 and $29,000 to total operating expenses in the nine months ended September 30, 2023 and 2022, respectively.

Stock Repurchase Program

During the three months ended September 30, 2023, pursuant to a stock repurchase plan adopted in 2022, as amended (the “2022 Repurchase Plan”), we repurchased approximately 262,000 shares of common stock for approximately $5.1 million. In October 2023, we repurchased, pursuant to the 2022 Repurchase Plan, approximately 62,000 shares of common stock for approximately $1.1 million. No more shares may be repurchased pursuant to the 2022 Repurchase Plan.

In October 2023, the Board of Directors approved a new share repurchase plan (the “2023 Repurchase Plan”) authorizing the repurchase of up to $10.0 million of shares of our common stock. Pursuant to the 2023 Repurchase Plan, through October 16, 2023 we repurchased approximately 71,000 shares of common stock for approximately $1.3 million. After giving effect to such repurchases, we are authorized to repurchase approximately $8.7 million of shares of our common stock.

We anticipate that due to the uncertain acquisition environment, and the current price of our common stock, that, in the near term, we will continue to repurchase our common stock.

Contracted and Contemplated Dispositions

From July 1, 2023 through November 1, 2023, we entered into contracts to sell three restaurant and two retail properties (excluding the TGI Fridays restaurant we sold in Greensboro, North Carolina and the Manahawkin Property) for an aggregate sales price of approximately $18.9 million. The buyers’ rights to terminate the contracts without penalty expire through December 2023. During the nine months ended September 30, 2023, these five properties generated $975,000 in aggregate of rental income and $42,000 and $189,000 of real estate expense and depreciation and amortization expense, respectively. Set forth below is information regarding these five properties, as of September 30, 2023, presented on an aggregate basis:

Weighted average remaining lease term: 9.7 years

Estimated gain on sale: $7.0 million to $8.0 million

Estimated sales proceeds, net of transactions costs: $16.0 million to $18.0 million

We anticipate that these transactions will close in the quarter ending December 31, 2023 and that the net proceeds therefrom will be used to pay down our credit facility indebtedness. We can provide no assurance that these transactions will be completed.

We also anticipate that over the next several months we may sell several additional retail properties and that the net proceeds therefrom will be used to pay down our credit facility indebtedness. These contemplated sales, if completed, will reduce our operating cash flow, and over the long term may reduce our ability to pay dividends.

Challenges Presented by Increasing or Prevailing Interest Rates

From October 1, 2023 through December 31, 2024, we have $56.9 million of mortgage debt maturing with a weighted average interest rate of 4.4%. If interest rates increase or continue at current levels, we may be required to refinance (including any cash-out refinancing) such mortgage debt on terms less favorable than those currently in effect (i.e., at higher interest rates) which will adversely affect our cash flow and profitability.

Results of Operations

Total revenues

The following table compares total revenues for the periods indicated:

(Dollars in thousands)

Rental income, net.

The following table details the components of rental income, net, for the periods indicated:

(Dollars in thousands)

(1) Represents rental income from properties acquired since January 1, 2022.

(2) Represents rental income from properties sold since January 1, 2022.

(3) Represents rental income from 108 properties that were owned for the entirety of the periods presented.

Changes at same store properties

The increases in same store rental income during the three and nine months ended September 30, 2023 are due primarily to increases of:

• $521,000 and $1.4 million, respectively, of rental income from various lease amendments and extensions at our properties,
• $123,000 and $754,000, respectively, of rental income due to new tenants at various properties, and
• $299,000 and $606,000, respectively, in tenant reimbursements, of which $258,000 and $403,000, respectively, relates to operating expenses generally incurred in the same period, and for the nine months ended September 30, 2023, $203,000 relates to real estate taxes.

The increases were offset during the three and nine months ended September 30, 2023 due to the inclusion, in the corresponding 2022 periods, of:

• $163,000 and $491,000, respectively, of rental income from leases that expired in 2022 and 2023 at several properties,
• $143,000 and $318,000, respectively, from Bed Bath & Beyond - Kennesaw, Georgia which filed for bankruptcy (including the write-off, during the nine months ended September 30, 2023, of the $133,000 unbilled rent receivable balance), and
• $145,000 and $257,000, respectively, of rental income from our wholly-owned Regal Cinemas properties due to lease amendments effectuated in connection with its bankruptcy reorganization.

Operating Expenses

The following table compares operating expenses for the periods indicated:

(Dollars in thousands)

Depreciation and amortization. The increases in the three and nine months ended September 30, 2023 are due primarily to (i) $391,000 and $1.2 million, respectively, of such expense from properties acquired in 2022 and 2023, and (ii) $141,000 and $362,000, respectively, of depreciation from improvements at several properties. In addition, the nine months ended September 30, 2023 includes $170,000 of amortization of leasing commissions at several properties.

The increases were offset by:

• decreases of $194,000 and $653,000, respectively, related to improvements and tenant origination costs at several properties that prior to September 30, 2023 were fully amortized, and
• the inclusion of $214,000 of such expense, in the nine months ended September 30, 2022, from the properties sold since January 1, 2022.

General and administrative. The increase in the nine months ended September 30, 2023 is due primarily to an increase of $422,000 of compensation expense related to additional employees, and to a lesser extent, higher levels of compensation.

Real estate expenses. The increases in the three and nine months ended September 30, 2023 are primarily due to:

• $169,000 and $633,000, respectively, from properties acquired in 2022 and 2023,
• $93,000 and $368,000, respectively, relating to real estate tax expense (primarily related to our El Paso, Texas and Ankeny, Iowa properties), and
• $113,000 and $382,000, respectively, of other real estate expenses, and in the nine months ended September 30, 2023, $218,000 of insurance expense for several properties.

These increases were offset due to the inclusion, in the corresponding 2022 periods of:

• $229,000 and $229,000, respectively, relating to the prior year period accrual for the potential real estate tax liability related to our wholly-owned Regal Cinemas properties due to uncertainty as to whether the tenant would satisfy its obligations to make such payments, and
• $247,000 of such expense, in the nine months ended September 30, 2022, from the properties sold since January 1, 2022.

A substantial portion of real estate expenses is rebilled to tenants and is included in Rental income, net, on the consolidated statements of income.

Gain on sale of real estate, net.

The following table compares gain on sale of real estate, net, for the periods indicated:

(Dollars in thousands)

The following table lists the properties sold and the related gains, net, for the periods indicated:

(Dollars in thousands)

Other Income and Expenses

The following table compares other income and expenses for the periods indicated:

(Dollars in thousands)

Equity in (loss) earnings of unconsolidated joint ventures. The decrease in the three and nine months ended September 30, 2023 includes our 50% share, or $850,000, of a $1.7 million impairment charge our joint venture recorded with respect to the Manahawkin Property. (See Note 7 to our consolidated financial statements.) The nine months ended September 30, 2023 also includes a $112,000 decrease in base rent collected from Regal Cinemas due to the lease amendment effectuated in connection with its bankruptcy reorganization. We anticipate that for the next several months, if not longer, we will not collect any rent from Regal Cinemas at the Manahawkin Property.

Income on settlement of litigation. In April 2022, we received $5.4 million in connection with the settlement of a lawsuit at our former Round Rock, Texas property (the “Round Rock Settlement”). (See Note 13 to our consolidated financial statements.)

Other income. The nine months ended September 30, 2022 includes $918,000 representing the final property insurance recovery related to our Lake Charles, Louisiana property damaged in a 2020 hurricane. (See Note 13 to our consolidated financial statements.)

Interest expense. The following table compares interest expense for the periods indicated:

(Dollars in thousands)

Mortgage interest

The following table reflects the average interest rate on the average principal amount of outstanding mortgage debt for the periods indicated:

(Dollars in thousands)

The increases in mortgage interest in the three and nine months ended September 30, 2023 are due primarily to increases in the average principal amount of mortgage debt outstanding as a result of refinancings and acquisitions. The increase was offset by mortgage payoffs (generally in connection with scheduled maturities) and scheduled amortization payments.

Credit line interest

The following table reflects the weighted average interest rate on the weighted average principal amount of outstanding credit line debt for the periods indicated:

(Dollars in thousands)

The increases in credit line interest in the three and nine months ended September 30, 2023 are due primarily to increases in the weighted average interest rates.

At November 1, 2023, $22.5 million was outstanding under our credit facility. Accordingly, we anticipate that over the short-term, until such outstanding amount is reduced, our interest expense will be higher than the interest expense incurred during the corresponding 2022 periods.

Amortization and write-off of deferred financing costs. The decrease in the nine months ended September 30, 2023 was primarily due to the $221,000 write-off of deferred costs related to the mortgages on the eleven Havertys properties that were paid off in June 2022.

Liquidity and Capital Resources

Our sources of liquidity and capital include cash flow from operations, cash and cash equivalents, borrowings under our credit facility, refinancing existing mortgage loans, obtaining mortgage loans secured by our unencumbered properties, issuance of our equity securities pursuant to our recently renewed at-the-market equity offering program and property sales. Our available liquidity at November 1, 2023, was $83.6 million, including $6.1 million of cash and cash equivalents (including the credit facility’s required minimum $3.0 million average deposit maintenance balance) and $77.5 million available under our credit facility. At November 1, 2023, the facility is available for the acquisition of commercial real estate, repayment of mortgage debt, and up to $26.0 million for renovation and operating expense purposes.

Liquidity and Financing

We expect to meet our short-term (i.e., one year or less) and long-term (i) operating cash requirements, including debt service, anticipated dividend payments and repurchases of our common stock, principally from cash flow from operations, our available cash and cash equivalents, proceeds from and, to the extent permitted and needed, our credit facility and (ii) investing and financing cash requirements (including an estimated aggregate of $3.6 million of capital and other expenditures) from the foregoing, as well as property financings and refinancings and property sales.

At September 30, 2023, excluding the mortgage debt of our unconsolidated joint venture, we had 68 outstanding mortgages payable secured by 69 properties in the aggregate principal amount of $420.9 million (before netting unamortized deferred financing costs of $3.3 million and mortgage intangibles of $838,000). These mortgages represent first liens on individual real estate investments with an aggregate carrying value of $670.4 million, before accumulated depreciation of $123.6 million. After giving effect to interest rate swap agreements, the mortgage payments bear interest at fixed rates ranging from 2.97% to 5.56% (a 4.18% weighted average interest rate) and mature between 2023 and 2047 (a 6.0 year weighted average remaining term to maturity).

The following table sets forth, as of September 30, 2023, information with respect to our mortgage debt that is payable during the three months ending December 31, 2023 and for each of the subsequent twelve months through December 31, 2026 (excludes our unconsolidated joint venture’s $20.8 million mortgage debt bearing an interest rate of 4.0% and maturing in 2025):

(Dollars in thousands)

(1)

We intend to make debt amortization payments from operating cash flow and, though no assurance can be given that we will be successful in this regard, generally intend to refinance, extend or pay off the mortgage loans which mature in 2023 through 2026. In particular, we anticipate refinancing a substantial portion of the debt maturing in 2023 and 2024 although given the significant increase in interest rates over the past year, we can provide no assurance that we will be able to do so on terms as favorable as those currently in effect or at all. We generally intend to repay the amounts not refinanced or extended from our existing funds and sources of funds, including our available cash, proceeds from the sale of our common stock and our credit facility (to the extent available).

We continually seek to refinance existing mortgage loans on terms we deem acceptable to generate additional liquidity. Additionally, in the normal course of our business, we sell properties when we determine that it is in our best interests, which also generates additional liquidity. Further, although we have done so infrequently and primarily in the context of a tenant default at a property for which we have not found a replacement tenant, if we believe we have negative equity in a property subject to a non-recourse mortgage loan, we may convey such property to the mortgagee to terminate our mortgage obligations, including payment of interest, principal and real estate taxes, with respect to such property.

Typically, we utilize funds from our credit facility to acquire a property and, thereafter secure long-term, fixed rate mortgage debt on such property. We apply the proceeds from the mortgage loan to repay borrowings under the credit facility, thus providing us with the ability to re-borrow under the credit facility for the acquisition of additional properties.

Credit Facility

Our credit facility provides that subject to borrowing base requirements, we can borrow up to $100.0 million for the acquisition of commercial real estate, repayment of mortgage debt, and renovation and operating expense purposes; provided, that if used for renovation and operating expense purposes, the amount outstanding for such purposes will not exceed the lesser of $40.0 million and 40% of the borrowing base. The facility matures December 31, 2026 and bears interest equal to 30-day SOFR plus the applicable margin. The applicable margin ranges from 175 basis points if our ratio of total debt to total value (as calculated pursuant to the facility) is equal to or less than 50%, increasing to a maximum of 275 basis points if such ratio is greater than 60%. The applicable margin was 175 basis points for each of the nine months ended September 30, 2023 and 2022. There is an unused facility fee of 0.25% per annum on the difference between the outstanding loan balance and $100.0 million. The credit facility requires the maintenance of $3.0 million in average deposit balances. The interest rate on the facility was 7.08% and 7.06% at September 30, 2023 and October 31, 2023, respectively. On October 31, 2023, $22.5 million was outstanding on the credit facility.

The terms of our credit facility include certain restrictions and covenants which may limit, among other things, the incurrence of liens, and which require compliance with financial ratios relating to, among other things, the minimum amount of tangible net worth, the minimum amount of debt service coverage, the minimum amount of fixed charge coverage, the maximum amount of debt to value, the minimum level of net income, certain investment limitations and the minimum value of unencumbered properties and the number of such properties. Net proceeds received from the sale, financing or refinancing of properties are generally required to be used to repay amounts outstanding under our credit facility. At September 30, 2023, we were in compliance with the covenants under this facility.

Other Financing Sources and Arrangements

We own a land parcel located in Beachwood, Ohio which is improved by a multi-family complex (i.e., The Vue Apartments) that we ground lease to the owner/operator of such complex. This ground lease did not generate any rental income during the nine months ended September 30, 2023 and 2022. At September 30, 2023, the carrying value of the land on our balance sheet was approximately $17.0 million; our leasehold position is subordinate to $63.9 million of mortgage debt incurred by our tenant, the owner/operator of the multi-family complex. In addition, we have agreed, in our discretion, to fund certain capital expenditures and operating cash flow shortfalls at this property. We do not believe that this type of off-balance sheet arrangement has been or will be material to our liquidity and capital resource positions, except to the extent we determine to continue to fund the capital expenditures required by, and the operating cash flow shortfalls at, this property. See Note 6 to our consolidated financial statements for additional information regarding this arrangement.

Application of Critical Accounting Estimates

A complete discussion of our critical accounting estimates is included in our Annual Report. There have been no changes in such estimates.

Funds from Operations and Adjusted Funds from Operations

We compute funds from operations, or FFO, in accordance with the “White Paper on Funds From Operations” issued by the National Association of Real Estate Investment Trusts (“NAREIT”) and NAREIT’s related guidance. FFO is defined in the White Paper as net income (calculated in accordance with GAAP), excluding depreciation and amortization related to real estate, gains and losses from the sale of certain real estate assets, gains and losses from change in control, impairment write-downs of certain real estate assets and investments in entities where the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO on the same basis. In computing FFO, we do not add back to net income the amortization of costs in connection with our financing activities or depreciation of non-real estate assets.

We compute adjusted funds from operations, or AFFO, by adjusting from FFO for straight-line rent accruals and amortization of lease intangibles, deducting from income additional rent from ground lease tenant, income on settlement of litigation, income on insurance recoveries from casualties, lease termination and assignment fees, and adding back amortization of restricted stock and restricted stock unit compensation expense, amortization of costs in connection with our financing activities (including our share of our unconsolidated joint ventures), debt prepayment costs and amortization of lease incentives and mortgage intangible assets. Since the NAREIT White Paper does not provide guidelines for computing AFFO, the computation of AFFO varies from one REIT to another.

We believe that FFO and AFFO are useful and standard supplemental measures of the operating performance for equity REITs and are used frequently by securities analysts, investors and other interested parties in evaluating equity REITs, many of which present FFO and AFFO when reporting their operating results. FFO and AFFO are intended to exclude GAAP historical cost depreciation and amortization of real estate assets, which assumes that the value of real estate assets diminish predictability over time. In fact, real estate values have historically risen and fallen with market conditions. As a result, we believe that FFO and AFFO provide a performance measure that when compared year over year, should reflect the impact to operations from trends in occupancy rates, rental rates, operating costs, interest costs and other matters without the inclusion of depreciation and amortization, providing a perspective that may not be necessarily apparent from net income. We also consider FFO and AFFO to be useful to us in evaluating potential property acquisitions.

FFO and AFFO do not represent net income or cash flows from operations as defined by GAAP. FFO and AFFO and should not be considered to be an alternative to net income as a reliable measure of our operating performance; nor should FFO and AFFO be considered an alternative to cash flows from operating, investing or financing activities (as defined by GAAP) as measures of liquidity. FFO and AFFO do not measure whether cash flow is sufficient to fund all of our cash needs, including principal amortization, capital improvements and distributions to stockholders.

Management recognizes that there are limitations in the use of FFO and AFFO. In evaluating our performance, management is careful to examine GAAP measures such as net income and cash flows from operating, investing and financing activities.

The tables below provide a reconciliation of net income and net income per common share (on a diluted basis) in accordance with GAAP to FFO and AFFO for the periods indicated (dollars in thousands, except per share amounts):

(a) The weighted average number of diluted common shares used to compute FFO and AFFO applicable to common stock includes unvested restricted shares that are excluded from the computation of diluted EPS.

Three Months Ended September 30, 2023 and 2022

The $462,000, or 5.0%, increase in FFO for the three months ended September 30, 2023 from the corresponding 2022 period is due primarily to a $1.1 million net increase in rental income.

Offsetting the increase is:

• a $401,000 increase in interest expense,
• an aggregate $186,000 increase in general and administrative expenses and real estate expenses, and
• a $137,000 decrease in equity in earnings of unconsolidated joint ventures.

The $359,000, or 3.6%, increase in AFFO is primarily due to the factors impacting FFO as described immediately above.

See “—Results of Operations” for further information regarding these changes.

Nine Months Ended September 30, 2023 and 2022

The $5.2 million, or 15.1%, decrease in FFO for the nine months ended September 30, 2023 from the corresponding 2022 period is due primarily to:

• the inclusion, in the corresponding 2022 period, of $5.4 million from the Round Rock Settlement,
• a $952,000 increase in interest expense,
• a $933,000 increase in real estate expenses,
• the inclusion, in the corresponding 2022 period, of $918,000 of income on insurance recovery from casualty loss,
• a $534,000 increase in general and administrative expenses,
• the inclusion, in the corresponding 2022 period, of an additional $298,000 in amortization of deferred financing costs, and
• a $221,000 decrease in equity in earnings of unconsolidated joint ventures.

Offsetting the decrease is a $3.4 million net increase in rental income.

The $854,000 or 2.7%, increase in AFFO is due to the factors impacting FFO as described immediately above, excluding the (i) $5.4 million Round Rock Settlement and (ii) $918,000 income on insurance recovery from casualty loss.

See “—Results of Operations” for further information regarding these changes.

Our primary market risk exposure is the effect of changes in interest rates on the interest cost of draws on our revolving variable rate credit facility and the effect of changes in the fair value of our interest rate swap agreements. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

We use interest rate swaps to limit interest rate risk on variable rate mortgages. These swaps are used for hedging purposes-not for speculation. We do not enter into interest rate swaps for trading purposes. At September 30, 2023, we had no liability in the event of the early termination of our swaps.

At September 30, 2023, we had 16 interest rate swap agreements outstanding. The fair market value of the interest rate swaps is dependent upon existing market interest rates and swap spreads, which change over time. As of September 30, 2023, if there had been an increase of 100 basis points in forward interest rates, the fair market value of the interest rate swaps and the net unrealized gain on derivative instruments would have increased by $395,000. If there were a decrease of 100 basis points in forward interest rates, the fair market value of the interest rate swaps and the net unrealized gain on derivative instruments would have decreased by $404,000. These changes would not have any impact on our net income or cash.

Our variable mortgage debt, after giving effect to the interest rate swap agreements, bears interest at fixed rates and accordingly, the effect of changes in interest rates would not impact the interest expense we incur under these mortgages.

Our variable rate credit facility is sensitive to interest rate changes. Based on the $12.5 million outstanding balance under this facility at September 30, 2023, a 100 basis point increase of the interest rate would increase our related interest costs over the next twelve months by approximately $125,000 and a 100 basis point decrease of the interest rate would decrease our related interest costs over the next twelve months by approximately $125,000.

The fair market value of our long-term debt is estimated based on discounting future cash flows at interest rates that our management believes reflect the risks associated with long-term debt of similar risk and duration.

Based on their evaluation as of the end of the period covered by this report, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective.

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