The following discussion and analysis should be read in conjunction with the
accompanying financial statements of KBS Real Estate Investment Trust II, Inc.
and the notes thereto. As used herein, the terms "we," "our" and "us" refer to
KBS Real Estate Investment Trust II, Inc., a Maryland corporation, and, as
required by context, KBS Limited Partnership II, a Delaware limited partnership,
which we refer to as the "Operating Partnership," and to their subsidiaries.
Forward-Looking Statements
Certain statements included in this Quarterly Report on Form 10-Q are
forward-looking statements. Those statements include statements regarding the
intent, belief or current expectations of KBS Real Estate Investment
Trust II, Inc. and members of our management team, as well as the assumptions on
which such statements are based, and generally are identified by the use of
words such as "may," "will," "seeks," "anticipates," "believes," "estimates,"
"expects," "plans," "intends," "should" or similar expressions. These include
statements about our plans, strategies and prospects and Plan of Liquidation
(defined herein) and these statements are subject to known and unknown risks and
uncertainties. Readers are cautioned not to place undue reliance on these
forward-looking statements. Actual results may differ materially from those
contemplated by such forward-looking statements. Further, forward-looking
statements speak only as of the date they are made, and we undertake no
obligation to update or revise forward-looking statements to reflect changed
assumptions, the occurrence of unanticipated events or changes to future
operating results over time, unless required by law. Moreover, you should
interpret many of the risks identified in this report, as well as the risks set
forth below, as being heightened as a result of the ongoing and numerous adverse
impacts of the COVID-19 pandemic.
The following are some of the risks and uncertainties, although not all of the
risks and uncertainties, that could cause our actual results to differ
materially from those presented in our forward-looking statements:
•The COVID-19 pandemic, together with the resulting measures imposed to help
control the spread of the virus, has had a negative impact on the economy and
business activity globally. The extent to which the COVID-19 pandemic further
impacts our completion of the Plan of Liquidation depends on future
developments, which remain uncertain and cannot be predicted with confidence,
including the demand for office space in downtown Los Angeles, where our
remaining property is located, which demand has significantly declined as a
result of the COVID-19 pandemic, with employees continuing to work from home.
•Although our board of directors and our stockholders have approved the sale of
all of our assets and our dissolution pursuant to the Plan of Liquidation, we
can give no assurance that we will be able to successfully implement the Plan of
Liquidation and sell our assets, pay our debts and distribute the net proceeds
from liquidation to our stockholders as we expect. If we underestimated our
existing obligations and liabilities or if unanticipated or contingent
liabilities arise, the amount of liquidating distributions ultimately paid to
our stockholders could be less than estimated. Given the uncertainty and current
business disruptions as a result of the outbreak of COVID-19 as well as the
current economic slowdown, the rising interest rate environment and inflation
(or the public perception that any of these events may continue), our completion
of the Plan of Liquidation may be materially and adversely impacted and this may
have a material effect on the ultimate amount and timing of liquidating
distributions received by stockholders.
•We may face unanticipated difficulties, delays or expenditures relating to our
implementation of the Plan of Liquidation, which may reduce or delay our payment
of liquidating distributions.
•We can give no assurance regarding the timing of the disposition of our
remaining real estate property, the sale price we will receive for this property
and the amount and timing of liquidating distributions to be received by our
stockholders.
•We may face risks associated with legal proceedings, including stockholder
litigation, that may be instituted against us related to the Plan of
Liquidation.
•All of our executive officers, one of our directors and other key professionals
are also officers, directors, managers, key professionals and/or holders of a
direct or indirect controlling interest in our advisor, the entity that acted as
our dealer manager and/or other KBS-affiliated entities. As a result, they face
conflicts of interest, including significant conflicts created by our advisor's
compensation arrangements with us and other KBS-sponsored programs and
KBS-advised investors and conflicts in allocating time among us and these other
programs and investors. These conflicts could result in unanticipated actions.
•We pay substantial fees to and expenses of our advisor and its affiliates.
These payments reduce the amount of liquidating distributions our stockholders
will receive.
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Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
•The resale value of a property depends principally upon the value of the cash
flow generated by the leases associated with that property. Non-renewals,
terminations or lease defaults could reduce our net sales proceeds and the
amount of liquidating distributions our stockholders receive. Accordingly, our
ability to successfully implement the Plan of Liquidation is partially dependent
upon the success and economic viability of our tenants and our ability to retain
and attract tenants.
•Our remaining real estate property has been and may continue to be affected by
unfavorable real estate market conditions, the rising interest rate environment
and general economic conditions, which could further decrease the value of this
property. Revenues from this property could decrease. Such events would make it
more difficult for us to successfully complete the Plan of Liquidation, which
could reduce our stockholders' returns and the amount of liquidating
distributions they receive.
•On November 1, 2021, in connection with our liquidation pursuant to the Plan of
Liquidation, our board of directors approved the termination of our share
redemption program effective as of November 22, 2021. As such, our stockholders'
primary source of liquidity is the completion of our Plan of Liquidation.
•As a result of our disposition activity in connection with our liquidation, our
general and administrative expenses, which are not directly related to the size
of the assets we own, have increased as a percentage of our cash flow from
operations, and we will continue to incur general and administrative expenses
until we have liquidated and dissolved.
All forward-looking statements should be read in light of the risks identified
in Part I, Item 1A of our Annual Report on Form 10-K for the year ended
December 31, 2021, as filed with the Securities and Exchange Commission (the
"SEC").
Overview
We were formed on July 12, 2007 as a Maryland corporation that elected to be
taxed as a real estate investment trust ("REIT") beginning with the taxable year
ended December 31, 2008 and we intend to continue to operate in such a manner.
We conduct our business primarily through our Operating Partnership, of which we
are the sole general partner. Subject to certain restrictions and limitations,
our business is managed by our advisor, KBS Capital Advisors LLC, pursuant to an
advisory agreement. KBS Capital Advisors conducts our operations and manages our
remaining real estate property. Our advisor owns 20,000 shares of our common
stock. We have no paid employees.
As of June 30, 2022, we owned one office property.
As of June 30, 2022, we had 183,346,918 shares of common stock issued and
outstanding.
On November 13, 2019, in connection with a review of potential strategic
alternatives available to us, a special committee composed of all of our
independent directors (the "Special Committee") and our board of directors
unanimously approved the sale of all of our assets and our dissolution pursuant
to the terms of the plan of complete liquidation and dissolution (the "Plan of
Liquidation"). The principal purpose of the Plan of Liquidation is to provide
liquidity to our stockholders by selling our assets, paying our debts and
distributing the net proceeds from liquidation to our stockholders. On March 5,
2020, our stockholders approved the Plan of Liquidation. The Plan of Liquidation
is included as an exhibit to this Quarterly Report on Form 10-Q.
Plan of Liquidation
In accordance with the Plan of Liquidation, our objectives are to pursue an
orderly liquidation of our company by selling all of our assets, paying our
debts and our known liabilities, providing for the payment of unknown or
contingent liabilities, distributing the net proceeds from liquidation to our
stockholders and winding up our operations and dissolving our company.
Pursuant to the Plan of Liquidation, our board of directors has authorized the
following liquidating distributions:
Record Date Payment Date Liquidating Distribution Per Share
March 5, 2020 March 10, 2020 $ 0.75
August 3, 2020 August 7, 2020 $ 0.25
December 24, 2020 December 30, 2020 $ 0.40
October 1, 2021 October 5, 2021 $ 0.50
December 9, 2021 December 14, 2021 $ 0.20
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Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
We expect to distribute substantially all of the remaining proceeds from
liquidation after the completion of the sale of our remaining real estate
property.
Our expectations about the implementation of the Plan of Liquidation and the
amount of any additional liquidating distributions that we will pay to our
stockholders and when we will pay them are subject to risks and uncertainties
and are based on certain estimates and assumptions, one or more of which may
prove to be incorrect. As a result, the actual amount of any additional
liquidating distributions we pay to stockholders may be less than we estimate
and the liquidating distributions may be paid later than we predict. There are
many factors that may affect the amount of liquidating distributions we will
ultimately pay to our stockholders. If we underestimate our existing obligations
and liabilities or the amount of taxes, transaction fees and expenses relating
to the liquidation and dissolution, or if unanticipated or contingent
liabilities arise, the amount of liquidating distributions ultimately paid to
our stockholders could be less than estimated. Moreover, the liquidation value
will fluctuate over time in response to developments related to our remaining
real estate property, in response to the real estate and finance markets, based
on the actual liquidation timing and the amount of net proceeds received from
the disposition of our remaining asset and due to other factors. Given the
uncertainty and current business disruptions as a result of the outbreak of
COVID-19 as well as the current economic slowdown, the rising interest rate
environment and inflation (or the public perception that any of these events may
continue), our completion of the Plan of Liquidation may be materially and
adversely impacted and this may have a material effect on the ultimate amount
and timing of liquidating distributions received by our stockholders. While we
have considered the impact from COVID-19 in our net assets in liquidation
presented on the Condensed Consolidated Statement of Net Assets as of June 30,
2022, the extent to which our completion of the Plan of Liquidation may be
further affected by COVID-19 or the other factors discussed above depends on
future developments, which remain uncertain and cannot be predicted with
confidence, including the demand for office space in downtown Los Angeles, where
our remaining property is located, which demand has significantly declined as a
result of the COVID-19 pandemic, with employees continuing to work from home.
See "- Market Outlook - Real Estate and Real Estate Finance Markets - COVID-19
Pandemic and Portfolio Outlook" for a discussion of the impact of the outbreak
of COVID-19 on our business and our liquidation. We can give no assurance
regarding the timing of the disposition of our remaining asset, the sale price
we will receive for this asset, and the amount or timing of liquidating
distributions to be received by our stockholders.
Market Outlook - Real Estate and Real Estate Finance Markets
Volatility in global financial markets and changing political environments can
cause fluctuations in the performance of the U.S. commercial real estate
markets. Possible future declines in rental rates, slower or potentially
negative net absorption of leased space 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 our remaining property. Further, revenues from our remaining property
could decrease due to a reduction in occupancy (caused by factors including, but
not limited to, tenant defaults, tenant insolvency, early termination of tenant
leases and non-renewal of existing tenant leases), rent deferrals or abatements,
tenants being unable to pay their rent and/or lower rental rates. Reductions in
revenues from our remaining property would adversely impact the timing of the
asset sale and/or the sale price we will receive for our property. Market
conditions can change quickly, potentially negatively impacting the value of
real estate investments. Most recently, the outbreak of COVID-19 as well as the
current economic slowdown, the rising interest rate environment and inflation
(or the public perception that any of these events may continue) have had a
negative impact on the office real estate market as discussed below.
COVID-19 Pandemic and Portfolio Outlook
One of the most significant risks and uncertainties facing us and the real
estate industry generally, and in particular office REITs like our company,
continues to be the effect of the public health crisis of the COVID-19 pandemic.
To date, we have not experienced significant disruptions in our operations from
the COVID-19 pandemic, although our completion of the Plan of Liquidation has
been delayed. During the six months ended June 30, 2022, we reduced the
estimated liquidation value of our remaining real estate property by $34.2
million (after estimated closing costs and disposition fees) partly due to
changes in leasing projections resulting in lower projected cash flow and a
lower projected sale price caused by the impact of the COVID-19 pandemic. During
the years ended December 31, 2021 and 2020, we reduced the estimated liquidation
value of our real estate portfolio by $78.1 million (or $54.6 million after
accounting for the decrease in estimated capital expenditures of $23.5 million
that was previously projected to be spent) and $90.2 million, respectively, due
to changes in leasing projections across our portfolio resulting in lower
projected cash flow and projected sales prices caused by the impact of the
COVID-19 pandemic. In future periods, we may need to recognize additional
decreases in the value of our remaining real estate property to the extent
leasing projections and the projected sale price declines.
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Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
We cannot predict to what extent economic activity, including the use of and
demand for office space, will return to pre-pandemic levels. During 2021 and the
first and second quarters of 2022, the usage of our assets remained lower than
pre-pandemic levels. In addition, we experienced a significant reduction in
leasing interest and activity when compared to pre-pandemic levels. See "-
Overview - Plan of Liquidation" above.
Liquidity and Capital Resources
As described above under "- Overview - Plan of Liquidation," on March 5, 2020,
our stockholders approved the sale of all of our assets and our dissolution
pursuant to the terms of the Plan of Liquidation. We expect to sell all of our
assets, pay all of our known liabilities, provide for unknown liabilities and
distribute the net proceeds from liquidation to our stockholders. Our principal
demands for funds through the completion of our liquidation will be for: the
payment of operating expenses, capital expenditures and general and
administrative expenses, including expenses in connection with the Plan of
Liquidation; and payments of distributions to stockholders pursuant to the Plan
of Liquidation. During our liquidation, we intend to use our cash on hand and
proceeds from the sale of real estate properties as our primary sources of
liquidity. To the extent available, we also intend to use cash flow generated by
our remaining real estate property.
Our investment in real estate generates cash flow in the form of rental revenues
and tenant reimbursements, which are reduced by operating expenditures, the
payment of asset management fees and corporate general and administrative
expenses. Cash flow from operations from our real estate investment is primarily
dependent upon the occupancy level of the property, the net effective rental
rates on our leases, the collectibility of rent and operating recoveries from
our tenants and how well we manage our expenditures. As of June 30, 2022, our
remaining real estate property was 59% occupied.
For the six months ended June 30, 2022, our cash needs for capital expenditures
were met with cash on hand. Operating cash needs during the same period were met
with cash flow generated by our real estate investment. We believe that our cash
on hand, our cash flow from operations to the extent available and proceeds from
the sale of our remaining real estate property will be sufficient to meet our
liquidity needs during our liquidation.
During the liquidating process, we intend to maintain adequate cash reserves for
liquidity, capital expenditures and other future capital needs. As of June 30,
2022, the estimated capital expenditures through the anticipated disposition
date for our remaining real estate property were $12.1 million.
We expect to continue to pay liquidating distribution payments to our
stockholders through the completion of our liquidation process and to pay the
final liquidating distribution after we sell all of our assets, pay all of our
known liabilities and provide for unknown liabilities. At the time of adopting
the Plan of Liquidation, we had anticipated completing the orderly liquidation
of our company and paying substantially all of our liquidating distributions
from the net proceeds from liquidation within 24 months after stockholder
approval of the Plan of Liquidation, which occurred on March 5, 2020. Given the
uncertainty and business disruptions as a result of the outbreak of COVID-19 and
more recently the rising interest rate environment, our completion of the Plan
of Liquidation has been delayed. We currently anticipate that we will complete
our liquidation by the fourth quarter of 2022. Although we were not able to
complete our liquidation within the 24-month period described above, we do not
anticipate any material unfavorable tax consequences to our stockholders or to
our status as a REIT. For U.S. federal income tax purposes, (i) we did not have
any current and accumulated earnings and profits (including any gain) or taxable
income or gain for the taxable years ended December 31, 2020 and December 31,
2021 and (ii) we do not anticipate any current and accumulated earnings and
profits (including any gain) or taxable income or gain for the taxable year
ended December 31, 2022 or in future periods. Our expectations about the amount
of future liquidating distributions that we will pay and when we will pay them
are based on certain estimates and assumptions, one or more of which may prove
to be incorrect. As a result, the actual amount of liquidating distributions we
pay to our stockholders may be less than our estimate and the liquidating
distributions may be paid later than we predict. See "- Overview - Plan of
Liquidation" and "-Market Outlook - Real Estate and Real Estate Finance Markets
- COVID-19 Pandemic and Portfolio Outlook" for a discussion of the impact of the
outbreak of COVID-19 on our business and our liquidation. We do not expect to
pay regular monthly distributions during the liquidating process.
In addition to using our capital resources for capital expenditures and for
operating costs, we use our capital resources to make certain payments to our
advisor. We paid our advisor fees in connection with the acquisition and
origination of our assets and pay our advisor fees in connection with the
management and disposition of our assets and for certain costs incurred by our
advisor in providing services to us. Among the fees payable to our advisor is an
asset management fee. With respect to investments in real estate, we pay our
advisor a monthly asset management fee equal to one-twelfth of 0.75% of the
amount paid or allocated to acquire the investment, plus the cost of any
subsequent development, construction or improvements to the property. This
amount includes any portion of the investment that was debt financed and is
inclusive of acquisition fees and expenses related thereto. We also continue to
reimburse our advisor and our dealer manager for certain stockholder services.
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Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
During the six months ended June 30, 2022, cash and cash equivalents decreased
by $6.9 million primarily as a result of $7.4 million of capital expenditure
payments and $3.0 million of corporate expenditures, offset by the net inflows
from investment in our remaining real estate property of $3.8 million.
Pursuant to our stockholders' approval of the Plan of Liquidation, we adopted
the liquidation basis of accounting as of February 1, 2020 (as the approval of
the Plan of Liquidation by our stockholders became imminent within the first
week of February 2020 based on the results of our solicitation of proxies from
our stockholders for their approval of the Plan of Liquidation) and for the
periods subsequent to February 1, 2020 in accordance with GAAP. Accordingly, on
February 1, 2020, assets were adjusted to their estimated net realizable value,
or liquidation value, which represents the estimated amount of cash that we will
collect through the disposal of our assets as we carry out our Plan of
Liquidation. The liquidation value of our operating property is presented on an
undiscounted basis. Estimated costs to dispose of assets and estimated capital
expenditures through the anticipated disposition date of the property have been
presented separately from the related assets. Liabilities are carried at their
contractual amounts due or estimated settlement amounts.
Changes in Net Assets in Liquidation
For the Six Months June 30, 2022
Net assets in liquidation decreased by approximately $34.7 million from $205.5
million on December 31, 2021 to $170.8 million on June 30, 2022. The primary
reason for the decrease in net assets in liquidation was due to a decrease in
the liquidation value our remaining real estate property located in Los Angeles,
California ("Union Bank Plaza"). The estimated net proceeds from the sale of
Union Bank Plaza decreased by approximately $34.2 million (after estimated
closing costs and disposition fees) as the liquidation value was adjusted based
on the contractual sales price less estimated closing credits as the property is
currently under contract to sell. See "- Subsequent Events - Purchase and Sale
Agreement for Sale of Union Bank Plaza." As of June 30, 2022, Union Bank Plaza
was 59% occupied. Demand for office space in downtown Los Angeles significantly
declined as a result of the COVID-19 pandemic, with employees continuing to work
from home. In addition, with rising interest rates, prospective buyers are
challenged to obtain favorable financing, which along with the lower demand for
office space, is impacting the projected cash flows of the property and the
purchase price prospective buyers are willing to pay for the property.
There is inherent uncertainty with these estimates and projections, and they
could change materially based on the timing of the sale of Union Bank Plaza, the
performance of Union Bank Plaza and any changes in the underlying assumptions of
the projected cash flows from this property.
Results of Operations
In light of the adoption of liquidation basis accounting as of February 1, 2020
and our liquidation pursuant to the Plan of Liquidation, the results of
operations for the current year period are not comparable to the prior year
period. The sale of assets under the Plan of Liquidation has had a significant
impact on our operations. Changes in liquidation values of our assets are
discussed above under "- Changes in Net Assets in Liquidation." See "- Overview
- Plan of Liquidation" and "- Market Outlook - Real Estate and Real Estate
Finance Markets - COVID-19 Pandemic and Portfolio Outlook" for a discussion of
the impact of the outbreak of COVID-19 on our business and our liquidation.
Due to the adoption of the Plan of Liquidation, we are no longer reporting funds
from operations and modified funds from operations as we no longer consider
these to be key performance measures.
Critical Accounting Policies and Estimates
Our consolidated interim financial statements and condensed notes thereto have
been prepared in accordance with GAAP and in conjunction with the rules and
regulations of the SEC. The preparation of our financial statements requires
significant management judgements, assumptions and estimates about matters that
are inherently uncertain. These judgments affect the reported amounts of assets
and liabilities and our disclosure of contingent assets and liabilities as of
the dates of the financial statements. With different estimates or assumptions,
materially different amounts could be reported in our financial statements. A
discussion of the accounting policies that management considers critical in that
they involve significant management judgements, assumptions and estimates is
included in our Annual Report on Form 10-K for the year ended December 31, 2021
filed with the SEC. There have been no significant changes to our policies
during 2022.
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Table of Contents
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Subsequent Events
Purchase and Sale Agreement for Sale of Union Bank Plaza
On September 15, 2010, we, through an indirect wholly owned subsidiary,
purchased Union Bank Plaza, a 40-story office building located in Los Angeles,
California containing 701,888 rentable square feet on approximately 3.7 acres of
land.
On July 20, 2022, we, through an indirect wholly owned subsidiary, entered into
a purchase and sale agreement and escrow instructions (the "Agreement") for the
sale of Union Bank to WB Union Plaza Holdings LLC (the "Purchaser"), an
affiliate of Waterbridge Capital. The Purchaser is unaffiliated with us or our
advisor. Pursuant to the Agreement, the sale price for Union Bank Plaza is
$155.0 million, subject to prorations and adjustments as provided in the
Agreement.
The closing date is expected to be October 19, 2022. There can be no assurance
that we will complete the sale of Union Bank Plaza. The Purchaser would be
obligated to purchase Union Bank Plaza only after satisfaction of agreed upon
closing conditions. In certain circumstances, if the Purchaser fails to complete
the acquisition, it may forfeit up to $7.5 million of earnest money.
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