# Seven Hills Realty Trust (SEVN) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Seven Hills Realty Trust's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1452477/000145247722000013/sevn-20211231.htm
Accession: 0001452477-22-000013
Filing date: 2022-02-17
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SEVN/
All MD&A years: /company/SEVN/mda/
Next year: /company/SEVN/mda/fy2022/ (FY 2022)

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K (dollars in thousands, except per share data).

OVERVIEW

On January 5, 2021, the SEC issued the Deregistration Order granting our request to deregister as an investment company under the 1940 Act. As a result, we changed our SEC registration to a reporting company under the Exchange Act. The issuance of the Deregistration Order enabled us to proceed with full implementation of our new business mandate to operate as a REIT that focuses primarily on originating and investing in first mortgage loans secured by middle market and transitional CRE. As a result of these changes to our business, we have not provided a comparison of our financial condition, any changes to financial conditions and results of operations to prior periods in which we were operating as a registered investment company because it would not be useful to our shareholders. The discussion herein is principally limited to our operations during the period following the SEC’s issuance of the Deregistration Order on January 5, 2021 to December 31, 2021. The results of operations from January 1, 2021 through January 4, 2021 were not material to our consolidated financial statements and have not been presented or discussed separately, but they are included in our results of operations for the year ended December 31, 2021.

Under our new business mandate of originating and investing in first mortgage loans secured by middle market and transitional CRE, we define middle market CRE as commercial properties that have values up to $100,000 and transitional CRE as commercial properties subject to redevelopment or repositioning activities that are expected to increase the value of the properties. These assets are classified as loans held for investment in our consolidated balance sheet. Loans held for investment are reported at cost, net of any unamortized loan fees, origination costs, premiums or discounts, as applicable, unless the assets are deemed impaired.

Our Manager is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended. We believe that our Manager provides us with significant experience and expertise in investing in middle market and transitional CRE.

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Merger with Tremont Mortgage Trust

On April 26, 2021, we and TRMT entered into the Merger Agreement, pursuant to which TRMT merged with and into us, with us continuing as the surviving entity. The purchase price, based on the per share closing price of our common shares on September 30, 2021 of $10.31 per share, was $169,150, including the assumption of $128,962 outstanding under the Citibank Master Repurchase Facility and closing costs of $6,160 and assumed working capital of $10,146. Pursuant to the terms of the Merger Agreement and the Letter Agreement, TRMT shareholders received 0.516 of our newly issued common shares, with cash paid in lieu of fractional shares.

For further information regarding the Merger, see Part I, Item 1, "Business" and the Notes 1, 5, 6, 7, 10 and 11 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.

COVID-19 Pandemic    

The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact have had a significant impact on the global economy, including the U.S. economy. Many of the restrictions that had been imposed in the United States during the pandemic have been lifted and commercial activity in the United States has increasingly returned to pre-pandemic practices and operations. To date, the COVID-19 pandemic has not had a significant impact on our business.

There remains uncertainty as to the ultimate duration and severity of the COVID-19 pandemic, including risks that may arise from mutations or related strains of the virus, the ability to successfully administer vaccinations to a sufficient number of persons or attain immunity to the virus by natural or other means to achieve herd immunity or otherwise render the virus reasonably manageable, and the impact on the U.S. economy that may result from the inability of other countries to administer vaccinations to their citizens or their citizens’ ability to otherwise achieve immunity to the virus. As a result, we are unable to determine what the ultimate impact will be on our borrowers’ and other stakeholders’ businesses, operations, financial results and financial position. For further information and risks relating to the COVID-19 pandemic on us and our business, see elsewhere in this Annual Report on Form 10-K, including "Warning Concerning Forward-Looking Statements" and Part I, Item 1A, “Risk Factors”.

Non-GAAP Financial Measures

We present Distributable Earnings, Adjusted Distributable Earnings and Adjusted Book Value per common share, which are considered “non-GAAP financial measures” within the meaning of the applicable SEC rules. Distributable Earnings and Adjusted Distributable Earnings do not represent net income or cash generated from operating activities and should not be considered as alternatives to net income determined in accordance with U.S. generally accepted accounting principles, or GAAP, or indications of our cash flows from operations determined in accordance with GAAP, measures of our liquidity or operating performance or indications of funds available for our cash needs. In addition, our methodologies for calculating Distributable Earnings and Adjusted Distributable Earnings may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures; therefore, our reported Distributable Earnings and Adjusted Distributable Earnings may not be comparable to the distributable earnings and adjusted distributable earnings as reported by other companies.

We believe that Adjusted Book Value per common share is a meaningful measure of our capital adequacy because it excludes the unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and which we acquired as a result of the Merger over the consideration we paid in the Merger. Adjusted Book Value per common share does not represent book value per common share or alternative measures determined in accordance with GAAP. Our methodology for calculating Adjusted Book Value per common share may differ from the methodologies employed by other companies to calculate the same or similar supplemental capital adequacy measures; therefore, our Adjusted Book Value per common share may not be comparable to the adjusted book value per common share reported by other companies.

We elected to be taxed as a REIT under the IRC effective for our 2020 taxable year. In order to maintain our qualification for taxation as a REIT, we are generally required to distribute substantially all of our taxable income, subject to certain adjustments, to our shareholders. We believe that one of the factors that investors consider important in deciding whether to buy or sell securities of a REIT is its distribution rate. Over time, Distributable Earnings and Adjusted Distributable Earnings may be useful indicators of distributions to our shareholders and are measures that are considered by our Board of Trustees when determining the amount of distributions. We believe that Distributable Earnings and Adjusted Distributable Earnings provide meaningful information to consider in addition to net income and cash flows from operating activities determined in accordance

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with GAAP. These measures help us to evaluate our performance excluding the effects of certain transactions, the variability of any management incentive fees that may be paid or payable and GAAP adjustments that we believe are not necessarily indicative of our current loan portfolio and operations. In addition, Distributable Earnings is used in determining the amount of base management and management incentive fees payable by us to our Manager under our management agreement.

Distributable Earnings and Adjusted Distributable Earnings

We calculate Distributable Earnings as net income, computed in accordance with GAAP, including realized losses not otherwise included in net income determined in accordance with GAAP, and excluding: (a) the management incentive fees earned by our Manager, if any; (b) depreciation and amortization, if any; (c) non-cash equity compensation expense; (d) unrealized gains, losses and other similar non-cash items that are included in net income for the period of the calculation (regardless of whether such items are included in or deducted from net income or in other comprehensive income under GAAP), if any; and (e) one-time events pursuant to changes in GAAP and certain non-cash items, if any. Distributable Earnings are reduced for realized losses on loan investments when amounts are deemed uncollectable.

We define Adjusted Distributable Earnings as Distributable Earnings, excluding the effects of certain non-recurring transactions.

Reconciliation of Book Value per Common Share to Adjusted Book Value per Common Share

The table below calculates our book value per common share and demonstrates how we calculate Adjusted Book Value per common share:

[[GREPCENT_TABLE]]
[["","December 31, 2021"],["Shareholders' equity","$","257,694"],["Total outstanding common shares","14,597"],["Book value per common share","$","17.65"],["Unaccreted purchase discount per common share","1.20"],["Adjusted Book Value per common share (1)","$","18.85"]]
[[/GREPCENT_TABLE]]

(1)Adjusted Book Value per common share is a non-GAAP financial measure that excludes the impact of the unaccreted purchase discount resulting from the excess of the fair value of the loans TRMT then held for investment and which we acquired as a result of the Merger over the consideration we paid in the Merger. The purchase discount of $36,443 was allocated to each acquired loan and is being accreted into income over the remaining term of the respective loan. As of December 31, 2021, the unaccreted purchase discount was $17,391.

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Our Loan Portfolio

The table below details overall statistics for our loan portfolio as of December 31, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","","As of December 31,"],["","","2021","","2020"],["Number of loans","","26","","5"],["Total loan commitments","","$","648,266","","$","111,720"],["Unfunded loan commitments (1)(2)","","$","57,772","","$","18,857"],["Principal balance (2)","","$","590,590","","$","92,863"],["Carrying value","","$","570,780","","$","91,879"],["Weighted average coupon rate","","4.54","%","","5.08","%"],["Weighted average all in yield (3)","","5.08","%","","5.71","%"],["Weighted average LIBOR floor","","0.68","%","","0.78","%"],["Weighted average maximum maturity (years) (4)","","3.8","","4.2"],["Weighted average risk rating","","2.9","","3.0"],["Weighted average LTV (5)","","68","%","","68","%"]]
[[/GREPCENT_TABLE]]

(1)    Unfunded loan commitments are primarily used to finance property and building improvements and leasing capital and are generally funded over the term of the loan.

(2)    The principal balance at December 31, 2021 includes $96 of capitalized interest that does not reduce the amount of unfunded loan commitments.

(3)     All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion.

(4)    Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions.

(5)    LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing.

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Loan Portfolio Details

The table below details our loan portfolio as of December 31, 2021:

[[GREPCENT_TABLE]]
[["Location","","Property Type","","Origination Date","","Committed Principal Amount","","Principal Balance","","","","Coupon Rate","","All in Yield (1)","","Maximum Maturity(2) (date)","","LTV(3)","","Risk Rating"],["St. Louis, MO","(4)","Office","","12/19/2018","","$","29,500","","","$","28,421","","","","","L + 3.25%","","L + 3.74%","","12/19/2023","","72","%","","2"],["Coppell, TX","(4)","Retail","","02/05/2019","","19,615","","19,615","","","","L + 3.50%","","L + 4.24%","","02/12/2022","","73","%","","3"],["Yardley, PA","(4)","Office","","12/19/2019","","14,900","","14,265","","","","L + 3.75%","","L + 4.47%","","01/24/2025","","75","%","","4"],["Allentown, PA","(4)","Industrial","","01/24/2020","","10,350","","10,350","","","","L + 3.50%","","L + 3.89%","","01/24/2025","","67","%","","3"],["Dublin, OH","(4)","Office","","02/18/2020","","22,820","","21,735","","","","L + 3.75%","","L + 4.82%","","02/18/2023","","33","%","","2"],["Downers Grove, IL","","Office","","09/25/2020","","30,000","","","29,500","","","","","L + 4.25%","","L + 4.69%","","11/25/2024","","67","%","","3"],["Durham, NC","","Lab","","12/17/2020","","21,500","","13,500","","","","L + 4.35%","","L + 5.06%","","12/17/2025","","57","%","","3"],["Los Angeles, CA","","Retail","","12/17/2020","","24,600","","18,374","","","","L + 4.25%","","L + 5.06%","","12/17/2024","","67","%","","3"],["Aurora, IL","","Office / Industrial","","12/18/2020","","16,500","","14,710","","","","L + 4.35%","","L + 5.04%","","12/18/2024","","73","%","","3"],["Miami, FL","","Office","","01/19/2021","","10,900","","10,900","","","","L + 4.50%","","L + 5.47%","","01/19/2025","","68","%","","2"],["Olmstead Falls, OH","","Multifamily","","01/28/2021","","54,575","","45,820","","","","L + 4.00%","","L + 4.64%","","01/28/2026","","63","%","","3"],["Colorado Springs, CO","","Office / Industrial","","04/06/2021","","34,275","","29,642","","","","L + 4.50%","","L + 5.03%","","04/06/2025","","73","%","","3"],["Londonderry, NH","","Industrial","","04/06/2021","","39,240","","34,391","","","","L + 4.00%","","L + 4.62%","","04/06/2026","","73","%","","3"],["Westminster, CO","(4)","Office","","05/25/2021","","15,250","","13,506","","","","L + 3.75%","","L + 4.25%","","05/25/2026","","66","%","","3"],["Plano, TX","","Office","","07/01/2021","","27,385","","24,935","","","","L + 4.75%","","L + 5.18%","","07/01/2026","","78","%","","3"],["Portland, OR","","Multifamily","","07/09/2021","","19,688","","19,688","","","","L + 3.57%","","L + 3.97%","","07/09/2026","","75","%","","3"],["Portland, OR","(4)","Multifamily","","07/30/2021","","13,400","","13,400","","","","L + 3.57%","","L + 4.01%","","07/30/2026","","71","%","","3"],["Seattle, WA","","Multifamily","","08/16/2021","","12,500","","12,229","","","","L + 3.55%","","L + 3.89%","","08/16/2026","","70","%","","3"],["Dallas, TX","(4)","Office","","08/25/2021","","50,000","","43,450","","","","L + 3.25%","","L + 3.64%","","08/25/2026","","72","%","","3"],["Sandy Springs, GA","","Retail","","09/23/2021","","16,488","","14,821","","","","L + 3.75%","","L + 4.11%","","09/23/2026","","72","%","","3"],["Carlsbad, CA","","Office","","10/27/2021","","24,750","","23,740","","","","L + 3.25%","","L + 3.59%","","10/27/2026","","78","%","","3"],["Bellevue, WA","","Office","","11/05/2021","","21,000","","20,000","","","","L + 3.85%","","L + 4.19%","","11/05/2026","","68","%","","3"],["Ames, IA","","Multifamily","","11/15/2021","","18,000","","17,680","","","","L + 3.80%","","L + 4.13%","","11/15/2026","","71","%","","3"],["Downers Grove, IL","","Office","","12/09/2021","","23,530","","23,530","","","","L + 4.25%","","L + 4.57%","","12/09/2026","","72","%","","3"],["West Bloomfield, MI","","Retail","","12/16/2021","","42,500","","37,388","","","","L + 3.85%","","L + 4.66%","","12/16/2024","","59","%","","3"],["Summerville, SC","","Industrial","","12/20/2021","","35,000","","35,000","","","","L + 3.50%","","L + 3.82%","","12/20/2026","","70","%","","2"],["Total/weighted average","","$","648,266","","","$","590,590","","","","","L + 3.86%","","L + 4.39%","","","","68","%","","2.9"]]
[[/GREPCENT_TABLE]]

(1)All in yield represents the yield on a loan, including amortization of deferred fees over the initial term of the loan and excluding any purchase discount accretion.

(2)Maximum maturity assumes all borrower loan extension options have been exercised, which options are subject to the borrower meeting certain conditions.

(3)    LTV represents the initial loan amount divided by the underwritten in-place value of the underlying collateral at closing.

(4)    These first mortgage loans were acquired in the Merger.

As of December 31, 2021, we had $648,266 in aggregate loan commitments, consisting of a diverse portfolio, geographically and by property type, of 26 first mortgage loans. The impact from the COVID-19 pandemic has negatively impacted some of our borrowers’ business operations or tenants, particularly in the cases of our retail and hospitality collateral, which are some of the types of properties that have been most negatively impacted by the pandemic. We expect that those negative impacts may continue and may apply to other borrowers and/or their tenants. Further, although economic activity in the United States has improved significantly from the low points during the pandemic to date, certain industries have not recovered to their pre-pandemic positions. Therefore, certain of our borrowers’ business plans will likely take longer to execute than initially expected and certain of our borrowers may be unable to pay their debt service obligation owed and due to us as currently scheduled. As of December 31, 2021, we had one loan representing approximately 2% of the carrying value of our loan portfolio with a loan risk rating of “4” or “higher risk”.

All of the loans in our portfolio are structured with risk mitigation mechanisms, such as cash flow sweeps or interest reserves, to help protect us against investment losses. In addition, we continue to actively engage with our borrowers regarding their execution of the business plans for the underlying collateral, among other things.

As of February 14, 2022, all of our borrowers had paid all of their debt service obligations owed and due to us and none of the loans included in our investment portfolio were in default.

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We did not have any impaired loans, non-accrual loans or loans in default as of December 31, 2021; thus, we did not record a reserve for loan loss as of that date. However, depending on the duration and severity of the COVID-19 pandemic and any resulting economic downturn, our borrowers' businesses, operations and liquidity may be materially adversely impacted. As a result, they may become unable to pay their debt service obligations owed and due to us, which may result in the impairment of those loans, and our recording loan loss reserves with respect to those loans and recording of any income with respect to those loans on a nonaccrual basis.

For further information regarding our risk rating policy, see Notes 3 and 6 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K. For further information regarding the risks associated with our loan portfolio, see Part I, Item 1A, “Risk Factors” of this Annual Report on Form 10-K.

Financing Activities

On February 18, 2021, one of our wholly owned subsidiaries entered into the UBS Master Repurchase Agreement and on September 30, 2021, in conjunction with the Merger, we assumed the Citibank Master Repurchase Facility, which was pursuant to the Citibank Master Repurchase Agreement, and was amended to, among other things, change the guarantor under the Citibank Master Repurchase Facility from TRMT to us.

On November 9, 2021, one of our wholly owned subsidiaries entered into the BMO Loan Program Agreement with BMO as administrative agent for the lenders for the BMO Facility, an uncommitted credit facility in the maximum principal amount of $100 million. Loans issued under the BMO Facility may be used to fund new mortgage loan originations and/or fund future funding obligations under existing and new mortgage loans pursuant to separate facility loan agreements, or the BMO Facility Loan Agreements. Loans issued under the BMO Facility will be coterminous with the pledged mortgage loan investments, are not subject to margin calls and allow for up to an 80% advance rate, subject to certain loan to cost and loan to value limits. Interest on advancements under the BMO Facility will be calculated at SOFR plus a premium. Loans issued under the BMO Facility are secured by a security interest and collateral assignment of the underlying loans to our borrowers which are secured by real property underlying such loans. Pursuant to the BMO Loan Program Agreement, one of our wholly owned subsidiaries will pay an upfront fee equal to a percentage of the aggregate amount of the facility loan, such percentage to be determined at the time of lenders’ approval of the BMO Facility Loan Agreement. Interest on advancements under the BMO Facility is calculated at SOFR plus a premium. For further information regarding our Secured Financing Facilities, see Note 7 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.

The table below is an overview of our Secured Financing Facilities as of December 31, 2021:

[[GREPCENT_TABLE]]
[["","","Maturity Date","","Principal Balance","","Unused Capacity","","Maximum Facility Size","","Collateral Principal Balance"],["Master Repurchase Facilities"],["UBS Master Repurchase Facility","","02/18/2024","","$","167,928","","","$","24,072","","","$","192,000","","","$","225,868"],["Citibank Master Repurchase Facility","","11/06/2022","","161,825","","","51,657","","","213,482","","","222,129"],["Asset Specific Financing"],["BMO Facility","","Various","","11,116","","","88,884","","","100,000","","","14,821"],["Total","","","","$","340,869","","","$","164,613","","","$","505,482","","","$","462,818"]]
[[/GREPCENT_TABLE]]

The table below details our Secured Financing Facilities activities during the year ended December 31, 2021:

[[GREPCENT_TABLE]]
[["","Carrying Value"],["Balance as of December 31, 2020","$","\u2014"],["Borrowings","249,804"],["Repayments","(37,897)"],["Deferred fees","(1,453)"],["Amortization of deferred fees","211"],["Assumed in Merger","128,962"],["Balance as of December 31, 2021","$","339,627"]]
[[/GREPCENT_TABLE]]

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As of December 31, 2021, outstanding advancements under our Secured Financing Facilities had a weighted average interest rate of 2.06% per annum, excluding associated fees and expenses. As of December 31, 2021 and February 14, 2022, we had a $340,869 and a $278,782, respectively, aggregate outstanding principal balance under our Secured Financing Facilities.

As of December 31, 2021, we were in compliance with all covenants and other terms under our Secured Financing Facilities.

RESULTS OF OPERATIONS

As a result of the changes to our business, we have not provided a comparison of our financial statements to the prior year in which we were operating as a registered investment company because it would not be useful to our shareholders.

For the year ended December 31, 2021, our net income was $24,650, or $2.18 per common share.

Reconciliation of Net Income to Distributable Earnings and Adjusted Distributable Earnings

The table below demonstrates how we calculate Distributable Earnings and Adjusted Distributable Earnings, which are non-GAAP measures, and provides a reconciliation of these non-GAAP measures to net income:

[[GREPCENT_TABLE]]
[["","","Year Ended"],["","","December 31, 2021"],["Reconciliation of net income to Distributable Earnings and Adjusted Distributable Earnings:"],["Net income","","$","24,650"],["Non-cash equity compensation expense","","627"],["Non-cash accretion of purchase discount","","(18,932)"],["Distributable Earnings","","6,345"],["Other transaction related costs (1)","","589"],["Income tax expense (2)","","282"],["Adjusted Distributable Earnings","","$","7,216"],["Weighted average common shares outstanding - basic and diluted","","11,304"],["Distributable Earnings per common share - basic and diluted","","$","0.56"],["Adjusted Distributable Earnings per common share - basic and diluted","","$","0.64"]]
[[/GREPCENT_TABLE]]

(1)Other transaction related costs primarily include expenses related to our conversion from a Maryland statutory trust to a Maryland REIT and the final settlement of legal complaints filed in connection with the Merger. For further information regarding such legal complaints, see Note 15 to the Notes to the Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.

(2)Income tax expense represents the portion of our income tax expense incurred on realized gains on the disposition of our securities portfolio as a result of the Business Change.

Factors Affecting Operating Results

Our results of operations are impacted by a number of factors and primarily depend on the interest income from our investments and the financing and other costs associated with our business. Our operating results are also impacted by general CRE market conditions and unanticipated defaults by our borrowers. For further information regarding the risks associated with our loan portfolio, see the risk factors identified in Part I, Item 1A, "Risk Factors", of this Annual Report on Form 10-K.

Credit Risk. We are subject to the credit risk of our borrowers in connection with our investments. We seek to mitigate this risk by utilizing a comprehensive underwriting, diligence and investment selection process and by ongoing monitoring of our investments. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results.

Changes in Fair Value of our Assets. We generally intend to hold our investments for their contractual terms, unless repaid earlier by the borrowers. We evaluate our investments for impairment at least quarterly. Impairments occur when it is probable that we will not be able to collect all amounts due according to the applicable contractual terms. If we determine that a loan is impaired, we will record an allowance to reduce the carrying value of the loan to an amount that takes into account both the

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present value of expected future cash flows discounted at the loan's contractual effective interest rate and the fair value of any available collateral, net of any costs we expect to incur to realize that value.

Although we intend to generally hold our investments for their contractual terms or until repaid earlier by the borrowers, we may occasionally classify some of our investments as held for sale. Investments held for sale will be carried at the lower of their amortized cost or fair value less costs to sell within loans held for sale on our consolidated balance sheet, with changes in fair value recorded through earnings. Fees received from our borrowers on any loans held for sale will be recognized as part of the gain or loss on sale. Currently, we do not expect to hold any of our investments for trading purposes.

Availability of Leverage and Equity. We use leverage to make additional investments that may increase our returns. We may not be able to obtain the expected amount of leverage we desire or its cost may exceed our expectation and, consequently, the returns generated from our investments may be reduced. Our ability to further grow our loan portfolio over time will depend, to a significant degree, upon our ability to obtain additional capital. However, our access to additional capital depends on many factors including the price at which our common shares trade relative to their book value and market lending conditions. See "—Market Conditions" below.

Market Conditions. After the initial market disruption resulting from the COVID-19 pandemic, the CRE debt markets have since stabilized. Increased vaccination rates, strong consumer demand, along with accommodating fiscal and monetary policies, resulted in strong economic growth through much of 2021. This strong economic growth coupled with pent up demand leftover from 2020 resulted in record overall CRE transaction volume. CRE transaction total volume for 2021 exceeded total 2019 volume, the previous annual high for CRE transaction volume. CRE values have also risen considerably, not only compared to 2020, but also in relation to values from 2019. This increase in transaction activity and property values, combined with historically low interest rates has resulted in significant demand for CRE debt. CRE mortgage borrowings in 2021 reached an all-time annual high, fueled by increased investor demand for the relative risk adjusted returns offered by CRE debt investments. In particular, issuance of CRE debt securities for floating rate CLOs during 2021 exceeded record volume set in 2019 by approximately double and we expect strong investor demand to continue into 2022.

Although debt and equity transaction volume has increased across all property types, the multifamily and industrial sectors remain the most coveted amongst both lenders and investors. Multifamily is expected to continue to be a preferred asset class due to the stability of cash flows, strong performance throughout the pandemic and the abundance of liquidity offered by debt capital available from government sponsored enterprises, such as Fannie Mae and Freddie Mac as well as alternative lenders, like debt funds and mortgage REITs who finance debt investments by issuing CRE CLO bonds. Today, multifamily properties comprise the majority of collateral for these floating rate CRE CLO bond offerings and, as a result, the competition among alternative lenders, like us, for loans secured by multifamily properties with transitional or value add business plans has resulted in low borrowing costs for owners of these properties. Industrial properties continue to benefit from shifts in consumer behavior to increased e-commerce and supply chain issues hastened by the COVID-19 pandemic. The increased demand for industrial real estate, and particularly warehouse, distribution and “last-mile” properties has made this property type the fastest growing in terms of valuation among all major property types.

The hospitality, office and retail sectors are among those that have been most negatively impacted by the economic downturn related to the pandemic. However, with the easing of government mandated restrictions, increased vaccination rates in the U.S., and strong household balance sheets, retail sales and leisure travel have experienced overall improvement throughout 2021, although business travel remains muted and the long term impacts to certain sub-sectors of the hotel industry remain. Lenders have been more willing to lend against certain types of retail, like grocery anchored and service-oriented neighborhood shopping centers, which has helped to support value increases throughout 2021, but continue to be cautious when evaluating loans secured by big box retailers, regional malls or lifestyle centers. As it relates to the office sector, capital remains readily available to lend for those buildings that are well leased and fully amenitized and, in particular, for properties with higher credit quality tenants and longer term leases. However, lenders will continue to face underwriting challenges, in part due to the shift to flexible work-from-home schedules, with respect to assumptions related to new leasing, tenant renewal probabilities and office occupancy rates, especially for older assets or those with significant near-term lease roll over and in particular those located in urban core or central business district markets.

Despite the strong performance of the debt capital markets in 2021, we believe challenges remain. The longer term impact of the COVID-19 pandemic and the risk of future variants of the virus is still uncertain. Supply chain issues remain and inflation has started to impact the broader markets in 2022. The U.S. Federal Reserve recently indicated that, in light of the economic recovery and higher than anticipated inflation, it expects to raise interest rates as early as March 2022, which will impact short term index rates such as LIBOR and SOFR. Any increases in interest rates may have an impact on debt coverage ratios for certain property types, particularly those with long term leases, such as office and industrial, or in multifamily where capitalization rates are at record lows and financed with short term, floating rate debt. Lastly, it is unclear how the transition

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away from LIBOR as the preferred index for pricing floating rate debt will affect liquidity and performance of the floating rate debt markets. Despite these challenges, we believe that as the U.S. economy continues to grow, there will continue to be significant opportunities for alternative lenders like us to provide creative, flexible debt capital for a wide array of circumstances and business plans.

Changes in Market Interest Rates. With respect to our business operations, increases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, if any, to increase; (b) the value of our fixed rate investments, if any, to decline; (c) the coupon rates on our variable rate investments, if any, to reset, perhaps on a delayed basis, to higher rates; and (d) it to become more difficult and costly for our borrowers, which may negatively impact their ability to repay our investments. See "—Market Conditions" above for a discussion of the current market including interest rates.

Conversely, decreases in interest rates, in general, may cause: (a) the interest expense associated with our variable rate borrowings, if any, to decrease; (b) the value of our fixed rate investments, if any, to increase; (c) the coupon rates on our variable rate investments, if any, to reset, perhaps on a delayed basis, to lower rates; and (d) it to become easier and more affordable for our borrowers to refinance, and as a result, repay our loans, but may negatively impact our future returns if any such repayment proceeds were to be reinvested in lower yielding investments.

The interest income on our loans and interest expense on our borrowings float with benchmark rates, such as LIBOR and SOFR. Because we generally intend to leverage approximately 75% of our investments, as benchmark rates increase, our income from investments, net of interest and related expenses, will increase. Decreases in benchmark rates are mitigated by interest rate floor provisions in all but one of our loan agreements with borrowers; therefore, changes to income from investments, net, may not move proportionately with the increase or decrease in benchmark rates. Based on our loan portfolio as of December 31, 2021, LIBOR was 0.10% and would have to exceed the floor established by any of our loans, which currently range from 0.00% to2.32%, for us to realize an increase in interest income.

As of December 31, 2021, LIBOR is phased out for new contracts and is expected to be phased out for pre-existing contracts by June 30, 2023. Our Master Repurchase Facilities provide that at such time as LIBOR shall no longer be made available or used for determining the interest rate of advances under our Master Repurchase Facilities, the replacement base rate shall be an alternative benchmark rate (including any mathematical or other adjustments to the benchmark rate (if any) incorporated therein so that the resulting rate approximates LIBOR as close as reasonably possible) as determined by UBS and Citibank under similar facilities for the financing of similar assets and is consistent with the pricing index of similarly situated counterparties. As of January 1, 2022, interest rates on new advances under our Master Repurchase Facilities are based on SOFR. We expect that, as a result of the phase out of LIBOR, the interest rates under our loan agreements with borrowers entered into prior to January 1, 2022 would be amended to replace LIBOR with an alternative benchmark rate (which may include SOFR) that will approximate the existing interest rate as calculated in accordance with LIBOR. As of January 1, 2022, interest rates under our new loan agreements with borrowers are based on SOFR.

Size of Portfolio. The size of our loan portfolio, as measured both by the aggregate principal balance and the number of our CRE loans and our other investments, is also an important factor in determining our operating results. Generally, if the size of our loan portfolio grows, the amount of interest income we receive would increase and we may achieve certain economies of scale and diversify risk within our loan portfolio. A larger portfolio, however, may result in increased expenses; for example, we may incur additional interest expense or other costs to finance our investments. Also, if the aggregate principal balance of our loan portfolio grows but the number of our loans or the number of our borrowers does not grow, we could face increased risk by reason of the concentration of our investments.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to fund our lending commitments, repay or meet margin calls resulting from our borrowings, if any, fund and maintain our assets and operations, make distributions to our shareholders and fund other business operating requirements. Our sources of cash flows include cash on hand, payments of principal, interest and fees we receive on our investments, other cash we may generate from our business and operations and any unused borrowing capacity, including under our Secured Financing Facilities or other repurchase agreements or financing arrangements, and may also include bank loans or public or private issuances of debt or equity securities. We believe that these sources of funds will be sufficient to meet our operating and capital expenses, pay our debt service obligations owed and make any distributions to our shareholders for the next 12 months and for the foreseeable future, subject to the duration and severity of the COVID-19 pandemic and economic impact on our borrowers and their ability to fund their debt service obligations owed to us. For further information regarding the risks associated with our loan portfolio, see Part I, Item 1A, "Risk Factors" of this Annual Report on Form 10-K.

Pursuant to our Master Repurchase Facilities, we may sell to, and later repurchase from, UBS and Citibank, the purchased assets. The initial purchase price paid by UBS or Citibank each purchased asset is up to 75% of the lesser of the market value of

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the purchased asset or the unpaid principal balance of such purchased asset, subject to UBS’s or Citibank's approval. Upon the repurchase of a purchased asset, we are required to pay UBS or Citibank the outstanding purchase price of the purchased asset, accrued interest and all accrued and unpaid expenses of UBS or Citibank relating to such purchased asset. The interest rate relating to a purchased asset is equal to one month LIBOR plus a customary premium within a fixed range, determined by the debt yield and property type of the purchased asset’s real estate collateral. UBS and Citibank each has the discretion under our respective Master Repurchase Agreements to make advancements at margins higher than 75%. On November 9, 2021, one of our wholly owned subsidiaries entered into the BMO Loan Program Agreement for the BMO Facility. Loans issued under the BMO Facility may be used to fund new mortgage loan originations and/or fund future funding obligations under existing and new mortgage loans pursuant to separate facility loan agreements, or the BMO Facility Loan Agreements. Loans issued under the BMO Facility will be coterminous with the pledged mortgage loan investments, are not subject to margin calls and allow for up to an 80% advance rate, subject to certain loan to cost and LTV limits. Interest on advancements under the BMO Facility will be calculated at SOFR plus a premium. Loans issued under the BMO Facility are secured by a security interest and collateral assignment of the underlying loans to our borrowers which are secured by real property underlying such loans. Pursuant to the BMO Loan Program Agreement, one of our wholly owned subsidiaries will pay an upfront fee equal to a percentage of the aggregate amount of the facility loan, such percentage to be determined at the time of lenders’ approval of the BMO Facility Loan Agreement. For further information regarding our Secured Financing Facilities, see Note 7 to the Notes to the Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K and "—Overview-Financing Activities" above.

The following is a summary of our sources and uses of cash flows for the period presented:

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[["","","Year Ended December 31, 2021"],["Cash, cash equivalents and restricted cash at beginning of period","","$","103,564"],["Net cash provided by (used in):"],["Operating activities","","792"],["Investing activities","","(283,863)"],["Financing activities","","205,802"],["Cash, cash equivalents and restricted cash at end of period","","$","26,295"]]
[[/GREPCENT_TABLE]]

During the year ended December 31, 2021, our cash provided by operating activities consisted of our net income, excluding the impact of accretion of the purchase discount as a result of the Merger, and unfavorable changes in working capital. During the year ended December 31, 2021, our cash used in investing activities consisted of loan originations, additional fundings on our loans held for investment and payment of transaction costs related to the Merger, partially offset by loan repayments and cash assumed in the Merger. During the year ended December 31, 2021, our cash provided by financing activities consisted of proceeds from our Secured Financing Facilities, partially offset by deferred financing cost payments related to our Secured Financing Facilities and distributions to our common shareholders.

Distributions

During the year ended December 31, 2021, we declared and paid distributions totaling $4,595, or $0.45 per common share, using cash on hand.

On January 13, 2022, we declared a regular quarterly distribution of $0.25 per common share, or $3,649, to shareholders of record on January 24, 2022. We expect to pay this distribution to our common shareholders on February 17, 2022 using cash on hand.

For further information regarding distributions, see Note 9 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.

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Contractual Obligations and Commitments

Our contractual obligations and commitments as of December 31, 2021 were as follows:

[[GREPCENT_TABLE]]
[["","","Payment Due by Period"],["","","Total","","Less than 1 Year","","1 - 3 Years","","3 - 5 Years","","More than 5 years"],["Unfunded loan commitments (1)","","$","57,772","","","$","9,120","","","$","48,652","","","$","\u2014","","","$","\u2014"],["Principal payments on Secured Financing Facilities (2)","","340,869","","","161,825","","","179,044","","","\u2014","","","\u2014"],["Interest payments (3)","","10,545","","","6,344","","","4,201","","","\u2014","","","\u2014"],["","","$","409,186","","","$","177,289","","","$","231,897","","","$","\u2014","","","$","\u2014"]]
[[/GREPCENT_TABLE]]

(1)The allocation of our unfunded loan commitments is based on the current loan maturity date to which the individual commitments relate.

(2)The allocation of outstanding advancements under our Secured Financing Facilities is based on the earlier of the current maturity date of each loan investment with respect to which the individual borrowing relates or the maturity date of the respective Master Repurchase Facilities.

(3)Projected interest payments are attributable only to our debt service obligations at existing rates as of December 31, 2021 and are not intended to estimate future interest costs which may result from debt prepayments, additional borrowings, new debt issuances or changes in interest rates.

Debt Covenants

Our principal debt obligations as of December 31, 2021 were the outstanding balances under our Secured Financing Facilities. Our Master Repurchase Agreements provide for acceleration of the date of repurchase of any then purchased assets and the liquidation of the purchased assets by UBS or Citibank upon the occurrence and continuation of certain events of default, including a change of control of us, which includes our Manager ceasing to act as our sole manager or to be a wholly owned subsidiary of RMR LLC. Our Master Repurchase Agreements also provide that upon the repurchase of any then purchased asset, we are required to pay UBS or Citibank the outstanding purchase price of such purchased asset and accrued interest and any and all accrued and unpaid expenses of UBS or Citibank relating to such purchased asset.

In connection with our Master Repurchase Agreements, we entered into our guarantees, or the Master Repurchase Guarantees, which require us to guarantee 25% of the aggregate repurchase price, and 100% of losses in the event of certain bad acts as well as any costs and expenses of UBS and Citibank related to our Master Repurchase Agreements. The Master Repurchase Guarantees also require us to comply with customary financial covenants, which include the maintenance of a minimum tangible net worth, minimum cash liquidity and a total indebtedness to stockholders' equity ratio and a minimum interest coverage ratio.

In connection with the BMO Loan Program Agreement, we have agreed to guarantee certain of the obligations under the BMO Loan Program Agreement and the BMO Facility Loan Agreements pursuant to a limited guaranty from us to and for the benefit of the administrative agent for itself and such other lenders, or the BMO Guaranty. Specifically, the BMO Guaranty requires us to guarantee 25% of the then current outstanding principal balance of the facility loans and 100% of losses or the entire indebtedness in the event of certain bad acts as well as any costs and expenses of the administrative agent or lenders related to the BMO Loan Program Agreement. In addition, the BMO Guaranty contains customary financial covenants that require us to maintain a minimum tangible net worth and a minimum cash liquidity and satisfy a total indebtedness to stockholders’ equity ratio. The BMO Loan Program Agreement and the BMO Guaranty contain representations, warranties, covenants, conditions precedent to funding, events of default and indemnities that are customary for agreements of these types.

As of December 31, 2021, we had a $329,753 aggregate outstanding principal balance under our Master Repurchase Facilities. Our Master Repurchase Agreements are structured with risk mitigation mechanisms, including a cash flow sweep, which would allow UBS or Citibank, as applicable, to control interest payments from our borrowers under our loans that are financed under our respective Master Repurchase Facilities, and the ability to accelerate dates of repurchase and institute margin calls, which may require us to pay down balances associated with one or more of our loans that are financed under our Master Repurchase Facilities.

As of December 31, 2021, we had a $11,116 aggregate outstanding principal balance under the BMO Facility.

As of December 31, 2021, we were in compliance with all covenants and other terms under our Secured Financing Facilities.

Related Person Transactions

We have relationships and historical and continuing transactions with our Manager, RMR LLC, RMR Inc. and others related to them. For further information about these and other such relationships and related person transactions, see Notes 10

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and 11 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K and our other filings with the SEC, which are incorporated herein by reference, including our definitive Proxy Statement for our 2022 Annual Meeting of Shareholders, or our 2022 Proxy Statement, to be filed with the SEC within 120 days after the fiscal year ended December 31, 2021. For further information about the risks that may arise as a result of these and other related person transactions and relationships, see elsewhere in this Annual Report on Form 10-K, including “Warning Concerning Forward-Looking Statements,” Part I, Item 1, “Business” and Part I, Item 1A, “Risk Factors.” We may engage in additional transactions with related persons, including businesses to which RMR LLC or its subsidiaries provide management services.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment regarding future events and other uncertainties. In accordance with SEC guidance, the following discussion addresses the accounting policies that apply to our operations. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that our decisions and assessments upon which our consolidated financial statements are based are reasonable, based upon information available to us. Our critical accounting policies and accounting estimates may be changed over time as our strategies change or as we expand our business. Those accounting policies and estimates that are most critical to an investor’s understanding of our financial results and condition and require complex management judgment are discussed below.

Revenue Recognition. Interest income related to our CRE mortgage loans is generally accrued based on the coupon rates applied to the outstanding principal balance of such loans. Fees, premiums and discounts, if any, are amortized or accreted into interest income over the remaining lives of the loans using the effective interest method, as adjusted for any prepayments.

If a loan’s interest or principal payments are not paid when due and there is uncertainty that such payments will be collected, the loan may be categorized as non-accrual and no interest will be recorded unless it is collected. When all overdue payments are collected and, in our judgment, a loan is likely to remain current, it may be re-categorized as accrual.

For loans purchased at a discount, GAAP limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. GAAP also requires that the excess of contractual cash flows over cash flows expected to be collected (non-accretable difference) not be recognized as an adjustment of yield, loss accrual or valuation allowance. Subsequent increases in cash flows expected to be collected from such loans generally will be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected will be recorded as impairment.

Loans Held For Investment. Generally, our loans are classified as held for investment based upon our intent and ability to hold them until maturity. Loans that are held for investment are carried at cost, net of unamortized loan origination fees, accreted exit fees, unamortized premiums and unaccreted discounts, as applicable, that are required to be recognized in the carrying value of the loans in accordance with GAAP, unless the loans are deemed to be impaired. Loans that we have a plan to sell or liquidate are held at the lower of cost or fair value less cost to sell.

We evaluate each of our loans for impairment at least quarterly by assessing a variety of risk factors in relation to each loan and assigning a risk rating to each loan based on those factors. Factors considered in these evaluations include, but are not limited to, property type, geographic and local market dynamics, physical condition, leasing and tenant profile, projected cash flow, risk of loss, current LTV, debt yield, collateral performance, structure, exit plan and sponsorship. Loans are rated “1” (less risk) through “5” (greater risk) as defined below:

"1" lower risk—Criteria reflects a sponsor having a strong financial condition and low credit risk and our evaluation of management's experience; collateral performance exceeding performance metrics included in the business plan or credit underwriting; and the property demonstrating stabilized occupancy and/or market rates, resulting in strong current cash flow and net operating income and/or having a very low LTV.

"2" average risk—Criteria reflects a sponsor having a stable financial condition and our evaluation of management's experience; collateral performance meeting or exceeding substantially all performance metrics included in the business plan or credit underwriting; and the property demonstrating improved occupancy at market rents, resulting in sufficient current cash flow and/or having a low LTV.

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"3" acceptable risk—Criteria reflects a sponsor having a history of repaying loans at maturity and meeting its credit obligations and our evaluation of management's experience; collateral performance expected to meet performance metrics included in the business plan or credit underwriting; and the property having a moderate LTV. New loans and loans with a limited history will typically be assigned this rating and will be adjusted to other levels from time to time as appropriate.

"4" higher risk—Criteria reflects a sponsor having a history of unresolved missed or late payments, maturity extensions and difficulty timely fulfilling its credit obligations and our evaluation of management's experience; collateral performance failing to meet the business plan or credit underwriting; the existence of a risk of default possibly leading to a loss and/or potential weaknesses that deserve management’s attention; and the property having a high LTV.

"5" impaired/loss likely—Criteria reflects a very high risk of realizing a principal loss or having incurred a principal loss; a sponsor having a history of default payments, trouble fulfilling its credit obligations, deeds in lieu of foreclosures, and/or bankruptcies; collateral performance is significantly worse than performance metrics included in the business plan; loan covenants or performance milestones having been breached or not attained; timely exit via sale or refinancing being uncertain; and the property having a very high LTV.

Impairment occurs when it is deemed probable that we will not be able to collect all amounts due under a loan according to its contractual terms. Impairment will then be measured based on the present value of expected future cash flows discounted at the loan’s contractual effective rate and the fair value of any available collateral, net of any costs we expect to incur to realize that value. The determination of whether loans are impaired involves judgments and assumptions based on objective and subjective factors. Consideration will be given to various factors, such as business plans, property occupancies, tenant profiles, rental rates, operating expenses and borrowers’ repayment plans, among others, and will require significant judgments, including assumptions regarding the values of loans, the values of underlying collateral and other circumstances, such as guarantees, if any. Upon measurement of an impairment, we will record an allowance to reduce the carrying value of the loan accordingly and record a corresponding charge to net income in our consolidated statement of operations.

Impact of Inflation

During the past several years there has been low inflation in the U.S. economy. As inflation increases, we believe it may have both positive and negative impacts upon our business. A positive impact of inflation on our business may be to increase the value of collateral for any existing loans, making the refinancing and repayment of principal easier for borrowers and reducing our risk of borrower defaults. A negative impact of inflation on our business may be to cause interest rates to rise, reducing the market value of any fixed rate loans we hold. A rise in interest rates may also make it more difficult for our borrowers to refinance loans in order to pay their obligations to us. Because all of our investments require interest at floating rates, we do not expect inflation to have a material impact upon our business for the reasonably foreseeable future.