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Gramercy Property Trust (NYSE:GPT)

Q3 2013 Earnings Call

November 07, 2013 2:00 pm ET

Executives

Gordon F. DuGan - Chief Executive Officer and Director

Benjamin P. Harris - President

Jon W. Clark - Chief Financial Officer, Chief Accounting Officer and Treasurer

Analysts

Mitchell B. Germain - JMP Securities LLC, Research Division

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Kevin Tracey

Operator

Thank you, everybody for joining us, and welcome to Gramercy Property Trust's Third Quarter 2013 Financial Results Conference Call. A reminder, presentation materials and a supplemental for the call are posted on the company's website, www.gptreit.com, in the Investor Center section, in the Events & Presentations tab.

[Operator Instructions]

Please note, this conference is being recorded.

The company would like to remind the listeners that during the call, management may make forward-looking statements. Actual results may differ from the predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company's Form 10-K and other reports filed with the Securities and Exchange Commission. Also, during today's conference call, the company may discuss non-GAAP financial measures as defined by the SEC Regulation G. The GAAP financial measures most directly comparable to each non-GAAP financial measure discussed and a reconciliation of differences between each non-GAAP financial measure and the comparable GAAP financial measures can be found in the company's press release announcing third quarter earnings, a copy of which can be found on the company's website, www.gptreit.com.

[Operator Instructions]

Thank you, and please go ahead, Mr. DuGan.

Gordon F. DuGan

Thank you very much, and welcome, everyone. And we're glad to be here this afternoon to talk about our Q3 results. With me is Ben Harris, our President; and Jon Clark, our Chief Financial Officer.

As you saw on the press release and the additional information that we've supplied, including the business plan update, which is located on our website that I'll be referring to, I think, hopefully, you come away with the same perspective that I do, which is that the momentum that we're building with Gramercy is really gathering steam. And I think what you're going to find is a picked up pace of activity at Gramercy in terms of investments, in terms of other initiatives. And a large part of that is we're really through all the legacy issues. They were very time-consuming to deal with the sale of the CDOs and all these other things that we've done and now we're really focused on growth. And I think that as a result of that, some of the momentum that's been building is going to continue to build. And hopefully, as investors, you see that. We've said many times in these calls that we felt that we were ahead of schedule with the business plan. And I think Q3 is probably a really good example of that. So what was Q3? Positive FFO, positive AFFO, it's really the first time in a long time that the company has been able to say that. We've been building up to that, but we've kind of crossed over that threshold.

We put in place a credit facility, we did an equity raise, we announced that the preferred stock will be trued up. Jon will give some details on that. And we're also announcing today that we expect, subject to things going the way we expect them to for the rest of this quarter and in Q1, we expect that Q1 of 2014, we will reinitiate our common dividend. I'll talk a little bit more about that later.

Ben and I also want to talk about the investment climate. We think it's an extremely interesting investment climate, one where there's a lot of capital in net lease. There are a lot of things going on in net lease. But quite interestingly and maybe somewhat unexpectedly, we find the investment environment extremely attractive. And we'll talk about why that is. So if everybody would, I'd like to flip through, in fairly short form, the business plan update. Before I turn it over to Jon Clark to go through the detailed numbers. Business plan update is again just our overview of how we're doing on the business plan, the progress we're making, areas that we still need to make progress. And then, we have some discussion of some new areas that are going to be areas of focus for us and we'll put a little bit of color in that.

So if we jump into Page 3, self-explanatory that our year will -- that we're experiencing upward trending FFO and AFFO. I would just caution, Q4 will have the additional dilution of the equity offering. If you really think about it, the equity offering was perfectly timed. Q4 is just a question of how much earnings we're going to retain, that's true for Q3 and Q4, those are basically retained earnings without a common dividend. And so, if you're going to experience any dilution, you couldn't pick a better quarter to have a little bit of dilution, which is Q4 of 2013, because it's before we start to pay dividends. But obviously, the trends are very good.

Page 4, this is a supplemental disclosure. This is our capacity analysis that I think we've included in basically all of our business plan updates. Let me just tick through a couple of the lines here. These are the numbers as of 10/30, cash was $50 million, borrowing capacity of $83.5 million. That is all of the unencumbered assets that we have. The plan is we currently have $63 million of availability under the credit facility. We have to submit properties and have them included on the credit facility, which takes a little bit of time. And we're also, one of the transactions in the pipeline we might finance with a long-term fixed-rate mortgage. But that's our borrowing capacity today. Borrowing capacity on preferred freezer, that's the building in Miami that we're doing a Build-to-Suit on, that will kick in Q2 of '14.

CDO advances, asset sales, those continue -- and those will continue to whittle down in turn into cash for us. And then going down to the lines below, you see borrowing capacity on the sources. Existing portfolio, that's a combination just to make sure it's apples-to-apples, of the borrowing capacity today plus the preferred freezer borrowing capacity. And then you if you go off to the right, you see the uses of funding of a pipeline of acquisitions, preferred freezer Build-to-Suit, and then the true up of dividends. And we still are in a very good liquidity position, which is good because we're seeing a lot of deal flow and we'll talk a little bit more about that because Q3, it's always lumpy in the investment side and Q3 was light, but we expect Q4 to not be light, to actually be quite heavy from an investment standpoint. So $64 million of net equity capacity.

Page 5, just a snapshot of our capitalization. This is our capitalization with joint ventures on our books, both the Philips and the Bank of America investments are accounted for by the equity method. But this is a more accurate snapshot of our capitalization. Let me just touch on one thing here. The Bank of America JV, that was purposely floating rate debt because we bought it knowing that we would do some work on the portfolio, potentially restructure the lease, and at the end of that period, we would term out the debt. So investors should expect that this thing gets termed out in 2014, maybe sooner in '14 than later, but it will get termed out in '14. And just to put that in perspective, the debt yield on the existing Bank of America loan is roughly 13%. The market has gotten much better on the lending side and it has a ridiculously high debt yield for very good property, very good lease and very good tenancy. So obviously, that's a no-brainer loan to refinance at that type of debt yield.

Page 6, I thought was interesting. We've been able to grow the equity base in exactly the right way. Issuing shares, but doing so accretively so that the equity market cap of Gramercy has gone from $128 million as of June 30, 2012, that should say 2012, on the left, to October 31 of this year where it stands around $325 million. And it's been a combination of both share appreciation and new share issuance. So it's really been, I think we've been very thoughtful about how we've issued shares. We've done all the share issuances at market, and all have been accretive issuances tied to very specific things other than my purchasing of the million shares, which again I bought with my own money last June of 2012. So, again, they've all been accretive.

Page 7, just a quick summary of the pipe issuance. We've covered this already, but I would just point out that the CVR value today of roughly $1.3 million is half of the value of what it was when we did the pipe. What that means is, the potential, the theoretical value of the insurance that we gave the investors when we did the pipe has been cut in half because of the share appreciation. And I think it really goes to why we love that transaction, the technology of the CVR so much. Our goal is to minimize the payment of that CVR, in fact our goal is to pay 0 on the CVR. And it really aligns when we were talking to investors in that, it really aligned the interest -- the investors also don't want to get paid out on that CVR because that means their stock that they purchase has gone down. So if we're able to accomplish our business plan and we don't end up paying on the CVR, investors are happy because the stock price went up and new investors, existing investors are happy because we issued at market with no dilution, and we're all happy because it was accretively done. So I think the pipe issuance has been a very positive thing for the company.

Page 8, our usual shameless self-promotion. You see that we've been knocked down to the third top-performing REIT in 2013, and that's over quite a long period, and that comes on the tail of good performance last year and we are doing everything we can to keep that up.

Page 10, let me skip ahead. Portfolio overview. I think one thing for people who spend time in the net lease world that hopefully comes off differently about us and is quite as differentiated strategy, is our time and attention spend talking about the assets we're buying. And the reason for that is very simple. It all starts -- returns generated for investors all start with ROA, return on assets. So you have to have good return on assets to create a good return on equity. The difference then -- the difference between return on assets and return on equity is just your capital structure and the cost of the debt you employ. And the companies that have been really successful in the public REIT world for over a period of time have been very good at generating ROA. And the portfolio we're constructing is being constructed with the view to how do we generate the highest ROA possible so that whatever leverage we employ -- at whatever cost we employ it, which is basically the same that every other net lease REIT is using, we're going to generate superior ROE. So ROA is the beginning of the process by which we have to generate returns for investors. But when you look at our portfolio, it looks like a really high-quality net lease portfolio. Average lease term of 12 years, 44% investment-grade, primarily industrial with a strong office banking center component, and then some specialty investments included in there. You should note, that includes the pipeline that we have on Page 12. So it includes the transactions that are in process. Obviously, with pipeline, there's no guarantee those will close even though they're all under contract and we expect them to close, something can always go wrong. So I just throw out that caveat.

Page 11. I think we've done a very good job on the right-hand side of this, of diversifying our tenant base pretty quickly, which is the hardest thing to do with a small company. By far, our biggest tenant as you see is Bank of America. We're very comfortable with that being our largest tenant. Just for perspective, Bank of America 10-year unsecured bonds yield 3.97%. So to generate the kinds of yields that we're generating on owning strategically important Bank of America properties is something that we're obviously very happy with. And then on the left, something that you're not going to see other net lease companies do, we break down our portfolio by markets. We're investing in markets with good, long-term demographics. So when these 8, 10, 12, 15-year leases are rolling, they're rolling in cities that have growing populations, growing employment bases, et cetera. And we think that's going to be one of the keys to our having higher ROA's and higher ROE's than other net lease companies.

Page 12, this is just our normal update of the portfolio. Down below there, you see the pipeline included.

And with that, let me turn it to Page 13 and have Ben just talk in an overview about how we see the investment environment today.

Benjamin P. Harris

Thank you, Gordon. The investment environment, as Gordon mentioned, remains very competitive. There is a lot of capital chasing investments. And within the net lease markets specifically, there's been an enormous amount of M&A activity, which has gotten a lot of attention. In our view, this has actually expanded the opportunity set considerably. And it's also, more importantly for us, it has narrowed the focus of many of the very large participants in the space. We're seeing the very large entities within the net lease space focus on a narrower and narrower opportunity set. It's a reality of the amount of money that they're looking to raise and deploy. They don't -- they just don't have the bandwidth or the scale to be going through and picking through individual assets. And so the answer -- in the similar -- if you think about it as a manufacturer, a high-volume manufacturer has to keep the fewest variations between individual items that they're manufacturing. In the net lease space, it's the same thing. People are narrowing their focus around specific credits. They're narrowing their focus around specific types of leases and specific types of assets. We're actually seeing that breed a significant amount of opportunity around the edges. So smaller transactions, complex transactions and transactions that don't quite fit the box for most of the large net lease participants are being drawn into the market by all the M&A activity and all the attention, but aren't getting acquired by these big acquirers. So it's actually increased the opportunities. As Gordon mentioned, Q2 -- I'm sorry, Q3 was not that busy from a number of acquisitions standpoint. I wouldn't read that much into it. The deal business is very lumpy. We're actually seeing our pipeline as robust today as it's been all year. There's been a real inflection point from what's being called the Bernanke Bounce, the end of May announcement that QE was going to be tapered. We've seen that begin to bring a lot of sale leaseback activity into the market. We have 5 separate sale leasebacks in our pipeline. That's a very new thing. The sale leaseback market has been very dormant since the date of the financial crisis as companies have been relying on short-term borrowings in a very robust bond market to finance themselves. Now you're seeing companies look, actively look to term out debt and sale leasebacks are obviously one of the areas. So as an investor in this space and as an investor focused on relative value opportunities within the net lease universe, we're seeing as good an opportunity set as we've seen since we took over, both in terms of breadth of opportunity and also specific individual transaction quality and return. So we're very excited about the investment environment. I think you're going to see, as Gordon mentioned, the company momentum. I think you're going to see that translate through to investment activity as we continue to deploy capital into the space.

Gordon F. DuGan

Let's flip ahead. Corporate earnings. Thanks, Ben. They remain the same for us. These are really more updates slides for those who have been following our what seem like monthly calls, but they're not quite monthly.

Asset management results, Page 16. We continue to see very steady profitability out of the asset management business. The effective tax rate is too high and we're working on an effort to lower that effective tax rate. It's just between Pennsylvania and New York and all these other things, we think the effective tax rate will end up being lower. And so one of the pushes on the asset management side is to lower the effective tax rate. But the other push is to continue doing what we're doing for a broader number of clients. We're really very, very good at this. And when I say we, it's the team that does it, which doesn't really include me very much. But the team that we have deployed on our asset management side is really, really good. And so we're looking for additional opportunities within that asset management group and we hope to be able to describe those as we go forward.

Page 17, MG&A. We've made very good progress here. It was a little bit high in Q3. Some of that's just timing of when bills come through or an accrual, expenses are accrued, except for some small expenses that we pay in cash. We account for them in cash, excuse me. And so there were some things that hid in that. There was increased stock expense, comp expense that Jon will talk about. We're still spending too much for certain things we're doing and we've been I think very diligent at cutting away at it. Anybody who's been in our offices will attest to the fact that we're not spending tons of money on office space and office furniture and the like. We run a very lean organization, but we've made very good progress. If you look at the net MG&A, which is after allocation asset management and deducting out stock comp, it's getting down to that $3 million number we want to hit. And then if you put it in perspective and take the quarterly asset management contribution, the MG&A, just to be in the net lease business, is getting down into that $8 million, $9 million range, which is just about the right number for a company our size. So, again, because of the profitability of the asset management business and the cuts we've made in the MG&A, I feel pretty good about where we are. We still have some progress to make through the end of the year, but I think we're making good progress.

Page 18. Value-add opportunities. Because of the types of assets we're buying, we think there's still inherent growth within the portfolio, expansions, lease extensions. One of the areas that we probably haven't focused -- we haven't really spent as much time explaining to investors. Within our portfolio, we own roughly $80 million of bank centers, bank branches in Southern California. Those are very low, with significantly below market lease rentals. Those are very low cap rate assets that we think, over time, will have the ability to sell and then redeploy into higher cap rate opportunities. And that's a great way, the recycling of capital, selling things at 5 caps and 6 caps and buying things at 7 caps and 8 caps. It's just a great business. The restructure of the BofA lease, I would put in the low probability category, but I didn't want to put it down.

Let's talk about Page 19, which is really the crux of what we're doing. Gramercy is a growth company. We're a growth REIT and we've been able to get through this initial stage and hit to the point where we're profitable. And now we're looking for growth opportunities. Within those growth opportunities, there are several different categories of things we're looking at. And those are in addition to the organic growth that we're going to experience by buying assets, increasing our NOI and potentially raising additional capital and accretive transactions and buying additional assets. That's the steady-state business plan that has plenty of inherent growth, but there are more growth opportunities. And let me just talk about what growth means to us. Growth does not mean for us being the biggest. Growth means growing value per share and growing earnings per share or FFO per share. So the sole focus of what we're doing is growing the shareholder value per share and the FFO or the earnings per share, not trying to worry about whether we're the biggest net lease company or the 10th biggest or the 5th biggest. We're 100% solely focused on growing value per share and earnings per share or FFO per share.

So let's talk about how do we do that. On Page 20, the portfolio acquisitions that have been much invoked, it is absolutely the case that the larger the portfolio, the lower the returns. And that's been, if anybody graphs out what's transpired in the net lease business, that's been the case. So and that's a theme you've heard from us before. So we continue to buy things one by one for the most part. And when you buy a portfolio, you have to buy the bad along with the good. It's just the nature of the beast, you have to buy some stuff that hasn't worked out well. We think we can do a much better job underwriting things one by one than having to take the good with the bad. That having been said, there are many, many portfolios that exist, small, medium-sized and large, that will seek liquidity. And some of those portfolios we think will be of high quality enough that we will have a keen interest in them. We also think that to the extent the sellers are looking for shares or OP units, that quite immodestly we think we would have a competitive advantage. Our portfolio is more transparent, it's easier to underwrite, it's easier to understand. And to some extent, when people take shares, they're betting on management. And we think we'll do it -- we would come up very well on that dog and pony show, where people are selling for shares or OP units. Now that we're going to be instituting a common dividend this is going to be a key focus of ours in terms of going forward. We also think the consolidation in net lease business is likely to continue. There are a number of reasons that -- and the participants that have been consolidating have been able to state the benefits of the consolidation. So everybody's heard that.

Page 21, we thought was an interesting chart. We got this from Barclays. So we sourced it. This is Barclays chart, not ours. And this is kind of a lay of the land of the net lease world, including a number of private companies. Again, we don't think you have to be bigger, we want to be bigger, but we don't think you have to be the biggest to drive earnings per share and value creation per share, which is our sole focus, but we do want to get bigger. We did think this is interesting. But our take on it was actually quite different. If you go to Page 22, if you've really breakdown that group, it breaks down into different components, different industry type components. There are the retail real estate-oriented companies, the realty incomes, the triple Ns, very, very fine companies. There are the industrial office-focused players that used to include cap lease, which is now part of ARCP. And I'll come back to that. There's the diversified or specialty, the EPRs, the GTY, the CARS. And then there's what I would describe as a private REIT sponsors, COLE, ARCP and WP Carey. And they're different because they have different business model. The equity they raise is raised through the non traded REIT business. They then go and buy assets into those funds and then merge them into the public company. So they have not yet been, and are probably not likely to be, growing significantly by accessing public REIT investors because they have these private REIT fundraising models that raise billions of dollars a year, however people may feel about that. On the industrial and office side, we think there's a real opportunity to be a market leader in terms of growing value per share, growing earnings per share and there are a number of players, some stronger, some bigger, some smaller. But we think we stack up very well in that net lease segment. And, again, our goal is to be the leading industrial and office net lease investor.

Page 23, JV opportunities. We think there are opportunities on assets that we either asset manage or assets that we see or know have some informational advantage to buy in a JV structure that leverages our existing equity base, but we would buy it in a JV because it wouldn't meet our investment criteria because of either high leverage, low current returns or it's a value-add opportunity. We wouldn't do very much of that kind of JV investing, but we do think there are some opportunities on assets that we see where there are many institutional investors that would love to team up with Gramercy to buy assets and we would put in just a little bit of equity and then earn a very high ROE by being a JV partner on things that don't fit our criteria but that we think are good investments and we have some informational advantage.

Lastly, on Europe. We've spend a lot of time investing there. Let me start by saying this is exploratory. I started investing in Europe. My personal experience goes back in 1998 when I was at WP Carey. We set up an office in Paris, had a fellow go over to France and start investing in European net lease real estate. As far as I know, we were the first American investor to do that. WP Carey has done very well doing that. They've built up a very good track record in that area. And in general, I would say it's a marketplace where there's less capital chasing opportunities, and certainly in the northern European countries, you have credit profiles of the countries that are quite similar to the United States. I don't want to spend a lot of time on this because it is exploratory, but it's something we have a lot of experience with. As I said, the opening of an office in 1998, that's a long time ago. And so I've seen a lot of transactions and a lot of things take place over the years. And I think there may be some interesting opportunity. More to come on that.

Let me finish by saying 2 things before I turn it over to Jon. Again, momentum is building. I think the pace of activity is picking up. We're very excited about where we are. The common dividend is coming. We are a growth-oriented REIT. We are going to stay away from being in an arms race on the common dividend, especially with the non traded REIT sponsors who tend to be very, very dividend-oriented. We are more growth-oriented than they are. And so our board will be balancing the right level of dividend. We have no guidance yet on what that dividend is going to look like and that will be a board decision coming up. But as I said to begin, we expect a Q1 2014 dividend and that dividend will be in the context of a growth REIT. So the board will deliberate and come up with dividend policy at a later date. But we did want to give some clarity for the reinitiation of common dividends.

I've gone on long enough. I'll turn it over to Jon to go through the quarter's financial highlights.

Jon W. Clark

Thank you, Gordon. I'd just like to provide a few highlights of the results for the quarter. Our headline figures are that we generated positive AFFO during the quarter of $2.2 million or a positive $0.04. And we also generated FFO of $2.7 million or positive $0.05. And as Gordon mentioned before, this is really an important milestone for the company. We may have had moments in the past where we generated a positive FFO figure, but really, this was the first that we've reached a period where it's upward trending. On a GAAP basis, we had a net loss of $1.3 million or $0.02 per diluted common share. And I just wanted to reiterate that we provided a reconciliation of GAAP net income to FFO and AFFO on Page 9 of our press release that we issued this morning.

Generally, the differences between GAAP and FFO are well-known. It's essentially the add back depreciation and amortization to arrive at FFO. The additional adjustments that we post to arrive at AFFO are comprised of the add back of property acquisition, costs that are expense for GAAP, noncash stock compensation cost, certain lease intangible, amortization and income under loss for discontinued operations, which primarily related to the disposition of the commercial real estate finance business that we sold in the first quarter of 2013. In addition, our AFFO measure excludes straight line rent recorded for GAAP and the incentive fee that we recognize on our asset management business net of the corresponding income tax.

This is the second quarter that we've presented an AFFO figure and we're finding it to be a really good measure of our performance.

We recorded total revenues of approximately $13.4 million for this quarter as compared to $16.3 million in the prior quarter. The largest component of revenue last quarter was the recognition of an additional $5.4 million in incentive fees, which was based on the expectation that the underlying value of the KBS managed portfolio will exceed its threshold. If you exclude that, revenues quarter-over-quarter increased by about $2.5 million or 22.5%. Rental revenues as a percentage of total revenues are continuing to grow with the acquisitions that we've made to date. Rental revenues were about 18% of revenues last quarter, if you exclude the additional incentive fees that we recorded. This quarter, rental revenues were about 33% of total revenues. And currently, because of the significance of our fee-based businesses in compared to our total revenues, we must conduct those activities in a taxable subsidiary. But as good REIT revenues grow, which is basically rental revenues, we expect to have opportunities to conduct some of our fee-based business within the REIT, which Gordon had talked earlier, could result in future income tax savings.

During 2013 to date our tax expense was significant and it was primarily driven by that incentive fee that we earned with respect to the KBS portfolio. The incentive fee for the managed portfolio is capped at $12 million. To date, we've recognized $8.8 million of incentive fee revenues and we expect to earn and recognize the remaining $3.2 million of fees over the term of the agreement. The fee is accrued for on our balance sheet, but pursuant to the terms, payment's expected on June 30, 2014 or March 31, 2015 if KBS elects to defer the payment and pays a onetime extension fee.

During the quarter, we recognized $1.1 million of incentive fees and it's expected that we're going to recognize the fee at this pace until the entire $12 million is accrued for. Management, general administrative expenses were $4.7 million for the quarter as compared to $4.3 million in the prior quarter and $8.3 million in the same quarter of the prior year. Approximately $3.7 million of the current quarter's expense was related to corporate and real estate investments and the $1 million was related to the asset management business. There were some onetime expenses this quarter, some of which was related to the move of our new corporate offices in New York City. We did move to a smaller office space here. We did have a slight increase in payroll costs, most of which I don't expect is going to repeat, and there were some additional costs related to our Investor Relations effort. But individually, none of these are really incremental costs or were very significant. And we're continuing to look for more and more ways to reduce costs, which are possible given the reduction and the complexity of the business subsequent to the disposal of the finance business. Some of the information technology efforts that we're working on to reduce costs won't really show a meaningful impact until 2014. We're currently working on a system conversion and I expect we're going to have realization of $300,000 of software costs alone once we are fully relying on the new system. But as Gordon said before, we still have some work to do on our MG&A, we just are not quite at the run rate of MG&A that we really set out to achieve.

Turning quickly to the balance sheet. There's just a few additional items I'd like to highlight. The changes in the carrying value of real estate in cash quarter-over-quarter just reflect the acquisition activity reported for the quarter. Our investment in our joint ventures on our GAAP balance sheet is declining quarter-over-quarter, but that's primarily due to the significant cash distributions that we've been receiving and our partner has been receiving. For the quarter, we received distributions of $4 million, and to date, we've received distributions from our JV of about $24.5 million. Servicing advanced receivables, which is a legacy receivable we retained after the sale of our finance business, decreased by approximately $4.6 million as compared to the prior quarter. That was due to the receipt of advances that we had historically made in the resolutions of those assets that occurred within the CDOs. Subsequent to quarter end an additional $400,000 was received reducing the balance subsequently. I don't expect much in the way of repayments for the advances for the remainder of 2013, perhaps another $200,000 will come in. The rest of it will be a 2014 event. Our retained CDO bonds accreted in value slightly to $8 million from $7.6 million in the prior quarter. The accretion of CDO bonds shows up on our income statement as investment income. Again, we've spoken about this before, but the expected cash flows from our CDO bonds are highly variable, and dependent on the resolution of individual investments in the underlying CDO trust, none of which we're essentially in control of, but the bonds will be accreting up to our expected cash flow, and this quarter, things worked as expected. But just to caution, it's also likely that in future quarters, the bonds may fluctuate in any given period up or down just based on the underlying assets, as well as some external factors such as change in interest rates. Again, we did pay significant taxes this quarter, primarily related to that incentive fee booked last quarter. Most of the taxes appear actually as prepaid taxes and sitting in other assets. The balance of mortgage notes payable was comparable to the prior quarter. There were not and today there have not been any new borrowings. We haven't drawn down on our financing facility as of yet. We do have a pending mortgage financing of an asset that we expect to close before month end and that's about $12.6 million. And as Gordon talked about earlier, subsequent to quarter end, we closed on a private placement of stock that raised approximately $45.6 million in net proceeds. And I just want to talk a moment about the contingent value right or the CVR. All of investors receiving stock as part of the private placement received 1 CVR for each share of stock that they bought. The CVR provides for a onetime cash payment on April 1, 2014, not to exceed $0.46 per share, if our common stock traded below the purchase price of $4.11, and it's measured on a volume-weighted average basis over a period. The CVR will be recorded on our December 31 balance sheet at a fair value. And as mentioned earlier, the fair value today is significantly lower than the value that it was at the date that the instrument was created. So today, the fair value is approximately $1.3 million. So once that gets recorded on our books, essentially, what you would do is you book a liability of $1.3 million and you have a corresponding charge on your P&L for the same amount. A CVR is not considered an accounting hedge, so you take a direct hit to the P&L. But assuming that the CVR expires pursuant to its terms without a cash payment, essentially that $1.3 million reverses itself out -- reversing itself out completely before the April 1, 2014 termination date.

With that, Gordon, I just want to say we're looking forward to the resumption of dividend payments and extinguishing the accrual on the preferred stock that's on our balance sheet once directed by the board. We expect that preferred dividend as well as the current dividend for the fourth quarter of 2013 will be paid no later than January 15, 2014 and it will be to shareholders of record as of December 31. So with that, Gordon?

Gordon F. DuGan

Thanks, Jon. At this point, we'll turn it over to Q&A, and we'll be happy to answer any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Mitch Germain of JMP Securities.

Mitchell B. Germain - JMP Securities LLC, Research Division

Curious, I know you kind of didn't give much color in terms of size of the dividend, but I'm just kind of curious, I know it's kind of out of your hands, but I'm curious. I've heard you mention in the past you wanted to pay something that was somewhat competitive with some of the other triple net REITs. Any color around? I mean, is that still somewhat accurate in terms of how you view the dividend here?

Gordon F. DuGan

Yes. No. Yes. I think that that's right. I think that with some color. What we've said pretty consistently to investors is that the 2 tensions on the dividend are paying a dividend that has enough oomph in it that it doesn't look like -- that it appears that earnings generation is very good. So we want to pay a dividend that's a reasonable dividend and a reasonable payout of AFFO. But I would also say that while we're in the growth phase of our business plan, which we expect to last for at least some period of time, that we don't -- I don't think we need to view -- I don't think investors will, they certainly shouldn't, and I don't think we need to view ourselves through the prism of what's the highest yielding net lease REIT paying that isn't growing or has structural problems or whatever it is. So we're a growth company -- a growth REIT that's going to be paying a dividend. And I think one way to think -- so there's going to be balancing those 2 tensions of paying something that looks like a reasonable dividend in REIT world but -- so I would say, the 2 guys to look at are net lease REITs on the one hand and then any growth-oriented REITs on the other hand like a Torino[ph] , who I believe you cover, Mitch. People like it. So there's going to be a combination of people to look at, companies that have growth prospects, as opposed to just pure net lease companies. And also where net lease companies are. Those will be the 2 groups we'll be looking at as a board as we sit down to deliberate on that.

Mitchell B. Germain - JMP Securities LLC, Research Division

Great. And I know that you said Europe was just, I guess, in your terms, exploratory. Your portfolio is 5 million, 6 million square feet. This time last year, I don't even know if it existed. So I guess, from that regard, I mean, isn't it too early to maybe take on the kind of geopolitical and foreign currency risk of investing in Europe? And isn't there -- I mean, what does that say about the population of deals available here in the states?

Gordon F. DuGan

Well, it's really just a question of can we grow faster than we would otherwise grow, right? It doesn't -- our ability to grow focusing on the United States is unquestioned and is going to happen. And then the only other question is, are there other ways to grow a company faster by investing in an area where there's investment opportunity? So I wouldn't think of it as, this or that, but rather, this is additional growth opportunity. And we -- as Ben said, we view the U.S. right now, the U.S. net lease real estate environment for us is great. So that's why I would put Europe in the exploratory category.

Mitchell B. Germain - JMP Securities LLC, Research Division

Okay. And last question for me. 6 deals under LOI, I think you just closed 1 or 2 others. I'm curious, Gordon, in terms of how those deals were sourced, were they off market? Were you able to leverage some of your contacts and the whatnot?

Gordon F. DuGan

Ben, you want to just...It's a great question.

Benjamin P. Harris

No. It runs the gamut. The majority of them were sourced off market. A couple of them were sale leasebacks with companies that we were -- that we had a relationship with. A couple of them were acquired from funds that we've had a relationship with that we've been sort of in an active dialogue with.

Gordon F. DuGan

If you go to Page 12, Mitch, and look at the list. The first one, the industrial portfolio. That's the portfolio we've been chasing for 2 years. It's a privately-owned portfolio, it's not marketed. Maybe another net lease investor knows of it. I don't think they do. So we've been working with the seller of that portfolio to try to free it up, and in the process, negotiated that directly. And then the Harrisburg deal, we bought one asset from a fund and we said, "What else you got?" And then negotiated in 2 days to buy this Harrisburg asset, again without that asset ever seeing the light of day. And then a couple of the deals, as Ben said, are sale leasebacks.

Benjamin P. Harris

Well, we're focusing, Mitch, and I think this is important because it ties into not only where the deals are being sourced but also really what we're looking to do from an investment standpoint. Our focus is on assets that are not readily understood by the broader market. So it's either a credit that we don't think is being priced properly. It's an asset that's not being priced properly. It's a renewal probability on a shorter lease that we don't think people are handicapping properly given the linkage between the asset and the tenant. But that's really where we're focusing on. We are -- we consider ourselves a value investor within the net lease space. So we're not looking to just sort of buy market deals. Some deals that we have acquired that have been marketed, we think have been mismarketed. So it's either -- it's a great real estate opportunity that's being mismarketed to a net lease universe that doesn't understand the intrinsic value of the real estate or vice versa. It's a great net lease deal that's being marketed to a universe of traditional real estate buyers that are looking at it solely on a price per pound and are missing some of the intrinsic value in the contract surrounding the lease. We are also focusing on portfolios and master lease transactions like the BofA transaction where we can go in and execute a plan, either a restructuring of a lease or the sale of certain assets where we can create value that way. And that's going to be a big part of what we're doing going forward. So I hope that gives a little bit of perspective. So it's not -- from our standpoint, it's not just that a deal is off market or on market, but we used to joke that some people end up paying sort of an off market premium because they are willing to pay someone more so that they can tell everyone that it's off market. Our focus is solely on whether we're getting good deals, as Gordon said, that generate high ROA, that have multiple potential generators of value, either through the lease, through the residual value or through some value-add play that exists in the specific asset.

Operator

Our next question is from Wilkes Graham of Compass Point.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Maybe just to follow-up on a couple of Mitch's questions. I'm curious, Gordon, if you're implying by the language in the slides on Europe that, that the credit profile of some of the investments that you see in Europe is the same, but essentially the cap rates are higher?

Gordon F. DuGan

Yes, I think that's a fair comment. I think that our premise is that you -- there is a spread on cap rates to the U.S. That spread is -- may be sufficient to overcome the foreign exchange risk. It may not be. We haven't concluded that, but we do believe that there are higher ROAs or similar ROAs and higher ROEs that make it at least compelling enough to look at.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Higher ROEs and the debt financing costs are similar?

Gordon F. DuGan

Yes, exactly.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

And Jon, can you just confirm on the CVR. Is it correct to say that if the stock is trading above $4.11 on April 1 that there's no payment?

Jon W. Clark

That's correct. It's a onetime payment on that date and only if it's below that threshold. And it's capped, obviously.

Benjamin P. Harris

Just to be clear, it's not -- it's a VWAP calculation. So It's not the closing price. It's the -- I believe it's a 5-day VWAP.

Jon W. Clark

5 or 10-day VWAP.

Benjamin P. Harris

I'm sorry, a 10-day VWAP. So it's the 10-day VWAP up to that point. So, not based on the screen price, but based on that VWAP. But provided the VWAP is at or above the $4.11, there's nothing due on the CVR.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Okay. 2 more questions. Gordon, I think you mentioned at the beginning that you might be looking to grow the asset management business. A lot of the questions we get about the asset management business is the KBS contract runs out in 2014, and I think you've commented in the past that you can't comment on whether it gets resigned, but you guys are very good managers of those assets and KBS may be stuck with you. I don't know if you can comment anymore on that. And then secondly, do you think there's an opportunity to grow the asset management business?

Gordon F. DuGan

Instead of having them -- instead of the characterization they're stuck with us, we prefer to think of it as a very happy marriage. I think the assets are very sticky. We really like the business, we are very good at it. Growth is probably a little strong, so I'm glad you brought that up, Wilkes. What I meant to say is that, while there are -- there to me is definitely an opportunity to continue with KBS, hopefully, beyond the lease -- the contract term. We also think there are opportunities as assets are sold to team up with buyers of those assets as we've done with Oaktree in an unrelated -- where we're just asset manager and where we've done with Garrison, where we're a JV partner and an asset manager. So I think that I would put it in the category if I think there are additional revenues that hopefully we can derive while doing a very good job for people and stay in that KBS business because it's really is a very, very good fit. The last thing I would say it's probably been the most pleasant surprise. It's a hard business to run. We have a lot of people dedicated to it. We do give it a lot of overhead time. Jon Clark, our CFO, is down in Philadelphia 2 days a week. Ed Matey, our General Counsel is there 2 or 3 days a week. So it isn't that it's easy to run, it's actually quite complicated, quite difficult to run, but it is a business where we have just real discernible competitive advantages. Just nobody understands these assets the way we do. And I think I've been very open about saying it's probably been the most pleasant surprise that we've had coming into Gramercy because this is not a skill set that Ben and I brought to Gramercy, that's a skill set that existed within Gramercy.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Okay. And then this last, probably just a technical question. If I look in the 10-Q, the contractual minimum rents over the next couple of years, there's some material increases and I'm just wondering, number one is that cash as opposed to GAAP? And second, is that a function of what we see sometimes in net leases where you've got maybe 5 years of a fixed lease and then it has a significant bump of 10% to 15% every 5 years or something like that? Is that fair?

Jon W. Clark

That's fair. These are rent bumps, these are future rent bumps.

Gordon F. DuGan

You're also -- at least in the first couple of years, there's a -- having the asset on the books for 365 days a year rather than from at least the next year versus the following year. Well, I shouldn't say that, Wilkes. I'm not sure how we're accounting for, in that chart, how we're accounting for preferred Miami.

Jon W. Clark

Just a way to think about the portfolio, there are going to be 2 sources of growth from this portfolio. The first is through the addition of assets. And as we add assets and get more fully invested, you'll see both NOI and FFO grow. And then also through contractual rent growth, and there's a mix across the portfolio of both fixed rental increases and also CPI-based rental increases. The fixed rental increases for GAAP gets straight lined. So there's actually, from a GAAP standpoint, they show up as a flat number, but then from a cash standpoint, they go up. Some of our leases have pretty substantial increases over the contracted term. And then other leases we actually have a fair number of CPI-based leases, so they're going up by inflation index, and those are not straight lined, so those will just show up as both GAAP and cash increases.

Wilkes Graham - Compass Point Research & Trading, LLC, Research Division

Great. And I actually do have one more question. Under contract pipeline, which has about $100 million left, can you comment at all on what your timing expectations are there?

Gordon F. DuGan

Yes, Ben?

Benjamin P. Harris

The majority of those will be in the next 60 days. Vast majority of those will be in the next 60 days.

Operator

Our next question is from Kevin Tracey of Oberon Asset Management.

Kevin Tracey

I just wanted to quickly follow-up on a question I asked on last month's call about the expected tax treatment of the preferred dividends to be paid for the fourth quarter. I think a month ago, you guys were uncertain if it would be treated as a return of capital or as a normal unqualified dividend. Is there any update on that?

Jon W. Clark

Kevin, I can give you a little bit of an update on that, but I'm going to admit, I'm going to be a little bit dovish [ph] on it in part because we do have 2 months to go through the year and our CDOs are creating taxable income and we are not in control of those assets. So those are being controlled by the CW, who we sold those contracts to. So to some extent, I can only attempt to predict what happens to some of those assets for the next 2 months. But with the preferred dividend being paid out to shareholders of record as of December 31, it's likely a substantial portion of that is going to be ordinary income. The way REITs work is that you take the dividends, paid deduction first before applying NOL. So, potentially we're in kind of a different situation here where we really have no taxable distribution requirement because of NOLs. But first you take a deduction for dividends paid then you go to NOLs. I would just caution that we're going to communicate the tax treatment of those dividends in a 1099 sometime in January. But my expectation...

Gordon F. DuGan

Yes, the moment it's final, Kevin. We'll communicate with investors. It's still little early for us.

Jon W. Clark

Also I think, Kevin, you might have asked last time about whether the dividends are qualified or non-qualified. And it's likely a piece of our dividends may be qualified dividends in part because of the significant taxes that we paid on our TRS. So again it's something I'll have to look for the 1099. But I would plan for a significant portion of this being ordinary income.

Operator

[Operator Instructions]

And our next question is from Amir Patel of Bonanza Capital.

Unknown Analyst

I have 2 questions. The first deals with your cap and borrow rates. If you flip to Page 5 of the supplemental, it looks like your guidance for the borrowing rates is from 3.5% to 5.5% and cap is from 7% to 9%. Obviously, top to bottom, that's a pretty wide range of potential spread. Now I understand that you're focusing on it from a value standpoint, you're focusing on residual value and market rents rather than just pure headline cap rate. But can you kind of give a little bit more color on where you see cap rates going forward and what factors might impact that?

Gordon F. DuGan

Yes. It's something, obviously, we grapple with quite a bit. If you go to Page 12, if you go to the pipeline, always the best is sort of like what's the forward-looking 60, 90-day pipeline look like. We have an 8.5% cap rate there. But I would caution that it is probably a little bit high because of the -- that second investment, the industrial property in Waco, which is a 9.7%. So I think it's been remarkably consistent around an 8% to 8.5% GAAP cap rate. And I think that a tighter range that's probably more reflective of where we are is 7.5% to 8.5%. And almost everything is falling out in that range. On the borrowing side, 5.5%, not something we've seen. So I would say the borrowing rates are really 3.5% to 5%. And if you were to just take 10-year maturity borrowing rate, 4% to 5% is where we see things. So maybe even as tight as 4% to 4.75%.

Unknown Analyst

Okay. That's really helpful. Second question is I think we've recently seen some very interesting M&A activity in the net lease space. So to the extent that you feel comfortable commenting on, in the context of maximizing shareholder value, how do you treat an offer from an interested third-party to acquire Gramercy?

Gordon F. DuGan

That's good question, Amir. We are focused in value creation for investors. So whatever creates the most value is what we're focused on doing. I will say this, we think we have a great business plan that we're executing very, very well, so it's just not something we spend a lot of time thinking about, but our job is to maximize shareholder value. So if somebody wanted to pay $100 a share, I guess we'd have to listen. But we're day in and day out just focused on growing our business and driving value per share for the investors. I know that's kind of a punt, but there really isn't much else I can say.

Operator

And we have no further questions at this time.

Gordon F. DuGan

Great. Well, thank you, all, for joining us today. And a lot of you are familiar with us, so please, if you have additional questions, concerns, thoughts, we're always available to discuss them. Thank you so much.

Operator

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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