MODIV INDUSTRIAL, INC. (MDV) FY 2023 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition, results of operations and cash flows together with the consolidated financial statements and related notes included in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors. Also, see “Cautionary Note Regarding Forward-Looking Statements” preceding Part I of this Annual Report on Form 10-K and Part I, Item 1A. Risk Factors herein.

Management’s discussion and analysis of financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

Overview

We are a Maryland corporation with issued and outstanding stock consisting of Series A Preferred Stock, listed on the NYSE under the symbol “MDV.PA,” and Class C Common Stock, listed on the NYSE under the symbol “MDV.” We currently own and manage single-tenant net-lease properties throughout the United States, which are primarily, but not exclusively, industrial properties. Our focus for future acquisitions is on critical industrial manufacturing properties with long-term leases to tenants that fuel the national economy and strengthen the nation's supply chains. We elected to be taxed as a REIT for U.S. federal income tax purposes beginning with our taxable year ended December 31, 2016. We believe that we have operated in conformity with the requirements for qualification as a REIT for U.S. federal income tax purposes. Since December 31, 2019, we have been internally managed, as further described below in Note 12 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

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Following the January and February 2024 sales of the two properties that were held for sale as of December 31, 2023, our real estate investment portfolio consists of 42 properties, including the TIC Interest, as further described in Notes 3 and 4 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K. Our portfolio is distributed across 15 states and consists of 38 industrial properties which represent approximately 76% of the portfolio by ABR, one retail property which represents approximately 11% of the portfolio by ABR, and three office properties which represent approximately 13% of the portfolio by ABR. As of December 31, 2023, excluding the two properties that were held for sale, our ABR was $39,328,192 with a WALT of 14.1 years and 33% of our tenants by ABR are investment grade.

Although we are not limited as to the form our investments may take, our investments in real estate will generally constitute acquiring fee title or interests in entities that own and operate real estate. We will make substantially all acquisitions of our real estate investments directly through the Operating Partnership or indirectly through limited liability companies or limited partnerships, including through other REITs, or through investments in joint ventures, partnerships, tenants-in-common, co-tenancies or other co-ownership arrangements with other owners of properties. We are the sole general partner of, and owned an approximate 68% partnership interest in the Operating Partnership on December 31, 2023. The Operating Partnership’s limited partners include holders of several classes of units with various vesting and enhancement terms as further described in Note 12 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K. We report with the SEC as a smaller reporting company under Rule 12b-2 of the Exchange Act.

Primary Investment Objectives

Our primary investment objectives are:

•to provide attractive growth in AFFO and sustainable cash distributions;

•to realize appreciation from proactive investment selection and management;

•to provide future opportunities for growth and value creation; and

•to provide an investment alternative for stockholders seeking to allocate a portion of their long-term investment portfolios to industrial manufacturing real estate.

We expect the trend of onshoring manufacturing to accelerate and we will continue to focus future acquisitions on industrial manufacturing properties, subject to market conditions and the availability of prices that we consider attractive. We can provide no assurance that we will achieve our investment objectives. See the Part I, Item 1A. Risk Factors section of this Annual Report on Form 10-K for additional information.

Recent Events and Uncertainties

There are continuing significant uncertainties in the market in which we operate related to inflation and interest rates, supply chain disruptions, and negative impacts associated with the violence and unrest in the Middle East, the ongoing Russian war against Ukraine and sanctions which have been implemented by the United States and other countries against Russia. Volatility in stock and bond markets and particularly the rapid rise in yields on U.S. Treasury securities during 2022 and 2023, the ripple effect of bank failures in the first half of 2023 and increasing bank regulations, may negatively impact our operating results, liquidity and sources of borrowings.

We, our tenants and operating partners are impacted by inflation and rising interest rates. While the rate of inflation has been declining over the last few months, inflation remains above the Federal Reserve's 2% target and there is significant uncertainty over the future rate of inflation. Depending on the future course of inflation, the Federal Reserve may refrain from reducing interest rates to try to rein in inflation, which could lead to a recession and will negatively impact our future results due to higher borrowing costs on any future floating rate borrowing. As of December 31, 2023, 100% of our $281,200,000 outstanding debt is at fixed rates with a weighted average rate of 4.52% as a result of the swap agreements entered into in May 2022 and October 2022. In addition, sustained elevated inflation rates may negatively impact our longer term leases if contractual rent increases are not sufficient to keep up with market leases.

Possible future declines in rental rates and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows from office properties. Following the January and February 2024 sales of the two properties held for sale leased by Levins and Cummins, respectively, we have no leases expiring in the next 12 months.

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Potential future declines in economic conditions could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our real estate portfolio, which could have the following negative effects on us: the values of our investments in commercial properties could decrease below the amounts paid for such investments; and/or revenues from our properties could decrease due to fewer tenants and/or lower rental rates, making it more difficult for us to make distributions or meet our debt service obligations. We successfully negotiated lease extensions for three and two properties during 2022 and 2023, respectively; however, changing circumstances may make future lease extensions more difficult.

The debt market remains sensitive to the macro environment, such as inflation, Federal Reserve policy, bank failures in the first half of 2023, the impacts of the COVID-19 pandemic on office properties, market sentiment and regulatory factors affecting the banking and commercial mortgage-backed securities industries. In January 2022, we refinanced all but four of our properties (including the TIC Interest) with proceeds from our Credit Facility (as defined below), which includes floating rates based on the Secured Overnight Financing Rate (“SOFR”) and our leverage ratio as described below. The mortgage on our Rancho Cordova, California property, which is leased to the State of California's Office of Emergency Services (“OES”) and was scheduled to mature on March 9, 2024, was fully repaid in December 2023 and the other three mortgages do not mature until after September 2027. All of the remaining mortgages are at fixed rates. As a result of the interest rate swap agreements entered into during 2022, 100% of our consolidated indebtedness as of December 31, 2023, held a weighted average fixed interest rate of 4.52%.

Any future uncertainties in the capital markets may cause difficulty in refinancing debt obligations prior to maturity at terms as favorable as the terms of existing indebtedness. If we are not able to refinance our indebtedness on attractive terms, or at all, at the various maturity dates, we may be forced to dispose of some of our assets. Market conditions can change quickly, potentially negatively impacting the value of real estate investments.

Liquidity and Capital Resources

Generally, our cash requirements for property acquisitions, debt payments and refinancings, capital expenditures and other investments will be funded by bank borrowings through our Credit Facility, mortgage indebtedness on our properties, real estate property sales, internally generated funds or offerings of shares of our Class C Common Stock.

Purchases of properties in the near-term will be funded primarily with proceeds from dispositions of remaining non-core properties, proceeds from our ATM program and cash on hand. In the future, we expect to sell additional shares of our Class C Common Stock, subject to market conditions and a recovery in the trading price of our Class C Common Stock. We are targeting leverage, over the long-term once we achieve scale, of 40% or lower of the aggregate fair value of our real estate properties plus our cash and cash equivalents; however, we increased our borrowing during 2023 in order to execute attractive acquisition opportunities resulting in leverage of 48% as of December 31, 2023. We have $150 million of borrowing capacity available under our Credit Facility (defined below) which we may utilize in the near or medium-term if we identify attractive investment opportunities in advance of completing dispositions or raising additional equity, which could result in temporary increases in leverage.

Our cash requirements for operating and interest expenses, dividends on our Series A Preferred Stock and distributions on our Class C Common Stock will be funded by internally generated funds. We expect to have adequate liquidity to meet our cash requirements for the next 12 months and beyond.

Credit Facility and Mortgages

Our Operating Partnership entered into an agreement for a line of credit (the “Credit Agreement”) on January 18, 2022 which was amended on October 21, 2022, and currently provides a $400,000,000 line of credit comprised of a $150,000,000 four-year Revolver, which may be extended by up to 12 months subject to certain conditions, and a $250,000,000 five-year Term Loan with KeyBank and the other lending institutions party thereto (collectively, the “Lenders”), including KeyBank as Agent for the Lenders (in such capacity, the “Agent”), as further described in Note 7 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K. The Credit Facility is available for general corporate purposes, including, but not limited to, acquisitions, repayment of existing indebtedness and capital expenditures.

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The Credit Facility includes an accordion option that allows us to request additional Revolver and Term Loan lender commitments up to a total of $750,000,000 subject to customary conditions, including the receipt of new commitments from the Lenders. The Revolver’s maturity is in January 2026, with options to extend for a total of 12 months, and the Term Loan’s maturity is in January 2027.

The Credit Facility is priced on a leverage-based grid that fluctuates based on our actual leverage ratio at the end of the prior quarter. With our leverage ratio at 48% as of September 30, 2023, the spread over SOFR, including a 10-basis point credit adjustment, is 185 basis points for the Revolver. Therefore, the interest rate on the Revolver was 7.1625% as of February 29, 2024; although there was no outstanding balance on the Revolver. We also pay an annual unused fee of up to 25 basis points on the Revolver, depending on the daily amount of the unused commitment, and paid total unused fees of $378,816 and $200,578 for the years ended December 31, 2023 and 2022, respectively.

On May 10, 2022, we entered into a swap agreement, effective from May 31, 2022 to January 17, 2027, subject to our counterparty’s one-time cancellation option on December 31, 2024, to fix SOFR at 2.258% with respect to our original $150,000,000 Term Loan. We granted the cancellation option because it reduced the swap rate by approximately 50 basis points. The Company has begun to explore, and intends to further explore various alternatives available to extend or restructure the cancellation option. This swap agreement resulted in a fixed interest rate of 4.058% on our original $150,000,000 Term Loan based on our leverage ratio of 48% as of December 31, 2023, as described in Note 8 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

On October 26, 2022, we entered into a swap agreement, effective from November 30, 2022 to November 30, 2027, subject to our counterparty’s one-time cancellation option on December 31, 2024, to fix SOFR at 3.44% with respect to our expanded Term Loan. We granted the cancellation option because it reduced the swap rate by approximately 50 basis points. This swap agreement resulted in a fixed interest rate of 5.240% on the additional $100,000,000 borrowed under the expanded Term Loan based on our leverage ratio of 48% as of December 31, 2023, as described in Note 8 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

As of December 31, 2023 and 2022, the outstanding principal balance of our mortgage notes payable on our operating properties was $31,200,000 and $44,515,009, respectively, our Revolver outstanding principal balance was zero and $3,000,000, respectively, and our Term Loan outstanding principal balance was $250,000,000 and $150,000,000, respectively. As of December 31, 2023, our approximate 72.7% pro-rata share of the TIC Interest’s mortgage note payable of $12,730,664 was $9,256,466, which is not included in our consolidated balance sheets in this Annual Report on Form 10-K.

The Credit Facility includes customary representations, warranties and covenants, including covenants regarding minimum fixed charge coverage of 1.50x, minimum tangible net worth of $208,629,727 plus 85% of net offering proceeds after January 18, 2022, and maximum consolidated leverage of 60%. The Credit Facility is secured by a pledge of all of the Operating Partnership’s equity interests in certain of the single-purpose, property-owning entities (the ‘‘Subsidiary Guarantors’’) that are indirectly owned by us, and various cash collateral owned by the Operating Partnership and the Subsidiary Guarantors. In connection with the Credit Facility, we and each of our Subsidiary Guarantors entered into an Unconditional Guaranty of Payment and Performance in favor of the Agent, pursuant to which we and each of our Subsidiary Guarantors agreed to guarantee the full and prompt payment of the Operating Partnership’s obligations under the Credit Agreement.

We are targeting leverage of 40% or lower over the long-term once we achieve scale; however, we increased our borrowing during 2023 in order to execute attractive acquisition opportunities resulting in leverage of 48% as of December 31, 2023. We may have higher leverage in the near or medium-term if we identify attractive investment opportunities in advance of completing dispositions or raising additional equity to fund future acquisitions.

While we intend for the Credit Facility to be an important source of financing, we may continue to use mortgage debt financing for certain real estate investments and acquisitions. This financing may be obtained at the time an asset is acquired or an investment is made or at such later time as determined to be appropriate. In addition, debt financing may be used from time-to-time for property improvements, lease inducements, tenant improvements and other working capital needs.

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The $150,000,000 unused capacity on our Revolver as of the date of this Annual Report on Form 10-K, subject to our borrowing base covenant, along with proceeds from any future offerings of shares of Class C Common Stock, can be used to invest in real estate and real estate-related investments or to re-lease and reposition our properties in accordance with our investment strategy and policies, including costs and fees associated with such investments, such as capital expenditures, tenant improvement costs and leasing costs. We also may use a portion of the proceeds from our equity offerings for payment of principal on our outstanding indebtedness and for general corporate purposes.

Compliance with All Debt Agreements

Pursuant to the terms of our Credit Facility and our two mortgage notes payable secured by certain of our properties, we and/or our subsidiary borrowers are subject to certain financial loan covenants. We and/or our subsidiary borrowers were in compliance with such financial loan covenants as of December 31, 2023.

Acquisitions and Sale of Real Estate Investments

We acquired a total of 12 industrial manufacturing properties for an aggregate of $129,753,499 (including closing costs) during the year ended December 31, 2023, at a blended initial cap rate of 7.8% and a weighted average cap rate of 10.3%. We define “initial cap rate” for property acquisitions as the initial annual cash rent divided by the purchase price of the property. We define “weighted average cap rate” for property acquisitions as the average annual cash rent including rent escalations over the lease term, divided by the purchase price of the property.

The details follow of the 12 and 16 properties we acquired during the years ended December 31, 2023 and 2022, respectively:

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(a)    Includes $1,800,000 funding provided for improvements to the previously acquired Lindsay property in Franklinton, North Carolina, which was initially recorded as a construction advance in prepaid expenses and other assets (see Note 6 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for the remaining balance as of December 31, 2023).

(b)    The Summit property was acquired in an ‘‘UPREIT’’ unit transaction wherein the seller received 287,516 Class C OP Units accounting for approximately 46% of the property value with the rest of the price paid in cash.

(c)    The KIA property was acquired in an ‘‘UPREIT’’ unit transaction wherein the seller received 1,312,382 Class C OP Units accounting for approximately 47% of the property value and we repaid a $36,465,449 existing mortgage, including accrued interest, on the property.

(d)    The South Carolina and Ohio properties each have a 25-year master lease and the Texas and Utah properties each have a 15-year master lease.

In evaluating the above properties as potential acquisitions, including the determination of an appropriate purchase price to be paid for the properties, we considered a variety of factors, including the condition and financial performance of the properties, the terms of the existing leases and the creditworthiness of the tenants, property location, visibility and access, age of the properties, physical condition and curb appeal, neighboring property uses, local market conditions, including vacancy rates, area demographics, including trade area population and average household income and neighborhood growth patterns and economic conditions.

We sold a total of 14 properties (11 retail, two office and one flex) during 2023, comprising 241,795 square feet for aggregate contract sales prices of $47,466,960, net losses on sales of $1,708,801 and aggregate net proceeds of $44,357,474, net of commissions and closing costs. See Note 3 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for further details of these dispositions.

Capital Expenditures and Tenant Improvements

Other than as discussed below, we do not have other plans to incur any significant costs to renovate, improve or develop our properties. We believe that our properties are adequately insured. Pursuant to our lease agreements, as of December 31, 2023 and 2022, we had obligations to reimburse $2,439,098 and $1,789,027, respectively, for future on-site and tenant improvements expected to be incurred by tenants. We expect that the related improvements will be completed during the 2024 calendar year and will be funded from cash on hand, operating cash flow, offerings of shares of our Class C Common Stock or borrowings under our Credit Facility.

In addition, we have identified approximately $664,611 of capital expenditures that are expected to be completed in the next 12 months which are not recoverable from tenants with double-net leases. These improvements will be funded from cash on hand or operating cash flows. More information on our properties and investments can be found in Note 3 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

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Funds from Operations and Adjusted Funds from Operations

In order to provide a more complete understanding of the operating performance of a REIT, the National Association of Real Estate Investment Trusts (“Nareit”) promulgated a measure known as Funds from Operations (“FFO”). FFO is defined as net income or loss computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, plus real estate-related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships, joint ventures, preferred dividends and real estate impairments. Because FFO calculations adjust for such items as depreciation and amortization of real estate assets and gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), they facilitate comparisons of operating performance between periods and between other REITs. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. It should be noted, however, that other REITs may not define FFO in accordance with the current Nareit definition or may interpret the current Nareit definition differently than we do, making comparisons less meaningful.

Additionally, we use Adjusted Funds From Operations (“AFFO”) as a non-GAAP financial measure to evaluate our operating performance. AFFO excludes non-routine and certain non-cash items such as revenues in excess of cash received, stock-based compensation, deferred rent, amortization of in-place lease valuation intangibles, deferred financing fees, gain or loss from the extinguishment of debt, unrealized gains (losses) on derivative instruments, and write-offs of due diligence expenses for abandoned pursuits. We also believe that AFFO is a recognized measure of sustainable operating performance of the REIT industry. Further, we believe AFFO is useful in comparing the sustainability of our operating performance with the sustainability of the operating performance of other real estate companies. Management believes that AFFO is a beneficial indicator of our ongoing portfolio performance and ability to sustain our current distribution level. More specifically, AFFO isolates the financial results of our operations. AFFO, however, is not considered an appropriate measure of historical earnings as it excludes certain significant costs that are otherwise included in reported earnings. Further, since the measure is based on historical financial information, AFFO for the period presented may not be indicative of future results or our future ability to pay our dividends. By providing FFO and AFFO, we present information that assists investors in aligning their analysis with management’s analysis of long-term operating activities.

For all of these reasons, we believe the non-GAAP measures of FFO and AFFO, in addition to income (loss) from operations, net income (loss) and cash flows from operating activities, as defined by GAAP, are helpful supplemental performance measures and useful to investors in evaluating the performance of our real estate portfolio. AFFO is useful in assisting management and investors in assessing our ongoing ability to generate cash flow from operations and continue as a going concern in future operating periods. However, a material limitation associated with FFO and AFFO is that they are not indicative of our cash available to fund distributions since other uses of cash, such as capital expenditures at our properties and principal payments of debt, are not deducted when calculating FFO and AFFO. Therefore, FFO and AFFO should not be viewed as a more prominent measure of performance than income (loss) from operations, net income (loss) or cash flows from operating activities and each should be reviewed in connection with GAAP measurements.

Neither the SEC, Nareit, nor any other applicable regulatory body has opined on the acceptability of the adjustments contemplated to adjust FFO in order to calculate AFFO and its use as a non-GAAP performance measure. In the future, the SEC or Nareit may decide to standardize the allowable exclusions across the REIT industry, and we may have to adjust the calculation and characterization of this non-GAAP measure.

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The following are the calculations of FFO and AFFO for the years ended December 31, 2023 and 2022:

(1)    Excludes 474,515 performance units in accordance with the terms of the Operating Partnership Agreement.

(2)    Includes the Class M OP Units which were automatically converted to Class C OP Units on January 30, 2024, and Class P and Class R OP Units (time vesting and performance vesting) which have now vested and will be automatically converted to Class C OP Units on March 31, 2024, to compute the fully diluted weighted average number of shares.

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Property Portfolio Information

Although we only have a single segment for financial reporting purposes, given our strategic initiative to focus solely on acquiring and operating industrial manufacturing properties, we are presenting the following information regarding our property portfolio to help investors better understand our strategic direction:

The following is a breakdown of our FFO and AFFO by property type for the year ended December 31, 2023:

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(1)    We categorize Tactical Non-Core Assets as those assets that offer compelling value-add or opportunistic investment characteristics when measured over a near-term or interim holding period. We currently hold three such assets: (i) our tactical non-core acquisition of a leading KIA auto dealership located in a prime location in Los Angeles County in January 2022, which was structured as an UPREIT unit transaction resulting in a favorable equity issuance of $32,809,550 value of Class C OP Units at a cost basis of $25.00 per unit; (ii) our 12 year lease to OES executed in January 2023 for one of our legacy office assets located in Rancho Cordova, California that includes an attractive purchase option by the tenant which we believe has a favorable probability of being executed upon in the next 24 months; and (iii) our office property leased to Costco located in Issaquah, Washington which offers compelling redevelopment opportunities following Costco's lease expiration on July 31, 2025 given its higher density infill location and the fact that the land is zoned for additional uses including multi-family. On January 11, 2024, we entered into a contingent purchase and sale agreement with a national homebuilder for the sale of this property as further described in Note 14 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

(2)    Other non-core assets include (1) one legacy office property leased to Cummins classified as held for sale beginning September 30, 2023, and sold on February 28, 2024 (see Notes 3 and 14 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for additional details), and (2) one additional legacy office property leased to Solar Turbines. We define legacy assets as those inherited through prior mergers and acquisitions activity and such assets that were acquired by different management teams utilizing different investment objectives or underwriting criteria.

(3)     We do not allocate non-property expenses across our property types; therefore, we report these expenses separately under the Non-Property & Other caption in the table above. Such expenses can include stock compensation expense, general and administrative, unrealized gains and losses on interest rate hedges, and other comprehensive items.

(4)    Excludes 474,515 performance units in footnote (5) (v) below in accordance with the terms of the Operating Partnership Agreement.

(5)    Weighted average fully diluted shares outstanding includes the following for the year ended December 31, 2023:

(i)    7,558,833 shares of Class C Common Stock;

(ii)    1,528,020 Class C OP Units for the year ended December 31, 2023, including 1,312,382 issued in January 2022 in connection with the acquisition of the KIA auto dealership property and the weighted average of 287,516 units which were issued in April 2023 in conjunction with our acquisition of the property in Reading, Pennsylvania leased to Summit Steel & Manufacturing, LLC;

(iii)    1,096,582 Class C OP Units that resulted from conversion of 657,949.5 Class M OP Units during January 2024;

(iv)     93,382 Class C OP Units that will result from the automatic conversion of 56,029 Class P OP Units on March 31, 2024, based on the conversion ratio of 1.6667 Class C OP Units for each Class P OP Unit outstanding; and

(v)    790,858 Class C OP Units that will result from the automatic conversion of 316,343 Class R OP Units on March 31, 2024, which reflects the conversion ratio of 2.5-for-1 based on the achievement of the FFO performance target of $1.05 per diluted share for the year ended December 31, 2023, as described in Note 12 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.

(6)    For the intra-period allocation, we treat all component per share amounts as fully-diluted to correspond with the consolidated FFO and AFFO results reflected above.

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The following is a breakdown of our accompanying consolidated statement of operations included in this Annual Report on Form 10-K by property type for the year ended December 31, 2023:

(1)-(3)    See footnotes (1) through (3) above.

(4)    Non-Property & Other interest expense includes amortization of a net unrealized gain on interest rate swap valuation of $1,015,151 and derivative cash settlements of $5,679,720 (see Notes 7 and 8 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for additional details).

(5)     Other income reflects management fees earned for managing the TIC Interest.

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The following is a breakdown of our accompanying consolidated balance sheet included in this Annual Report on Form 10-K by property type as of December 31, 2023:

(1)-(3)    See footnotes (1) through (3) above.

(4)    Non-Property & Other prepaid expenses and other assets include deferred financing fees on our Revolver and prepaid directors and officers insurance.

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Distributions

The source of cash used to pay our distributions has been and is expected to continue to be internally generated funds from operations.

A table of distributions declared and paid is disclosed in Part II, Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - Distribution Information.

We expect that our board of directors will continue to declare distributions based on a single record date as of the end of each month and to pay these distributions on a monthly basis. Distributions will be determined by our board of directors based on our financial condition and such other factors as our board of directors deems relevant. We have not established a minimum dividend or distribution level, and our charter does not require that we make dividends or distributions to our stockholders other than as necessary to meet REIT qualification standards.

Cash Flow Summary

The following table summarizes our cash flow activity for the years ended December 31, 2023 and 2022:

Cash Flows from Operating Activities

Net cash provided by operating activities was $16,578,228 for the year ended December 31, 2023 compared to $16,648,821 for the year ended December 31, 2022, resulting in a net decrease in cash provided by operating activities of $70,593 year-over-year primarily due to the increase in cash interest expense during 2023, partially offset by decreases in general and administrative and property expenses.

Cash Flows from Investing Activities

Net cash used in investing activities was $93,602,234 for the year ended December 31, 2023 compared to $61,063,193 for the year ended December 31, 2022, resulting in an increase in cash used in investing activities of $32,539,041, primarily due to a reduction in net sales proceeds received of $34,737,474 in 2023 for 14 properties, which were primarily smaller retail properties, compared with net sales proceeds of $70,662,287 received in 2022 for eight office, flex and retail properties. This decrease in net proceeds from asset sales was partially offset by a decrease in funds utilized to invest in acquisitions and additions to existing real estate investments of $3,970,067, reflecting 12 property acquisitions in 2023 compared with 16 property acquisitions in 2022.

Cash Flows from Financing Activities

Net cash provided by financing activities was $71,544,771 for the year ended December 31, 2023 compared to cash used in financing activities of $5,384,499 for the year ended December 31, 2022, which primarily reflects a decrease of $117,181,737 in the principal payments on notes payable that were refinanced with borrowings under our Credit Facility in January 2022, or repaid upon sales of properties, partially offset by a decrease in our Credit Facility Term Loan borrowings of $50,000,000 year-over-year. In addition, payments of deferred financing costs incurred in 2022 aggregated $3,638,229. No such charges were incurred in 2023.

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Results of Operations

Portfolio Information

Our wholly-owned investments in real estate properties as of December 31, 2023 and 2022, including two and one properties held for sale as of the years ended December 31, 2023 and 2022, respectively, and the 91,740 square foot industrial property underlying the TIC Interest for all balance sheet dates presented were as follows:

(a)    Includes the TIC Interest.

(b)    Includes two properties (one industrial and one office) held for sale as of December 31, 2023, which were sold on January 10, 2024 and February 28, 2024.

(c)    Includes one flex property held for sale as of December 31, 2022, which was sold on August 31, 2023.

We acquired 12 and 16 operating properties during 2023 and 2022, respectively. We sold 14 properties (11 retail, two office and one flex) during 2023 and eight properties (six office, one retail and one flex) during 2022. The operating results of each property that was classified as held for sale as of December 31, 2023 and 2022, and the 14 and eight properties that were sold during 2023 and 2022, respectively, were included in the continuing results of operations in our accompanying consolidated financial statements included in this Annual Report on Form 10-K. We expect that rental income, depreciation and amortization expense, and interest expense will increase in 2024 as compared with 2023, as a result of the $129,753,499 of industrial manufacturing property acquisitions during 2023, which were partially offset by the sale of 14 properties completed in August 2023, along with the sale of the two properties held for sale in January and February 2024. Our results of operations for the year ended December 31, 2023, may not be comparable to those expected for 2024 or in future periods.

Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022

Rental Income

Rental income, including tenant reimbursements, for the years ended December 31, 2023 and 2022 was $46,936,599 and $43,822,032, respectively. Rental income during 2022 included early termination fee revenue of $3,751,984 related to an office property in Rancho Cordova, California leased to Sutter Health, which was subsequently leased to OES effective January 4, 2023. The increase in rental income of $6,866,551, or 17%, year-over-year, excluding the 2022 early termination fee revenue, primarily reflects the rental income contribution from our acquisitions of 12 industrial manufacturing properties acquired during the first three quarters of 2023, partially offset by the decrease in rental income from the sale of eight properties during 2022 and 14 properties sold during August 2023. Pursuant to most of our lease agreements, tenants are required to pay or reimburse all or a portion of the property operating expenses. The ABR of the 44 operating properties owned as of December 31, 2023, was $40,114,613 and December 31, 2023 ABR, excluding periods subsequent to the sales of Levins and Cummins, was $39,586,711.

General and Administrative

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General and administrative expenses were $6,642,990 and $7,812,057 for the years ended December 31, 2023 and 2022, respectively. The decrease of $1,169,067, or 15%, year-over-year primarily reflects decreases in (i) employee compensation due to personnel reductions during 2022; (ii) directors and officers insurance; and (iii) costs for technology services, offset in part by an increase in costs for professional services during 2023.

Stock Compensation

Stock compensation expense was $11,171,207 and $2,401,022 for the years December 31, 2023 and 2022, respectively. The increase of $8,770,185 reflects a catch-up adjustment of $8,555,529 related to our achievement of management’s performance target for FFO of $1.05 per diluted share for the year ended December 31, 2023, exclusive of the dilutive effect of the performance units and related stock compensation expense. Our FFO per fully diluted share excluding the dilutive impact of the performance units and the related stock compensation expense was $1.77 for the year ended December 31, 2023 (see “Funds from Operations and Adjusted Funds from Operations” above). This exceeded the performance target of $1.05 per diluted share by $0.72, or 69%. As a result of achieving our performance target of $1.05 per diluted share, exclusive of the effect of the performance units and related stock compensation expense, an additional 474,515 Class C OP Units will be issued on March 31, 2024, upon the automatic conversion of our Class R OP Units based on a conversion ratio of 2.5 Class C OP Units for each Class R OP Unit. The catch-up adjustment reflects amortization of the $19.58 per share fair value of the performance units from the January 25, 2021 grant date through December 31, 2023. The remaining unamortized fair value of $733,331 will be recorded as compensation expense for the performance units through the end of the vesting period on March 31, 2024. The performance target was established in January 2021 and represented a 20% increase over the FFO per diluted share achieved for the year ended December 31, 2020. The $1.77 of FFO per diluted share, exclusive of the effect of the performance units and related stock compensation expense, represents a 101% increase over the FFO per diluted share achieved for the year ended December 31, 2020. The remaining $224,656 increase in stock compensation expense reflects the absence of forfeitures during the year ended December 31, 2023, as compared to recapture of stock compensation expense related to employee departures and forfeitures in 2022.

Depreciation and Amortization

Depreciation and amortization expense was $15,551,173 and $14,929,574 for the years ended December 31, 2023 and 2022, respectively. The purchase price of properties acquired is allocated to tangible assets, identifiable intangibles and assumed liabilities, if any, and depreciated or amortized over their estimated useful lives. The increase of $621,599, or 4%, year-over-year primarily reflects an increase in depreciation of real estate properties acquired, partially offset by reductions due to properties sold in the second half of 2022 and August 2023, along with reductions in amortization of intangible lease assets for the year ended December 31, 2023, due to the disposition of properties with acquired leases rather than leases initiated by us.

Property Expenses

Our property expenses generally consist of site repair and maintenance costs, real estate taxes, business licenses, insurance, utilities, property management fees and other property costs. Property expenses were $5,161,017 and $6,547,391 for the years ended December 31, 2023 and 2022, respectively. A significant portion of these expenses are reimbursed by tenants and rental income includes tenant reimbursements of $2,962,297 and $4,244,009 for the years ended December 31, 2023 and 2022, respectively. The decrease of $1,386,374, or 21%, year-over-year primarily reflects decreases in property taxes and repairs and maintenance related to assets sold, which included double-net and modified gross leases, offset in part by increases in property management fees associated with acquired properties during the current year.

Impairment of Goodwill

The impairment of goodwill of $17,320,857 for the year ended December 31, 2022 reflects the significant decline in the market value of our Class C Common Stock following the inception of our trading on the NYSE in February 2022. For the quarter ended March 31, 2022, management considered the fact that the trading price of our Class C Common Stock caused our market capitalization to be below the book value of our equity as of March 31, 2022. Our stock price was evaluated to be materially below both our historical net asset value and the book value of our equity, reflecting the negative impacts of rising inflation and interest rates, declining office occupancy rates affecting owners of real estate properties and fears of a potential recession. We, therefore, reduced the carrying value of goodwill to zero as of March 31, 2022.

(Loss) Gain on Sale of Real Estate Investments, Net

The loss on sale of real estate investments of $1,708,801 for the year ended December 31, 2023 includes the $1,887,040 loss on sale of the 13 properties (11 retail and two office) sold to GIPR on August 10, 2023, partially offset by the $178,239 gain on sale of the flex property sold on August 31, 2023. The loss includes the $2,380,000 difference between the $12,000,000

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liquidation value and the $9,620,000 fair value of our investment in GIPR's newly-created Series A Redeemable Preferred Stock received on August 10, 2023 as a portion of the sale proceeds (see Note 5 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for more details). The gain on sale of real estate investments of $12,196,371 for the year ended December 31, 2022 relates to the gain on sale of eight properties (six office, one retail and one flex) sold during 2022 (see Note 3 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for more details).

Other (Expense) Income

Interest income was $325,888 and $21,910 for the years ended December 31, 2023 and 2022, respectively, reflecting interest earned on cash proceeds from April 2023 draws on the Term Loan prior to utilizing such cash to acquire industrial manufacturing properties in May 2023 and higher interest rates earned on available cash and cash equivalents during 2023.

Dividend income was $475,000 and zero for the years ended December 31, 2023 and 2022, respectively, reflecting dividends on the GIPR Series A Redeemable Preferred Stock received in August 2023.

Income from unconsolidated investment in a real estate property, which reflects our approximate 72.7% TIC Interest in the Santa Clara, California property's results of operations, was $279,549 and $278,002 for the years ended December 31, 2023 and 2022, respectively.

Interest expense, including unrealized loss on interest rate swaps and net of derivative settlements was $13,806,838 and $8,106,658 for the years December 31, 2023 and 2022, respectively (see Note 7 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K for details of the components of interest expense, net). The increase of $5,700,180 year-over-year primarily reflects the increase in interest expense incurred on our Credit Facility due to larger balances outstanding and net unrealized loss on interest rate swap valuations, partially offset by an increase in derivative settlements.

The net unrealized loss on swap valuation of $1,633,451 for the year ended December 31, 2023 reflects the change in valuation of both our $150,000,000 first swap and $100,000,000 second swap. The unrealized loss was partially offset by the $1,015,151 amortization of the unrealized gain on interest rate swap derivative previously recorded in accumulated other comprehensive income. The first swap derivative instrument failed to qualify as a cash flow hedge beginning January 1, 2023, because the swap was deemed ineffective due to our counterparty’s one-time cancellation option on December 31, 2024, as compared with the maturity date of the Term Loan. We granted this cancellation option because it reduced the swap rate by approximately 50 basis points. The second derivative instrument was not designated as a cash flow hedge. These unrealized losses reflect decreases during the year ended December 31, 2023 in the forward curve for future SOFR rates through December 31, 2024 (the one-time cancellation option date). We have begun, and intend to further explore various alternatives available to extend or restructure the cancellation option.

The increase in fair value of our investment in preferred stock of $1,418,658 reflects the change in the fair value between when the stock was acquired on August 10, 2023 and the fair value as of December 31, 2023.

Loss on early extinguishment of debt of $1,725,318 for the year ended December 31, 2022 reflects non-cash charges of $1,164,998 for deferred financing costs and prepayment penalties of $615,336 upon repayment of 20 mortgages on 27 properties, full repayment of our Prior Credit Facility and mortgage repayments related to four asset sales, as well as $733,000 of swap termination fees related to the four mortgage refinancings, which were offset by the related write-off of unrealized swap valuation losses of $788,016.

Other income of $297,695 and $93,971 for the years ended December 31, 2023 and 2022, respectively, reflects our monthly management fee from the entities that own the TIC Interest property, partially offset in 2022 by charges for the write-off of certain crowdfunding related investments. The monthly management fee is equal to 0.1% of the total investment value of the property. The total management fee was $263,971 for each of the years ended December 31, 2023 and 2022, of which our portion of expense relating to the TIC Interest was $191,933 for each year and is reflected as a component of income from unconsolidated investment in a real estate property in our accompanying consolidated statements of operations included in this Annual Report on Form 10-K.

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Critical Accounting Policies and Estimates

The policies and estimates discussed below reflect those that management believes are or will be critical in affecting the preparation of our consolidated financial statements. We consider these policies critical in that they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and because they are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities as of the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our consolidated financial statements. Management evaluates these estimates based upon information currently available and on various assumptions that it believes are reasonable an ongoing basis. Additionally, other companies may have utilized different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. See “Note 2 – Summary of Significant Accounting Policies” to our consolidated financial statements of this report on Form 10-K for additional discussion of our significant accounting policies.

Real Estate Investments

Real Estate Acquisition Valuation

We record acquisitions that meet the definition of a business as a business combination. If the acquisition does not meet the definition of a business, we record the acquisition as an asset acquisition. Under both methods, all assets acquired and liabilities assumed are measured based on their acquisition-date fair values. Transaction costs that are related to a business combination are charged to expense as incurred. Transaction costs that are related to an asset acquisition are capitalized as incurred.

We assess the acquisition date fair values of all tangible assets, identifiable intangibles, and assumed liabilities using methods similar to those used by independent appraisers, generally utilizing a discounted cash flow analysis that applies appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors, including historical operating results, known and anticipated trends, and market and economic conditions. The fair value of tangible assets of an acquired property considers the value of the property as if it were vacant.

We record above-market and below-market in-place lease values for acquired properties based on the present value (using a discount rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of above-market in-place leases plus any extended term for any leases with below-market renewal options. We amortize any recorded above-market or below-market lease values as a reduction or increase, respectively, to rental income over the remaining non-cancelable terms of the respective lease, including any below-market renewal periods.

We estimate the value of tenant origination and absorption costs by considering the estimated carrying costs during hypothetical expected lease-up periods, considering current market conditions. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease up periods. We amortize the value of tenant origination and absorption costs to depreciation and amortization expense over the remaining non-cancelable term of the respective lease.

Estimates of the fair values of the tangible assets, identifiable intangibles and assumed liabilities require us to make significant assumptions to estimate market lease rates, property-operating expenses, carrying costs during lease-up periods, discount rates, market absorption periods, and the number of years the property will be held for investment. The use of inappropriate assumptions would result in an incorrect valuation of our acquired tangible assets, identifiable intangibles and assumed liabilities, which would impact the amount of our net income (loss).

Impairment of Investment in Real Estate Properties

We monitor events and changes in circumstances that could indicate that the carrying amounts of real estate properties may not be recoverable. When indicators of potential impairment are present that indicate that the carrying amounts of real estate and related intangible assets may not be recoverable, management assesses whether the carrying value of the real estate properties will be recovered through the future undiscounted operating cash flows expected from the use of and eventual disposition of the property. If, based on the analysis, we do not believe that we will be able to recover the carrying value of the real estate properties, we will record an impairment charge to the extent the carrying value exceeds the estimated fair value of the real estate properties.

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Recent Accounting Pronouncements

See Note 2 to our accompanying consolidated financial statements included in this Annual Report on Form 10-K.