<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 21, 1998
REGISTRATION NO. 333-47887
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-11
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
------------------------
CLARION COMMERCIAL HOLDINGS, INC.
(Exact name of Company as specified in its Charter)
335 MADISON AVENUE
NEW YORK, NEW YORK 10017
(212) 883-2500
(Address of Company's principal executive offices)
------------------------
DANIEL HEFLIN
335 MADISON AVENUE
NEW YORK, NEW YORK 10017
(212) 883-2500
(Name and address of agent for service for the Company)
------------------------
COPIES TO:
<TABLE>
<S> <C>
Robert Evans III, Esq. Stuart H. Coleman, Esq.
Shearman & Sterling Stroock & Stroock & Lavan LLP
599 Lexington Avenue 180 Maiden Lane
New York, New York 10022 New York, New York 10038
(212) 848-4000 (212) 806-5400
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF THE PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
------------------------
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. / / ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. / / ____________
If this Form if a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / ____________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------
THIS COMPANY HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE COMPANY SHALL FILE A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION
8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
SUBJECT TO COMPLETION, DATED APRIL 21, 1998
10,000,000 SHARES
[LOGO]
CLASS A COMMON STOCK
Clarion Commercial Holdings, Inc. (the "Company") is a newly-organized
specialty finance company that will invest in commercial mortgage-backed
securities ("CMBS") (primarily subordinate securities), commercial mortgage
loans, mezzanine investments and other real estate related investments. The
Company will elect to be taxed as a real estate investment trust (a "REIT") for
U.S. Federal income tax purposes. Clarion Capital, LLC (the "Manager") will
manage the day-to-day operations of the Company, subject to the supervision of
the Company's Board of Directors.
All of the 10,000,000 shares of Class A common stock, $.001 par value (the
"Common Stock"), offered pursuant to this Prospectus are being offered by the
Company (the "Offering"). Prior to the Offering, there has been no public market
for the Common Stock. It is currently estimated that the initial public offering
price for the Common Stock will be $20.00 per share. Application will be made to
have the Common Stock approved for listing on the New York Stock Exchange (the
"NYSE") under the symbol " ."
(CONTINUED ON NEXT PAGE)
SEE "RISK FACTORS" BEGINNING ON PAGE 16 FOR A DISCUSSION OF MATERIAL RISK
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS IN CONNECTION WITH
AN INVESTMENT IN THE COMMON STOCK, INCLUDING, AMONG OTHERS:
- - The Company was organized in February 1998, has no operating history or
established sources of financing and its directors and officers, and those of
the Manager, have no prior experience in managing or operating a REIT
- - The Manager has been recently formed and will rely upon its parent, Clarion
Partners, and its affiliates for mortgage origination and servicing and
acquisition, asset and property management services for which such entities
will be compensated
- - The Company has no separate employees or facilities and is completely reliant
on the Manager, which has significant operating discretion, including as to
the use of proceeds of the Offering and the implementation of the Company's
operating policies and strategies
- - The Management Agreement does not require the Manager to devote a fixed
minimum amount of time to the management of the Company's affairs
- - The Company and the Manager have common directors and officers, which may
present conflicts of interest with respect to the Company's purchase of assets
from other funds managed by the Manager and the Manager's allocation of
investment opportunities to the Company
- - The Manager has an incentive fee arrangement with the Company that may
encourage speculative investment
- - The Company has contracted, subject to the approval of the Independent
Directors, to purchase its initial investments from other funds managed by the
Manager and may acquire additional investments from, or co-invest with, such
funds
- - The Company intends to invest in assets, such as the Initial Investments, that
are risky and suitable only for sophisticated investors. Accordingly, the
Company's investors will be reliant on the Manager
- - The Company intends to own subordinate CMBS which will be subject to risk of
loss of principal and nonpayment of interest, and there will be no limitation
on the amount of subordinate CMBS that the Company may acquire
- - The Company will invest in commercial mortgage loans and mezzanine
investments, each of which will expose the Company to risks of borrower
default, risk of loss from casualty or condemnation, legal risks relating to
local law and the risks generally associated with real estate investment
- - Increases in the Company's short-term borrowing rates without a corresponding
increase in the yield on the Company's long-term investments may reduce or
eliminate the Company's net income
- - The Company will engage in hedging strategies that will reduce the overall
return of the Company's investments and may not be successful in insulating
the Company from exposure to changing interest rates and prepayment rates
- - The Company's assets will be leveraged, which may compound losses or result in
operating or capital losses, and there will be no limitation on borrowings
- - The Company's operating, hedging and credit policies and strategies have yet
to be established. Each of such policies and strategies will be established by
the Board of Directors and may be changed without stockholder consent
- - The Company will face significant competition in purchasing commercial real
estate assets consistent with its investment objectives
- - Certain of the Company's investments may result in taxable income in excess of
GAAP income resulting in distributions that represent, in part, a return of
capital to stockholders
(RISK FACTORS CONTINUED ON NEXT PAGE)
------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT (1) COMPANY (2)
<S> <C> <C> <C>
Per Share.......................... $ $ $
Total (3).......................... $ $ $
</TABLE>
(FOOTNOTES ON NEXT PAGE)
The shares of Common Stock are offered subject to prior sale, when, as and
if delivered to, and accepted by, the Underwriters and subject to certain
conditions. The Underwriters reserve the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. It is expected that
delivery of the shares of Common Stock will be made at the offices of Bear,
Stearns & Co. Inc., 245 Park Avenue, New York, New York 10167 on or about
, 1998.
--------------------------
BEAR, STEARNS & CO. INC. LEHMAN BROTHERS
, 1998
<PAGE>
(CONTINUED FROM COVER)
Subject to the approval of the Independent Directors, Gramon Fund (BVI),
L.P. and Monroe Investment Corp., each a private fund managed by the Manager,
will be selling the Initial Investments to the Company for the respective fair
market values of such Initial Investments. The Company intends to make such
purchases from the net proceeds of the Offering, and, as a result, Gramon Fund
(BVI), L.P. will be receiving approximately $166.4 million, and Monroe
Investment Corp. will be receiving approximately $48.5 million, from the net
proceeds of the Offering. See "INVESTMENT OBJECTIVES AND POLICIES--Initial
Investments."
------------------------
(RISK FACTORS CONTINUED FROM COVER)
- - Failure to maintain REIT status would subject the Company to corporate tax
which would reduce earnings and cash available for distribution to
stockholders
- - Stockholders may be subject to significant potential dilution from future
equity offerings
- - Termination of the Management Agreement, or failure to extend the Management
Agreement beyond its initial term, may result in the payment of a substantial
termination fee to the Manager, which could adversely affect the Company's
financial condition
- - The Company has no established limits with respect to the geographic
concentration of, or the credit quality of the borrowers under, the commercial
mortgage loans, or the mortgage loans underlying the CMBS, that it may
originate or acquire, which may increase the Company's exposure to adverse
real estate market conditions in a particular region and to borrower default
------------------------------
(FOOTNOTES CONTINUED FROM COVER)
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). See "UNDERWRITING."
(2) Before deducting expenses payable by the Company, estimated to be $ .
(3) The Company has granted the Underwriters a 30-day option to purchase up to
1,500,000 additional shares of Common Stock to cover over-allotments, on the
same terms and conditions as set forth above. If all such shares of Common
Stock are purchased, the total Price to Public, Underwriting Discount and
Proceeds to Company, before deducting expenses of the Offering, will be
$ , $ and $ , respectively. See "UNDERWRITING."
------------------------------
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS AND
IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
CERTAIN STATEMENTS CONTAINED IN THIS PROSPECTUS CONSTITUTE "FORWARD-LOOKING
STATEMENTS" WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY
SUCH AS "MAY," "WILL," "EXPECT," "ANTICIPATE," "ESTIMATE," "INTEND," "CONTINUE"
OR "BELIEVE" OR THE NEGATIVES THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE
TERMINOLOGY. THE STATEMENTS IN "RISK FACTORS" IN THIS PROSPECTUS CONSTITUTE
CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS, INCLUDING CERTAIN RISKS AND
UNCERTAINTIES, WITH RESPECT TO SUCH FORWARD-LOOKING STATEMENTS THAT COULD CAUSE
THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO DIFFER
MATERIALLY FROM THOSE REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS. THESE
FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF THIS PROSPECTUS.
THE COMPANY MAY PROVIDE PROJECTIONS, FORECASTS OR ESTIMATES OF FUTURE
PERFORMANCE OR CASH FLOWS OF THE COMPANY. PROJECTIONS, FORECASTS AND ESTIMATES
ARE ALSO FORWARD-LOOKING STATEMENTS AND WILL BE BASED UPON CERTAIN ASSUMPTIONS.
ACTUAL EVENTS ARE DIFFICULT TO PREDICT AND MAY BE BEYOND THE COMPANY'S CONTROL.
ACTUAL EVENTS MAY DIFFER FROM THOSE ASSUMED. SOME IMPORTANT FACTORS THAT WOULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN ANY FORWARD-LOOKING
STATEMENTS INCLUDE CHANGES IN INTEREST RATES; DOMESTIC AND FOREIGN BUSINESS,
MARKET, FINANCIAL OR LEGAL CONDITIONS; DIFFERENCES IN THE ACTUAL ALLOCATION OF
THE ASSETS OF THE COMPANY FROM THOSE ASSUMED; AND THE DEGREE TO WHICH ASSETS ARE
HEDGED AND THE EFFECTIVENESS OF THE HEDGE, AMONG OTHERS. IN ADDITION, THE DEGREE
OF RISK WILL BE INCREASED BY THE COMPANY'S LEVERAGING OF ITS ASSETS.
ACCORDINGLY, THERE CAN BE NO ASSURANCE THAT ANY ESTIMATED RETURNS OR PROJECTIONS
CAN BE REALIZED OR THAT ACTUAL RETURNS OR RESULTS WILL NOT BE MATERIALLY LOWER
THAT THOSE THAT MAY BE ESTIMATED.
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY................ 5
The Company....................... 5
The Manager....................... 6
Private Placement................. 6
Clarion Partners.................. 6
Agreement Between the Manager and
CLARION.......................... 7
Risk Factors...................... 7
Management Agreement.............. 9
Investment Strategy and Initial
Investments...................... 10
Conflicts of Interest and Benefits
to Related Parties............... 11
Tax Status of the Company......... 13
Distribution Policy............... 13
The Offering...................... 14
Organization and Relationships.... 15
RISK FACTORS...................... 16
Conflicts of Interest of the
Manager May Result in Decisions
That Do Not Fully Reflect
Stockholders' Best Interests..... 16
No Operating History; No Prior
Market for Common Stock; No
Established Lines of Credit...... 17
Complete Reliance on the Manager;
Lack of REIT Management
Experience; Termination of the
Management Agreement............. 17
Reliance on Messrs. Heflin and
Sullivan......................... 18
Limited Right of Action Against
the Manager...................... 18
Lack of Operating Policies; Board
of Directors May Change Policies
Without Stockholder Consent...... 18
Subordinated CMBS Are Subject to
Greater Risk of Loss of Principal
and Interest..................... 18
Risk of Loss on Mortgage Loans.... 19
Investments in Real Property May
Involve Substantial Risks........ 22
Interest Rate Fluctuations Will
Adversely Affect the Value of the
Company's CMBS and Commercial
Mortgage Loans................... 25
Significant Competition May
Adversely Affect the Company's
Ability to Acquire Assets at
Favorable Spreads Relative to
Borrowing Costs.................. 26
Hedging Transactions Can Limit
Gains and Increase Exposure to
Losses........................... 27
Leverage May Increase Exposure to
Loss............................. 28
Failure to Maintain REIT Status
Would Subject the Company to
Corporate Taxation............... 29
<CAPTION>
PAGE
----
<S> <C>
REIT Asset and Income Requirements
May Limit the Company's
Investments...................... 29
Certain Investment Techniques May
Be Subject to Corporate
Taxation......................... 30
REIT Distribution Requirements May
Limit the Company's Operations... 30
Phantom Income May Result in
Distribution of Capital.......... 31
Taxable Mortgage Pool Risk;
Increased Taxation to
Stockholders..................... 31
Failure to Maintain Investment
Company Act Exemption Would
Restrict the Company's Operating
Flexibility...................... 31
Restrictions on Ownership of
Common Stock..................... 32
Limitation on Liability of
Directors and Officers........... 33
Common Stock Price May Be
Adversely Affected by Interest
Rate Volatility and the
Performance of Other REITs....... 33
Potential Future Offerings May
Dilute Stockholders' Interest.... 34
Year 2000 Compliance.............. 34
USE OF PROCEEDS................... 35
CAPITALIZATION.................... 35
INVESTMENT OBJECTIVES AND
POLICIES......................... 36
Proposed Investments.............. 36
Initial Investments............... 40
Investment Management............. 44
THE COMPANY....................... 48
Directors and Executive Officers
of the Company................... 48
Committees of the Board of
Directors........................ 49
Compensation of Directors......... 49
Executive Compensation............ 49
Stock Incentive Plan.............. 49
Grants of Awards.................. 52
Compensation Committee
Interlocks....................... 52
Dividend Reinvestment Plan........ 52
Employees......................... 52
Facilities........................ 52
Legal Proceedings................. 52
THE MANAGER....................... 53
Clarion Partners.................. 53
Agreement Between the Manager and
CLARION.......................... 54
Directors and Executive
Officers......................... 55
Management Agreement.............. 55
Portfolio Management.............. 57
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
Management Fees................... 57
<S> <C>
Third Party Fees and Expenses..... 58
Limits of Responsibility.......... 58
10% OWNERSHIP OF THE MANAGER;
OPTION TO PURCHASE REMAINING
INTEREST IN THE MANAGER.......... 58
CONFLICTS OF INTEREST AND BENEFITS
TO RELATED PARTIES............... 60
The Manager, CLARION and the
Management Agreement............. 60
Material Interests of
Affiliates....................... 60
DISTRIBUTION POLICY............... 61
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........ 62
General........................... 62
Initial Investments............... 63
Leveraging........................ 63
Hedging........................... 63
Liquidity and Capital Resources... 63
Inflation......................... 63
Certain Accounting Policies and
Procedures....................... 64
THE OPERATING PARTNERSHIP......... 64
General........................... 65
General Partner Not to Withdraw... 65
Capital Contribution.............. 65
Redemption Rights................. 66
Operations........................ 66
Distributions..................... 66
Allocations....................... 67
Term.............................. 67
Tax Matters....................... 67
FEDERAL INCOME TAX
CONSIDERATIONS................... 67
Taxation of the Company........... 67
Requirements for Qualification.... 69
Qualified REIT Subsidiaries....... 74
Operating Partnership and
Disregarded Entities............. 74
Noncontrolled Taxable
Subsidiaries..................... 75
Distribution Requirements......... 75
Recordkeeping Requirements........ 76
Failure to Qualify................ 76
<CAPTION>
PAGE
----
<S> <C>
Sales of the Company's Assets..... 77
Taxation of Taxable U.S.
Stockholders..................... 77
Taxation of Tax-Exempt
Stockholders..................... 80
Taxation of Non-U.S.
Stockholders..................... 81
Federal Estate Taxes.............. 83
State and Local Taxes............. 83
ERISA CONSIDERATIONS.............. 83
Employee Benefit Plans,
Tax-Qualified Retirement Plans
and IRAs......................... 83
Status of the Company Under
ERISA............................ 84
CERTAIN PROVISIONS OF MARYLAND LAW
AND THE COMPANY'S CHARTER AND
BYLAWS........................... 85
Certain Anti-takeover
Provisions....................... 85
Staggered Board of Directors...... 85
Number of Directors, Filling
Vacancies, Removal............... 86
Advance Notice Provisions for
Stockholder Nominations and
Stockholder Proposals............ 86
Rights to Purchase Securities and
Other Property................... 86
Indemnification................... 87
Limitation of Liability........... 87
Business Combinations............. 87
Control Share Acquisitions........ 88
DESCRIPTION OF CAPITAL STOCK...... 88
General........................... 88
Common Stock...................... 89
Class B Stock..................... 89
Preferred Stock................... 89
Registration Rights............... 90
Restrictions on Transfer.......... 90
Transfer Agent and Registrar...... 92
SHARES ELIGIBLE FOR FUTURE SALE... 93
UNDERWRITING...................... 94
PRIVATE PLACEMENT................. 95
LEGAL MATTERS..................... 96
EXPERTS........................... 96
ADDITIONAL INFORMATION............ 96
GLOSSARY.......................... 97
INDEPENDENT AUDITOR'S REPORT...... F-1
</TABLE>
4
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION INCLUDED ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED,
THE INFORMATION CONTAINED IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS'
OVER-ALLOTMENT OPTION IS NOT EXERCISED. ANY DEFINED TERMS USED HEREIN AND NOT
OTHERWISE DEFINED SHALL HAVE THE MEANINGS GIVEN IN THE GLOSSARY, WHICH STARTS ON
PAGE 97.
THE COMPANY
Clarion Commercial Holdings, Inc. (the "Company"), a Maryland corporation,
was organized in February 1998 as a specialty finance company that will elect to
be a real estate investment trust (a "REIT") for U.S. Federal income tax
purposes. The Company's objective will be to build a diverse portfolio of
commercial real estate investments ("Real Estate Investments") in an attempt to
provide a high rate of return to its stockholders, without incurring risk deemed
unacceptable by the Manager or compromising the Company's REIT qualification.
The Company will focus primarily on the following types of Real Estate
Investments:
- CMBS. The Company intends to originate and acquire various classes
(primarily subordinate, including "first loss") of commercial
mortgage-backed securities ("CMBS"). CMBS are generally multi-class debt
or pass-through securities backed by a commercial mortgage loan or a pool
of commercial mortgage loans. Subordinate classes of CMBS offer a higher
expected rate of return than more senior classes of CMBS, but are subject
to greater risk of loss of principal and non-payment of interest.
- COMMERCIAL MORTGAGE LOANS; SECURITIZATION. The Company intends to
originate, acquire and accumulate commercial mortgage loans for investment
and securitization, which will subject the Company to the risks associated
with mortgage lending, including borrower default, risk of loss from
casualty or condemnation and legal risks relating to local law and the
risks generally associated with real estate investment. Upon
securitization, the Company will generally sell the senior classes of the
new securities and retain the subordinate classes. By originating
commercial mortgage loans and securitizing such loans itself, the Company
expects to achieve higher returns than from purchasing subordinate classes
of CMBS from third parties.
- MEZZANINE INVESTMENTS. The Company intends to invest in preferred or PARI
PASSU equity, leveraged joint venture equity and subordinate and
participating mortgage loans (collectively, "Mezzanine Investments").
These investments will provide the Company with interest at a higher rate
than generally paid on the senior mortgage on the same property plus, in
most cases, a percentage of gross revenues or, to the extent consistent
with REIT qualification, net operating income from the underlying
property, payable to the Company on an ongoing basis, and a percentage of
any increase in value of the property, payable upon maturity or
refinancing. Mezzanine Investments may be riskier than first lien mortgage
loans since they are subordinate to such loans and, therefore, in the
event of borrower default, may not be repaid from the proceeds of the sale
of the mortgaged property.
The Company may also make other investments in commercial real estate
assets, including real property investments and investments in companies that
have substantial holdings of real estate related assets. See "INVESTMENT
OBJECTIVES AND POLICIES--Proposed Investments." The commercial mortgage loans
and Mezzanine Investments in which the Company will be investing will be
identified primarily by affiliates of the Manager. See "--Agreement Between the
Manager and CLARION."
The Board of Directors of the Company is comprised of five members, three of
whom have had no prior affiliation with the Company (the "Independent
Directors"). The Company's principal executive offices are located at 335
Madison Avenue, New York, New York 10017, and its telephone number is (212)
883-2500.
5
<PAGE>
THE MANAGER
The day-to-day operations of the Company will be managed by Clarion Capital,
LLC (the "Manager"), which is registered with the Securities and Exchange
Commission (the "SEC") as an investment adviser. The Manager was formed in
December 1997 and is a subsidiary of Clarion Partners, LLC (formerly known as
Jones Lang Wootton Realty Advisors) ("Clarion Partners"). The Manager, comprised
of ten investment professionals, directs all of the real estate debt investment
activity of Clarion Partners. Neither the Company's nor the Manager's directors
or officers has prior experience in managing or operating a REIT.
The President and CEO of the Manager is Daniel Heflin who has over ten years
of fixed income, securitization and real estate investment experience. Mr.
Heflin has supervised the acquisition and/or structuring of more than $2 billion
of mortgages, debt securities and Mezzanine Investments and has participated in
the securitization of more than $20 billion of assets.
Frank L. Sullivan, Jr. is one of the founders of Clarion Partners and is
Chairman of the Board of Directors of the Manager. Mr. Sullivan has over 25
years of real estate investment experience and has supervised the acquisition
and/or structuring of more than $7 billion in mortgages, Mezzanine Investments
and direct equity. He is also a Professor of Finance at the New York University
Graduate School of Business. Mr. Sullivan has agreed to serve as Clarion
Partners' investment officer for the Company and, while serving in such
capacity, not to provide his services to any other entity with investment
objectives similar to those of the Company.
Upon consummation of the Offering, the Company will issue 200,000 shares of
Class B common stock, $.001 par value, of the Company (the "Class B Stock") in
exchange for a 10% interest in the Manager and an option to purchase the
remaining 90% interest in (or all of the assets of) the Manager for 90% of fair
market value. The option may be exercised between January 2, 2000 (the "Option
Exercise Date") and March 31, 2001 only with the approval of the Independent
Directors.
After the Option Exercise Date, and in certain circumstances prior to such
time, shares of Class B Stock will become convertible into shares of Common
Stock on a one-for-one basis. Until such time as shares of Class B Stock become
convertible into shares of Common Stock, distributions with respect to the Class
B Stock will be subordinate to distributions with respect to the Common Stock.
See "--Distribution Policy;" "10% OWNERSHIP OF THE MANAGER; OPTION TO PURCHASE
REMAINING INTEREST IN THE MANAGER" and "DESCRIPTION OF CAPITAL STOCK--Class B
Stock."
PRIVATE PLACEMENT
Mr. Heflin, Clarion Partners (including Mr. Sullivan) and Monroe Investment
Corp., a private fund managed by the Manager (an "Affiliated Fund"), have
committed to purchase 1,000,000 shares of Common Stock at the initial public
offering price in a private placement to occur concurrently with the
consummation of the Offering.
CLARION PARTNERS
Clarion Partners was organized in 1982 as a fiduciary for institutional real
estate investors, specializing in sourcing, underwriting and managing Real
Estate Investments, and is registered with the SEC as an investment adviser.
Headquartered in New York, Clarion Partners and its affiliates (collectively,
"CLARION") have offices in 20 cities and have over 350 employees, including 19
principals who average over 20 years of real estate investment experience.
CLARION is one of the country's largest institutional real estate investment
advisers, managing over $6 billion in Real Estate Investments, including over
$4.5 billion in real property, $1.5 billion in REIT stocks and $600 million in
debt securities, commercial mortgage loans and Mezzanine Investments. Since
inception, CLARION has completed acquisitions and dispositions of over $10
billion in Real Estate
6
<PAGE>
Investments, acquired, and negotiated the resolution of, over $2 billion in
non-performing and sub-performing real estate investments and structured over
$2.5 billion in Mezzanine Investments.
CLARION acts as fiduciary for more than 75 institutional investors,
including:
<TABLE>
<S> <C>
- - Ameritech Pension Trust - State of Hawaii Employees Retirement
- - Florida State Board of Administration Systems
- - IBM Retirement Fund - State of Wisconsin Investment Board
- - New York State Common Retirement Fund - United Mine Workers of America 1974
- - New York State Teachers' Retirement Pension Trust
System - US West, Inc.
- - Oregon Public Employees Retirement Fund
</TABLE>
The funds advised by CLARION for its institutional investors, including
those named above, have investment strategies different from the intended
strategies of the Company.
Clarion Partners has been approved as a special servicer by Standard &
Poor's Rating Group, a division of McGraw Hill, Inc. ("S&P"), Moody's Investors
Service, Inc. ("Moody's") and Fitch IBCA, Inc. ("Fitch IBCA"). As an approved
special servicer, Clarion Partners should be able to assist the Company in
attempting to control credit losses by managing the "work-out" of sub-performing
loans underlying CMBS in which the Company invests.
AGREEMENT BETWEEN THE MANAGER AND CLARION
Under the terms of an agreement between the Manager and CLARION, CLARION
will provide mortgage origination and servicing and acquisition, asset and
property management services to the Manager. Compensation for these services is
described in "THE MANAGER--Agreement Between the Manager and CLARION." The
Manager has been granted a right of first refusal to acquire all commercial debt
investments originated by CLARION until the earlier of (i) such time as the
Company owns assets having a market value in excess of 2.5 times the net
proceeds of the Offering and the Private Placement, anticipated to be $511.3
million (the "Purchasing Priority Amount"), and (ii) May , 2001, the
expiration of the initial term of the Management Agreement. Thereafter, CLARION
has agreed to allocate such investments to the Manager and CLARION's other
clients on a fair and equitable basis. The Manager has agreed with the Company
that this right of first refusal will inure solely to the benefit of the Company
and not to any Affiliated Fund until the Company owns assets in excess of the
Purchasing Priority Amount. Thereafter, the Manager has agreed to allocate such
investments among the Affiliated Funds and the Company on a fair and equitable
basis.
During the term of such agreement, CLARION has agreed not to provide any of
the services covered by such agreement to any other public REIT with investment
objectives similar to those of the Company. See "THE MANAGER--Agreement Between
the Manager and CLARION."
RISK FACTORS
An investment in the Common Stock involves various risks, and prospective
investors should consider carefully the matters discussed under the full "RISK
FACTORS" section appearing later in this Prospectus. These risks include, among
others:
- The Company was organized in February 1998, has no operating history or
established sources of financing and its directors and officers, and those
of the Manager, have no prior experience managing or operating a REIT
- The Manager has been recently formed and will rely upon CLARION for
mortgage origination and servicing and acquisition, asset and property
management services for which CLARION will be compensated
7
<PAGE>
- The Company has no separate employees or facilities and is completely
reliant on the Manager, which has significant operating discretion,
including as to the use of proceeds of the Offering and the implementation
of the Company's operating policies and strategies
- The Company and the Manager have common directors and officers, which may
present conflicts of interest with respect to the Company's purchase of
assets from the Affiliated Funds and the Manager's allocation of
investment opportunities to the Company
- The Manager has an incentive fee arrangement with the Company that may
encourage speculative investment
- Although transactions between the Company and the Affiliated Funds will be
subject to review by the Independent Directors, it is anticipated that the
Independent Directors will rely primarily on information provided by the
Manager in such review
- The Company has contracted, subject to approval by the Independent
Directors, to purchase the Initial Investments from certain Affiliated
Funds and may acquire additional assets from, or co-invest with,
Affiliated Funds
- The Company intends to invest in assets, such as the Initial Investments,
that are risky and suitable only for sophisticated investors. Accordingly,
the Company's investors will be reliant on the Manager
- The Company intends to own subordinate CMBS, which will be subject to risk
of loss of principal and nonpayment of interest, and there will be no
limitation on the amount of subordinate CMBS that the Company may acquire
- The Company will invest in commercial mortgage loans and Mezzanine
Investments, each of which will expose the Company to the risks of
borrower default, risk of loss from casualty or condemnation, legal risks
relating to local law and the risks generally associated with real estate
investment
- Increases in the Company's short-term borrowing rates without a
corresponding increase in the yield on the Company's long-term investments
may reduce or eliminate the Company's net income
- The Company will engage in hedging strategies that will reduce the overall
return of the Company's investments and may not be successful in
insulating the Company from exposure to changing interest and prepayment
rates. Such hedging strategies, including the use of U.S. Treasury
securities, swaps, options on such instruments and caps and floors,
involve risk and typically involve costs, including transaction costs
- The Company's assets will be leveraged, which may compound losses or
result in operating or capital losses, and there will be no limitation on
borrowings
- The Company's operating, hedging and credit policies and strategies have
yet to be established. Each of such policies and strategies will be
established by the Board of Directors and may be changed without
stockholder consent
- The Company will face significant competition in obtaining commercial real
estate assets consistent with its investment objectives
- Certain of the Company's investments may result in taxable income in
excess of GAAP income resulting in distributions that represent, in part,
a return of capital to stockholders
- The income derived from certain hedging or other investment techniques
(e.g. swaps, floors and caps) employed by the Company may be subject to
corporate taxation
8
<PAGE>
- Failure to maintain REIT status would subject the Company to corporate tax
which would reduce earnings and cash available for distribution to
stockholders
- Stockholders may be subject to significant potential dilution from future
equity offerings
- Termination of the Management Agreement, or failure to extend the
Management Agreement beyond its initial term, may result in the payment of
a substantial termination fee to the Manager, which could adversely affect
the Company's financial condition
- The Company has no established limits with respect to the geographic
concentration of, or the credit quality of the borrowers under, the
commercial mortgage loans, or the mortgage loans underlying the CMBS, that
it may originate or acquire, which may increase the Company's exposure to
adverse real estate market conditions in a particular region and to
borrower default
MANAGEMENT AGREEMENT
At or prior to consummation of the Offering, the Company will enter into the
Management Agreement with the Manager pursuant to which the Manager, subject to
the supervision by the Company's Board of Directors, will, among other things:
- formulate operating strategies for the Company;
- arrange for asset acquisition, property management, servicing and asset
management for the Company;
- arrange for various types of financing and hedging for the Company;
- monitor the performance of the Company's investment portfolio; and
- provide certain administrative and managerial services.
The Management Agreement does not specify a fixed minimum amount of time
that the Manager must devote to the management of the Company's affairs;
however, during the term of the Management Agreement, the Manager has agreed not
to provide any of the foregoing services to any other public REIT with
investment objectives similar to those of the Company.
For performing these services, the Manager will receive an annual base
management fee, payable monthly, and an annual incentive fee, payable quarterly,
in the amounts set forth in the following table. The incentive fee for the first
four quarters of the Company's operating history shall be paid at the end of the
fourth such quarter.
9
<PAGE>
<TABLE>
<CAPTION>
MANAGEMENT FEE INCENTIVE FEE
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
1% of the average stockholders' equity in the Company, The product of (A) 25% of the dollar amount by which (1)
determined in accordance with generally accepted Adjusted Net Income of the Company per share of common
accounting principles ("GAAP"), excluding any stock (based on the weighted average number of shares
mark-to-market adjustments to the Company's assets. outstanding) exceeds (2) an amount equal to (a) the
weighted average of the price per share of the common
stock at the initial offering and the prices per share
at any secondary offerings of common stock by the
Company multiplied by (b) the Ten-Year U.S. Treasury
Rate plus 2.5% per annum multiplied by (B) the weighted
average number of shares of common stock outstanding,
calculated as a quarterly average over the prior four
quarters. "Adjusted Net Income" means the taxable income
of the Company within the meaning of the Internal
Revenue Code of 1986, as amended (the "Code"), less any
unrealized capital depreciation with respect to any
assets of the Company for which market quotations are
readily available but before any incentive fees and
before deduction of dividends paid.
</TABLE>
The Manager is expected to use its base management fee and incentive fee in
part to pay compensation to its officers and employees who, notwithstanding that
certain of them are officers of the Company, will receive no cash compensation
directly from the Company.
In addition, because the Manager's employees will perform certain due
diligence tasks that outside consultants otherwise would perform, the Manager
will be reimbursed for (or charge the Company directly for) its reasonable and
customary out-of-pocket costs in performing such due diligence on assets
purchased by the Company or considered for purchase by the Company. There will
be no cap applicable to such out-of-pocket costs. The Manager will not charge
the Company for its corporate overhead or employees' salaries.
The Management Agreement will have an initial term of three years from the
date of the closing of the Offering (the "Closing Date"). Thereafter, successive
extensions, each for a period not to exceed one year, may be made by agreement
between the Company and the Manager. Unless mutually agreed upon by the Company
and the Manager, the base management fee and the incentive fee will be
calculated during any such extension in the same manner as they are calculated
during the initial term. The Company or the holders of a majority of the
outstanding shares of Common Stock may terminate, or decline to extend the term
of, the Management Agreement without cause at any time upon 60 days' prior
written notice to the Manager; provided, that, upon any such termination without
cause or failure to extend, the Manager shall be entitled to receive from the
Company a termination fee in an amount equal to the fair market value of the
Management Agreement (without giving effect to any termination and assuming it
is extended in accordance with its terms) plus any amounts payable by the
Manager to third parties, including CLARION, as a result of the termination of
such parties' services to the Company. See "THE MANAGER-- The Management
Agreement."
INVESTMENT STRATEGY AND INITIAL INVESTMENTS
The Company's income will result primarily from the spread between the
earnings generated by the Company's assets, investment income thereon and
related income over the cost of financing and hedging
10
<PAGE>
these assets. The Company will also realize capital gains or losses upon the
disposition of its assets. The Company will leverage its investments in such
assets primarily through securitizations, bank borrowings and other types of
financings. The degree to which the Company's assets may be leveraged is not
limited. The Company may also engage in a variety of interest rate risk
management techniques to manage the interest rate sensitivity of its assets
using hedging instruments such as U.S. Treasury securities, swaps, options on
such instruments and caps and floors. Any such transaction is subject to risks
and may limit the potential earnings from the Company's investments.
Furthermore, such interest rate risk management techniques may not produce the
intended result. See "INVESTMENT OBJECTIVES AND POLICIES-- Investment
Management."
The Company, through its subsidiary partnership, CCHI Limited Partnership
(the "Operating Partnership"), has contracted (subject to the approval of the
Independent Directors) with certain Affiliated Funds to purchase, on the Closing
Date with the net proceeds of the Offering and the Private Placement and
additional financing to be obtained prior to the Closing Date, the following
investments (the "Initial Investments"): (i) 22 classes of CMBS, (ii) two
commercial mortgage loans and (iii) one Mezzanine Investment. The Initial
Investments were selected by the Manager after analyzing various Real Estate
Investments for inclusion in the Company's portfolio, giving careful
consideration to the Company's investment objectives and the limitations
resulting from the Company's REIT qualification and the maintenance of its
exemption from the Investment Company Act. The Company will be purchasing the
Initial Investments at fair market value, determined as of the Closing Date. On
March 31, 1998, the fair market value of the Initial Investments was estimated
to be $212.2 million, which exceeds the expected net proceeds of the Offering
and the Private Placement. Such purchase price will be adjusted to reflect any
change in fair market value between March 31, 1998 and the Closing Date. The
fair market value for the CMBS and the commercial mortgage loans included in the
Initial Investments has and will be based on bids solicited from investment
banks for each such Initial Investment plus one-half of the bid/offer price
spread for similar securities. The fair market value of the Mezzanine Investment
included in the Initial Investments will equal the sum of the unpaid principal
balance of such Mezzanine Investment as of the Closing Date plus any accrued
interest thereon and associated acquisition costs. See "INVESTMENT OBJECTIVES
AND POLICIES--Initial Investments."
In connection with the sale of the Initial Investments to the Company,
Gramon Fund (BVI), L.P. and Monroe Investment Corp., each an Affiliated Fund,
will receive $166.4 million and $45.8 million, respectively, of the net proceeds
of the Offering.
CONFLICTS OF INTEREST AND BENEFITS TO RELATED PARTIES
The Company is subject to conflicts of interest involving the Manager
because, among other reasons, (i) the Manager will advise the Affiliated Funds
and many investments appropriate for the Company may also be appropriate for one
or more Affiliated Funds, (ii) all of the officers of the Company, and two of
its directors, will also be officers, employees and/or directors of the Manager
or one or more of its affiliates and (iii) the incentive fee may create an
incentive for the Manager to recommend investments with higher yield potential,
which investments generally are riskier or more speculative than would be the
case if such fee did not include a performance-based component. Nevertheless,
the Manager intends to conduct its operations in a manner that will attempt to
minimize the negative effect of any conflicts of interest. Moreover, a majority
of the Company's Board of Directors must be Independent Directors, individuals
unaffiliated with the Company, the Manager or CLARION (either by ownership or
through business), who will be responsible for approving certain activities to
be taken by the Company and/or the Manager. See "RISK FACTORS--Conflicts of
Interest of the Manager May Result in Decisions That Do Not Fully Reflect
Stockholders' Best Interests."
The Management Agreement does not limit or restrict the Manager or any of
its officers, directors, employees or affiliates from engaging in any business
or rendering services of any kind to any other person.
11
<PAGE>
The ability of the Manager and its officers and employees to engage in other
business activities could reduce the time and effort the Manager spends managing
the Company.
In addition, situations may arise in which the investment activities of the
Affiliated Funds may disadvantage the Company, such as the inability of the
market to fully absorb orders for the purchase or sale of particular CMBS placed
by the Manager for the Company and the Affiliated Funds at prices and in
quantities that would be obtained if the orders were being placed only for the
Company. The Manager, however, will not permit the Affiliated Funds to sell
securities or other assets to, or purchase securities or other assets from, the
Company unless such sale or purchase is made at the fair market value of such
security or asset and is approved by the Board of Directors. Furthermore, the
incentive fee payable to the Manager by the Affiliated Funds or other clients
may be higher than the fee paid by the Company, which may increase the potential
conflict of interest.
The Manager may also receive incentive fees from Affiliated Funds in
connection with the performance of any investments in the Common Stock by the
Affiliated Funds.
The Manager and certain of its affiliates will have a material interest in
connection with the Offering. The following table summarizes the nature of their
respective interests:
<TABLE>
<CAPTION>
PROSPECTUS SECTION PROVIDING
ENTITY NATURE OF INTEREST AND CONFLICT, IF ANY MORE DETAILED INFORMATION
- ------------------ ---------------------------------------------------------- ---------------------------------
<S> <C> <C>
The Manager The Manager will manage the Company's Real Estate "THE MANAGER-- Management
Investments for a base management fee and an incentive Agreement"
fee. Such incentive fee may encourage speculative
investment decisions by the Manager.
The Manager The owners of the Manager have received from the Company "10% OWNERSHIP OF THE MANAGER;
200,000 shares of Class B Stock in exchange for a 10% OPTION TO PURCHASE REMAINING
interest in the Manager and an option to purchase the INTEREST IN THE MANAGER;"
remaining 90% interest in the Manager (or all of its "DISTRIBUTION POLICY" and
assets) for 90% of fair market value. The option may be "DESCRIPTION OF CAPITAL
exercised between January 2, 2000 and March 31, 2001 only STOCK--Class B Stock."
with the approval of the Independent Directors.
CLARION CLARION will provide the Manager with mortgage origination "THE MANAGER-- Agreement Between
and servicing, acquisition, asset and property management the Manager and CLARION"
services. CLARION will receive compensation for providing
such services.
CLARION The Manager has also been granted a right of first refusal "THE MANAGER-- Agreement Between
to acquire all commercial debt investments originated by the Manager and CLARION"
CLARION until the earlier of (i) such time as the Company
owns assets having a market value in excess of the
Purchasing Priority Amount or (ii) the expiration of the
initial term of the Management Agreement. Thereafter,
CLARION has agreed to allocate such investments to the
Manager and CLARION's other clients on a fair and
equitable basis. The Manager has agreed with the Company
that these benefits will inure solely to the benefit of
the Company and not to any Affiliated Fund until the
Company owns assets in excess of the Purchasing Priority
Amount.
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
PROSPECTUS SECTION PROVIDING
ENTITY NATURE OF INTEREST AND CONFLICT, IF ANY MORE DETAILED INFORMATION
- ------------------ ---------------------------------------------------------- ---------------------------------
<S> <C> <C>
Affiliated Funds Subject to the approval of the Independent Directors, "INVESTMENT OBJECTIVES AND
certain Affiliated Funds will sell the Initial Investments POLICIES--Initial Investments"
to the Company and, subject to the approval of the Board and "CONFLICTS OF INTEREST AND
of Directors, may sell to, or purchase from, the Company BENEFITS TO RELATED PARTIES"
additional Real Estate Investments. The Manager may
receive incentive fees from the Affiliated Funds in
connection with such transactions.
Directors, The Company will grant options to purchase an aggregate of "THE COMPANY--Stock Incentive
Officers and 770,000 shares (885,500 shares if the Underwriters' Plan"
Employees of the over-allotment option is exercised in full) of Common
Company, the Stock to such individuals.
Manager and
CLARION
Mr. Heflin, Such parties have committed to purchase, in the aggregate, "PRIVATE PLACEMENT"
Clarion Partners 1,000,000 shares of Common Stock at the initial public
(which includes offering price in a private placement to occur
Mr. Sullivan) and concurrently with the consummation of the Offering.
an Affiliated Fund
</TABLE>
TAX STATUS OF THE COMPANY
The Company intends to qualify and will elect to be taxed as a REIT under
Sections 856 through 860 of the Code (the "REIT Provisions of the Code"). If the
Company qualifies for taxation as a REIT, the Company will not be subject to
federal corporate income tax on its taxable income that is distributed to its
stockholders. Failure to qualify as a REIT would render the Company subject to
federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates and distributions to the Company's
stockholders would not be deductible by the Company. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain federal,
state, local and foreign taxes on its income and property. In connection with
the Company's election to be taxed as a REIT, the Company's Charter imposes
restrictions on the transfer and ownership of the Common Stock. See "RISK
FACTORS--Failure to Maintain REIT Status Would Subject the Company to Corporate
Taxation" and "FEDERAL INCOME TAX CONSIDERATIONS--Requirements for
Qualification."
DISTRIBUTION POLICY
The Company intends to make distributions to its stockholders of all or
substantially all of its net taxable income each year (subject to certain
adjustments) so as to qualify for the tax benefits accorded to REITs under the
Code. The Company intends to make distributions at least quarterly. It is
anticipated that the first distribution to stockholders will be made after the
first full calendar quarter following the Closing Date.
In exchange for a 10% interest in the Manager and an option to purchase the
remaining 90% interest in the Manager (or all of its assets), the Company has
issued 200,000 shares of Class B Stock to the owners of the Manager. The Class B
Stock will not be entitled to receive distributions during any quarter unless
the holders of Common Stock have received a per share distribution during such
quarter of no less than __% (on an annualized basis) of the initial public
offering price of the Common Stock (adjusted on account of any stock splits,
stock dividends or reclassifications) during such quarter (the "Yield
Threshold"). Such restriction, however, applies only until the earlier to occur
of (such earlier date, the
13
<PAGE>
"Class B Subordination Termination Date"): (i) the Option Exercise Date or (ii)
the date on which the Company makes its fourth consecutive quarterly
distribution with respect to the Common Stock in an amount that equals or
exceeds the Yield Threshold.
Before the Class B Subordination Termination Date, any amounts available for
distribution will be distributed quarterly (i) first, to the holders of the
Common Stock, until such holders have received the Yield Threshold with respect
to their shares of Common Stock, (ii) second, to the holders of the Class B
Stock, until such holders have received the Yield Threshold with respect to
their shares of Class B Stock plus the cumulative amount, if any, by which
distributions with respect to the Class B Stock were less than the Yield
Threshold in the prior three quarters and (iii) third, to the holders of the
Common Stock and the holders of the Class B Stock, PRO RATA in accordance with
their respective share ownership. From and after the Class B Subordination
Termination Date, quarterly distributions will be made PRO RATA to the holders
of the Common Stock and the holders of the Class B Stock, in accordance with
their respective share ownership. See "DESCRIPTION OF CAPITAL STOCK--Class B
Stock."
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered Hereby(1)............... 10,000,000 shares
Common Stock to be Outstanding after the
Offering:
Class A Common Stock(1)(2)................. 11,000,750 shares
Class B Common Stock....................... 200,000 shares
---------------
Total...................................... 11,200,750 shares
---------------
---------------
Use of Proceeds.............................. The Company intends to use the net proceeds
of the Offering and Private Placement,
together with additional financing to be
obtained prior to the Closing Date, to
purchase the Initial Investments. See "USE OF
PROCEEDS."
Proposed NYSE Symbol......................... ""
</TABLE>
- ------------------------
(1) Assumes that the Underwriters' option to purchase up to an additional
1,500,000 shares to cover over-allotments is not exercised.
(2) Includes 1,000,000 shares subscribed for in the Private Placement, but does
not include 1,300,000 shares (1,495,000 shares if the Underwriters'
over-allotment option is exercised in full) authorized for issuance under
the Company's Stock Incentive Plan. In connection with the Offering, the
Company will grant options to acquire 770,000 shares (885,500 shares if the
Underwriters' over-allotment option is exercised in full) of the Common
Stock at the initial public offering price to directors, officers, employees
and consultants of the Company and/or the Manager and its affiliates. See
"THE COMPANY--Stock Incentive Plan."
14
<PAGE>
ORGANIZATION AND RELATIONSHIPS
The relationships among the Company, its subsidiaries, the Manager and
CLARION are depicted in the chart below.
[CHART]
- ------------------------
(1) The Company will issue 200,000 shares of Class B Stock to the owners of the
Manager in exchange for a 10% interest in the Manager and the option to
purchase the remaining 90% interest in the Manager (or all of its assets)
for 90% of fair market value. The option may be exercised between January 2,
2000 and March 31, 2001 only with the approval of the Independent Directors.
See "10% OWNERSHIP OF THE MANAGER; OPTION TO PURCHASE REMAINING INTEREST IN
THE MANAGER."
15
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE COMMON STOCK INVOLVES VARIOUS RISKS. IN ADDITION TO THE
OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE
CAREFULLY CONSIDERED IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE
PURCHASING SHARES OF COMMON STOCK.
CONFLICTS OF INTEREST OF THE MANAGER MAY RESULT IN DECISIONS THAT DO NOT FULLY
REFLECT STOCKHOLDERS' BEST INTERESTS
THE COMPANY AND THE MANAGER WILL HAVE COMMON DIRECTORS AND OFFICERS. The
Company is subject to conflicts of interest involving the Manager. All of the
officers and employees of the Company, and two of its directors, are directors,
officers and/or employees of the Manager or an affiliate thereof. A majority of
the Company's directors will be Independent Directors.
THE MANAGER WILL BE PROVIDING SERVICES FOR OTHER PARTIES. The Management
Agreement does not limit or restrict the Manager or any of its directors,
officers, employees or affiliates from engaging in any business or rendering
services of any kind to any other person. The ability of the Manager and its
officers and employees to engage in other business activities could reduce the
time and effort the Manager spends on managing the Company's investment
portfolio.
REAL ESTATE INVESTMENTS APPROPRIATE FOR THE COMPANY WILL ALSO BE APPROPRIATE
FOR THE AFFILIATED FUNDS. Situations may arise in which the investment
activities of the Affiliated Funds may disadvantage the Company, such as
competition for the available supply of Real Estate Investments. Such
circumstances may result in decisions and allocations of investments by the
Manager that are not in the best interests of the Company because, among other
things, the incentive fee payable to the Manager by the Affiliated Funds or
other clients may be higher than the incentive fee paid by the Company. The
Manager, however, has agreed to make available to the Company, until such time
as the Company owns assets in excess of the Purchasing Priority Amount,
anticipated to be $511.3 million, the benefit of its right of first refusal from
CLARION with respect to all commercial debt investments originated by CLARION.
See "THE MANAGER--Agreement Between the Manager and CLARION." Thereafter, the
Manager has agreed to allocate such investments among the Affiliated Funds and
the Company on a fair and equitable basis. In addition, the Manager will not
permit the Affiliated Funds to sell securities or other assets to, or purchase
securities or other assets from, the Company unless such sale or purchase is
made at the fair market value of such security or asset and is approved by the
Independent Directors.
The Manager may also receive incentive fees from the Affiliated Funds in
connection with the performance of any investment by the Affiliated Funds in the
Common Stock.
THE INITIAL INVESTMENTS WILL BE PURCHASED FROM AFFILIATED FUNDS. The
Company, through the Operating Partnership, has contracted (subject to the
approval of the Independent Directors) with certain Affiliated Funds to
purchase, on the Closing Date with the net proceeds of the Offering and the
Private Placement and additional financing to be obtained prior to the Closing
Date, the Initial Investments. The Company will be purchasing the Initial
Investments at fair market value, determined as of the Closing Date. On March
31, 1998, the fair market value of the Initial Investments was estimated to be
$212.2 million, which exceeds the expected net proceeds of the Offering and the
Private Placement. Such purchase price will be adjusted to reflect any change in
fair market value between March 31, 1998 and the Closing Date. The fair market
value for the CMBS and the commercial mortgage loans included in the Initial
Investments has and will be based on bids solicited from investment banks for
each such Initial Investment plus one-half of the bid/offer price spread for
similar securities. The fair market value of the Mezzanine Investment included
in the Initial Investments will equal the sum of the unpaid principal balance of
such Mezzanine Investment as of the Closing Date plus any accrued interest
thereon and associated acquisition costs.
The purchase of the Initial Investments will acquire the approval of the
Independent Directors. Although transactions between the Company and the
Affiliated Funds will be subject to review by the Independent Directors, it is
anticipated that the Independent Directors will rely primarily on information
16
<PAGE>
provided by the Manager in such review. The Manager may receive an incentive fee
from the Affiliated Funds as a result of their sale of the Initial Investments
to the Company.
THE MANAGER'S INCENTIVE FEE MAY ENCOURAGE SPECULATIVE INVESTMENTS. The
incentive fee payable to the Manager is based upon the income (including gains
and losses recognized for U.S. Federal income tax purposes) received by the
Company. This may create an incentive for the Manager to recommend investments
with greater income potential, which generally are riskier or more speculative
than would be the case if its fees did not include a performance-based
component, and which may impair the value of the Company's investment portfolio.
THE MANAGER MAY RECEIVE A SIGNIFICANT TERMINATION FEE UPON TERMINATION OF
THE MANAGEMENT AGREEMENT. The Company has agreed that if it terminates the
Management Agreement without cause or the Board of
Directors fails to approve a continuation of the Management Agreement, the
Manager will be entitled to receive a termination fee in an amount equal to the
fair market value of the Management Agreement (without giving effect to any
termination and assuming it is renewed in accordance with its terms) plus any
amounts payable by the Manager to third parties, including CLARION, as a result
of the termination of such parties' services to the Company.
NO OPERATING HISTORY; NO PRIOR MARKET FOR COMMON STOCK; NO ESTABLISHED LINES OF
CREDIT
The Company was organized in February 1998 and, therefore, has no operating
history and will commence operations only if it completes the Offering. No prior
market exists for the Company's Common Stock. The Company will apply for listing
of the Common Stock on the New York Stock Exchange (the "NYSE"). There can be no
assurance that an active trading market will develop or be sustained after the
Offering or that, even if such a market develops, the market price will not
decline below the public offering price. The initial public offering price of
the Common Stock will be determined through negotiations between the Company and
the Underwriters, and may not be indicative of future market prices. See
"UNDERWRITING." The results of the Company's operations depend on many factors,
including the availability of opportunities for the acquisition of assets, the
level and volatility of interest rates, conditions in the financial markets and
economic conditions. The Company will require additional financing in order to
close its purchase of the Initial Investments. The Company will require
substantial lines of credit or collateralized financing facilities in order to
conduct its intended business, and there can be no assurance that the Company
will be able to obtain such additional financing or, even if such financing is
available, that it will be available on favorable terms. Furthermore, no
assurance can be given that the Company will be able successfully to operate its
business as described in this Prospectus.
COMPLETE RELIANCE ON THE MANAGER; LACK OF REIT MANAGEMENT EXPERIENCE;
TERMINATION OF THE MANAGEMENT AGREEMENT
The Company's day-to-day operations will be administered by the Manager,
subject to the supervision of the Company's Board of Directors. Thus, the
Company is completely reliant on the services of the Manager and its officers,
directors and employees for the success of the Company. The Manager will have
significant operating discretion, including as to the use of proceeds of the
Offering and in developing the Company's operating policies even though the
Manager has been recently organized and none of its directors or officers has
prior experience in managing a REIT. The Company is subject to the risk that the
Manager will terminate the Management Agreement and that no suitable replacement
will be found to manage the Company. The Company and the Manager may terminate
the Management Agreement at any time upon 60 days' written notice to the other
party. The Company would be materially and adversely affected if it were unable
to engage an appropriate replacement for the Manager. The Management Agreement
does not limit or restrict the right of the Manager or any of its officers,
directors, employees or affiliates from engaging in any business or rendering
services of any kind to any other person. In addition, the Management Agreement
does not impose a minimum time commitment that the Manager and its personnel
must make in providing services to the Company. The ability of the Manager and
its employees to engage in other business activities could reduce the time and
effort spent by the Manager and its
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employees on the management of the Company. See "--Conflicts of Interests of the
Manager May Result in Decisions That Do Not Fully Reflect Stockholders' Best
Interests" and "THE MANAGER."
RELIANCE ON MESSRS. HEFLIN AND SULLIVAN
The Company will depend on the experience and knowledge of Messrs. Heflin
and Sullivan. Mr. Heflin will be a director of the Company and will enter into
an employment contract with the Manager for a term equal to or greater than the
term of the Management Agreement. If the Company exercises its option to
purchase the remaining 90% interest in the Manager, Mr. Heflin is expected to
remain employed by the Manager which will then be a wholly-owned subsidiary of
the Operating Partnership or another partnership subsidiary of the Company. Mr.
Sullivan will not be employed by the Manager but will serve as a Director of the
Company and the Manager. He has agreed to serve as Chairman of the Board of the
Company and as Clarion Partners' investment officer for the Company and, while
serving in such capacity, not to provide his services to any other entity with
investment objectives similar to those of the Company, as determined by the
Independent Directors. The Company would be adversely affected if the Manager
lost the services of Mr. Heflin or if Clarion Partners lost the services of Mr.
Sullivan.
LIMITED RIGHT OF ACTION AGAINST THE MANAGER
The Management Agreement provides that the Manager and its affiliates will
be indemnified by the Company against costs and expenses incurred in connection
with, and will not be liable to the Company or an investor for any action taken
or failure to act on behalf of the Company in connection with, the business of
the Company, unless such action or omission constitutes gross negligence or
intentional misconduct. Therefore, an investor may have a more limited right of
action against the Manager and its affiliates than would be available absent
these provisions in the Management Agreement. See "THE MANAGER--Limits of
Responsibility."
LACK OF OPERATING POLICIES; BOARD OF DIRECTORS MAY CHANGE POLICIES WITHOUT
STOCKHOLDER CONSENT
The Company currently does not have specific operating guidelines. Any
operating policies, including investment and operating policies and other
policies with respect to acquisitions, leveraging, hedging, growth, operations
and distributions will be determined by the Manager, subject to the supervision
of the Board of Directors. The Board of Directors may amend or revise these and
other policies, or approve transactions that deviate from these policies, from
time to time without a vote of the holders of the Common Stock. The Company,
however, may not change its policy of seeking to maintain its qualification as a
REIT without the approval of the holders of two-thirds of the outstanding shares
of Common Stock.
SUBORDINATE CMBS ARE SUBJECT TO GREATER RISK OF LOSS OF PRINCIPAL AND INTEREST
The Company intends to originate and acquire a significant amount of various
classes of CMBS, including unrated "first loss" subordinate CMBS. A first loss
class is the most subordinate class of a multi-class issuance of pass-through or
debt securities which is the last class to receive payment of interest and
principal and the first class to bear the loss upon a default on the commercial
mortgage loans underlying CMBS (the "Mortgage Collateral"). Subordinate CMBS are
subject to special risks, including a substantially greater risk of loss of
principal and non-payment of interest than more senior classes. The market
values of subordinate classes of CMBS tend to be more sensitive to changes in
economic conditions than more senior classes. As a result of these and other
factors, subordinate CMBS generally are not actively traded and may not provide
holders thereof with liquidity of investment. In addition, the Company's
investments in CMBS will be subject to the risks of adverse conditions in the
securities markets, particularly in the commercial mortgage-backed securities
market. Such adverse conditions would impair the value and marketability of the
Company's investments in CMBS.
The yield-to-maturity on subordinate CMBS may be extremely sensitive to the
default and loss experience of the underlying Mortgage Collateral and the timing
of any such defaults or losses. Because the subordinate classes generally have
no credit support, to the extent there are realized losses on the
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Mortgage Collateral, the Company may not recover the full amount or, in extreme
cases, any of its investment in such subordinate CMBS.
The subordination of subordinate classes of CMBS to more senior classes may
adversely affect the yield on such subordinate classes even if realized losses
ultimately are not allocated to such classes. On any payment date, interest and
principal generally would be paid on the more senior classes before interest and
principal would be paid with respect to the subordinate classes. Typically,
interest deferred on subordinate classes would be payable on subsequent payment
dates to the extent funds become available, but such deferral itself may not
bear interest. Such deferral of interest generally will adversely affect the
yield on the subordinate classes.
The yield of CMBS will also be affected by the rate and timing of payment of
principal on the Mortgage Collateral. The rate of principal payments may vary
significantly over time depending on a variety of factors such as the level of
prevailing mortgage loan interest rates and economic, demographic, tax, legal
and other factors. Prepayments on the Mortgage Collateral are generally
allocated to the more senior classes until the balance of such senior classes is
reduced to zero. As a result, the weighted average lives of subordinate
securities may be longer than would otherwise be the case. To the extent that
the holders of subordinate securities are not paid compensating interest on
interest shortfalls due to prepayments, liquidations or otherwise, the yield on
the subordinate securities may be adversely affected.
When the Company acquires subordinate CMBS, it typically will be unable to
obtain the initial right to service the underlying performing Mortgage
Collateral. To minimize its losses, however, the Company will seek to obtain the
rights to service the underlying Mortgage Collateral in default (the rights to
service defaulted mortgage loans are referred to as "Special Servicing Rights").
To the extent the Company does not obtain Special Servicing Rights, the servicer
of such Mortgage Collateral may not have the same incentive to exercise remedies
with respect to such defaulted Mortgage Collateral as would the holders of the
subordinate classes who would experience loss as a result of such defaulted
Mortgage Collateral earlier than the holders of the more senior classes.
Accordingly, the Mortgage Collateral may not be serviced in a manner that is
most advantageous to the Company as the holder of a subordinate class. In
addition, CMBS without Special Servicing Rights may not be Qualifying Interests
under the Investment Company Act. See "--Failure to Maintain Investment Company
Act Exemption Would Adversely Affect Results of Operations."
Certain of the CMBS that the Company will acquire will include interests
that have not been registered under the Securities Act of 1933, as amended (the
"Securities Act") or other applicable relevant securities laws, resulting in a
prohibition against transfer, sale, pledge or other disposition of those CMBS
except in a transaction that is exempt from the registration requirements of, or
otherwise in accordance with, those laws. Thus, the ability of the Company to
vary its portfolio in response to changes in economic and other conditions may
be relatively limited.
RISK OF LOSS ON COMMERCIAL MORTGAGE LOANS
As part of its investment strategy, the Company intends to originate,
acquire, accumulate and securitize mortgage loans that generally will be secured
by existing commercial real estate, including office buildings, hotels, shopping
centers and other retail, industrial properties, hospitals, nursing homes and
multifamily buildings (collectively, "Commercial Property"). Property pledged as
security for mortgage loans is referred to herein as "mortgaged property."
VOLATILITY OF VALUES OF MORTGAGED PROPERTIES MAY ADVERSELY AFFECT MORTGAGE
LOANS. Mortgaged property values and the net operating income derived therefrom
are subject to volatility and may be adversely affected by a number of factors,
including, but not limited to, national, regional and local economic conditions
(which may be adversely impacted by plant closings, industry slowdowns and other
factors); local real estate conditions (such as an oversupply of office space,
hotel rooms, retail, industrial or other commercial space); changes or continued
weakness in specific industry segments; perceptions by prospective tenants and,
in the case of retail properties, retailers and shoppers, of the safety,
convenience, services and attractiveness of the property; the willingness and
ability of the property's owner to provide
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capable management and adequate maintenance; construction quality, age and
design; demographic factors; retroactive changes to building or similar codes;
and increases in operating expenses (such as energy costs). The historical
operating results of the mortgaged properties may not be comparable to future
operating results. In addition, other factors may adversely affect the mortgaged
properties' value without affecting the net operating income, including changes
in governmental regulations, zoning or tax laws, potential environmental or
other legal liabilities, the availability of refinancing, and changes in
interest rate levels.
LIMITED RECOURSE LOANS MAY LIMIT THE COMPANY'S RECOVERY TO THE VALUE OF THE
MORTGAGED PROPERTY. The Company anticipates that a substantial portion of the
commercial mortgage loans that it will originate or acquire and of the Mortgage
Collateral that it will originate or acquire may contain limitations on the
mortgagee's recourse against the borrower. In other cases, the mortgagee's
recourse against the borrower may be limited by applicable provisions of the
laws of the jurisdictions in which the mortgaged properties are located or by
the mortgagee's selection of remedies and the impact of those laws on that
selection. In those cases, in the event of a borrower default, recourse may be
limited to only the specific mortgaged property and other assets, if any,
pledged to secure the relevant mortgage loan. As to those mortgage loans that
provide for recourse against the borrower and its assets generally, there can be
no assurance that such recourse will provide a recovery in respect of a
defaulted mortgage loan greater than the liquidation value of the applicable
mortgaged property.
POSSIBLE LOSSES ON MORTGAGE LOANS DURING WAREHOUSING PERIOD. The Company
intends to originate, acquire and accumulate mortgage loans for securitization
as part of its investment strategy. The Manager, in its discretion, will
determine the quantity of mortgage loans sufficient for securitization after
discussions with potential underwriters and rating agencies and an evaluation of
the costs of securitization. During the accumulation period, the Company will be
subject to risks of borrower defaults, bankruptcies, fraud and losses and
special hazard losses that are not covered by standard hazard insurance. In the
event of any default under mortgage loans held by the Company, the Company will
bear the risk of loss of principal to the extent of any deficiency between the
value of the mortgage collateral and the principal amount of the mortgage loan.
During the accumulation or warehousing period, the cost of financing and hedging
the mortgage loans could exceed the interest income on the mortgage loans. It
may not be possible or economical for the Company to securitize all of the
mortgage loans which it acquires, in which case the Company will continue to
hold the mortgage loans and bear the risks of borrower defaults, bankruptcies,
fraud losses and special hazard losses.
The Company intends to retain the subordinated interests in such
securitizations and, as a result, it will retain the risks associated with
investment in subordinate CMBS. See "--Subordinated CMBS Are Subject to Greater
Risk of Loss of Principal and Interest."
The Company expects that when it acquires mortgage loans, the seller of the
mortgage loans (the "Mortgage Seller") generally will represent and warrant to
the Company that there has been no fraud or misrepresentation during the
origination of the mortgage loans and will agree to repurchase any loan with
respect to which there is fraud or misrepresentation. Although the Company will
have recourse to the Mortgage Seller based on the Mortgage Seller's
representations and warranties to the Company, the Company will be at risk of
loss to the extent the Mortgage Seller does not or cannot perform its repurchase
obligations.
In addition, substantial delays could be encountered in connection with the
foreclosure of defaulted mortgage loans, with corresponding delays in the
receipt of related proceeds by the Company. State and local statutes and rules
may delay or prevent the Company's foreclosure on or sale of the mortgaged
property and may prevent the Company from receiving new proceeds sufficient to
repay all amounts due on the related mortgage loan. Moreover, the Company's
servicing agent may be entitled to receive all expenses reasonably incurred in
attempting to recover amounts due and not yet repaid on liquidated mortgage
loans, thereby reducing amounts available to the Company.
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LACK OF ACCESS TO SECURITIZATIONS WOULD ADVERSELY AFFECT THE COMPANY. The
Company intends to rely upon securitizations of commercial mortgage loans to
generate cash proceeds for the purchase of additional commercial mortgage loans
and other Real Estate Investments. Several factors will affect the Company's
ability to complete securitizations, including conditions in the securities
markets generally, conditions in the mortgage-backed securities market
specifically, the credit quality of the Company's portfolio of mortgage loans
and the Company's ability to obtain credit enhancement. If the Company were
unable to securitize successfully a sufficient amount of mortgage loans, then
the Company would have to rely on other, potentially more expensive short-term
methods of financing, or curtail or reduce its acquisition of mortgage loans.
There can be no assurance that the Company will be able to securitize
successfully any mortgage loans which it acquires or, if it is not successful,
that the Company will obtain financing alternatives to securitization.
UNINSURED LOSS; SUFFICIENCY OF INSURANCE. The Company's commercial mortgage
loans and the Mortgage Collateral for its CMBS will generally require the
borrowers thereunder to obtain insurance coverage of the type and in the amount
customarily obtained by owners of properties similar to the applicable mortgaged
property, including liability and fire and extended coverage in amounts
sufficient to permit replacement of the mortgaged property in the event of a
total loss, subject to applicable deductibles. There are certain types of
losses, however, generally of a catastrophic nature, such as earthquakes, floods
and hurricanes, that may be uninsurable or not economically insurable. Under
such circumstances, the insurance proceeds received by the borrower, if any,
might not be adequate to restore the mortgaged property. In such event, upon a
default under such mortgage loans or Mortgage Collateral, there may be
insufficient proceeds from the foreclosure sale of such impaired mortgaged
property to prevent the Company from incurring loss.
COURT IMPOSED LIMITATIONS. As a lender, the Company will be exposed to a
range of court imposed limitations. Lenders held to have inappropriately
exercised control of the management and policies of a borrower or to have acted
otherwise than in good faith or in a commercially reasonable manner may be found
liable for damages suffered by the borrower or other parties as a result of such
actions and, if the borrower becomes a debtor in a bankruptcy proceeding, the
lender may have its claims subordinated or disallowed and interest payments to
the lender and, thus, distributions by the Company to its stockholders may be
reclaimed if any payment is later determined to have been a fraudulent
conveyance or a preferential payment. If a lender is deemed to have become a
partner of a borrower, the lender could become liable for claims of non-partner
creditors of the borrower. In addition, a lender who actually participates in
the management or operational affairs of a borrower may be deemed an operator
liable for environmental cleanup costs under the Comprehensive Environmental
Response, Compensation and Liability Act, as amended ("CERCLA").
MEZZANINE INVESTMENTS MAY BE SUBJECT TO GREATER RISKS OF LOSS THAN FIRST
MORTGAGE LOANS. The Company intends to make Mezzanine Investments, primarily in
the form of preferred and PARI PASSU equity, leveraged joint venture equity and
subordinate and participating mortgage loans. Mezzanine Investments will be
subject to the risks incident to the ownership of real estate, including risks
associated with the general economic climate, changes in the overall real estate
market, local real estate conditions, the financial condition of tenants, buyers
and sellers of properties, supply of, or demand for, competing properties in an
area, accelerated construction activity, technological innovations that
dramatically alter space requirements, availability of financing, changes in
interest rates, competition based on rental rates, energy and supply shortages,
various uninsured and uninsurable risks, the ability of the property owners to
manage the underlying real estate properties in which the Company has indirectly
acquired an interest and government regulations. Mezzanine Investments made by
the Company, whether secured or unsecured, may be lost in their entirety as the
result of a foreclosure by the holder of the senior loan.
A subordinate mortgage loan will be subordinate to one or more senior
mortgage loans on the applicable mortgaged property. As a result, in the event
of a decline in the value of such mortgaged property to below the sum of the
outstanding balances of the subordinate loan and the balances of the such
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senior loan(s), upon foreclosure of such mortgaged property, insufficient
proceeds will be available to repay the investment in such subordinate mortgage
loan.
The Company may, in some cases, make a Mezzanine Investment in a partnership
or other entity that owns real property, which is secured by the partnership
interests in such owner so that, in the event of a default, the Company can take
over the management of the property and seek to minimize losses. There can be no
assurance, however, that it will be able to do so.
Investment in preferred, PARI PASSU and leveraged joint venture equity
involves risks generally attributable to equity investments in real estate or
entities owning real estate as well as risks generally attributable to debt
investments. There is no guarantee that the entity will have sufficient cash
flow to make the preferred dividend payments. In addition, liquidation of the
investment within the time frame contemplated is uncertain and will depend on
many factors, including the condition of the real estate and financial markets
generally, the position and nature of the real estate underlying the investment
and the buy/sell or other liquidation rights.
The Company has no established limits with respect to the amount of
Mezzanine Investments in which it may invest, including the foregoing types of
investments.
INVESTMENTS IN REAL PROPERTY MAY INVOLVE SUBSTANTIAL RISKS
The value of the Company's investments in real property and the Company's
income and ability to make distributions to its stockholders will depend on the
ability of the Manager to hire and supervise capable property managers to
operate the real property in a manner that maintains or increases revenues in
excess of operating expenses and debt service or, in the case of real property
leased to a single lessee, the ability of the lessee to make rent payments.
Revenues from real property may be affected adversely by changes in national or
local economic conditions, competition from other properties offering the same
or similar attributes, changes in interest rates and in the availability, cost
and terms of mortgage funds, the impact of present or future environmental
legislation and compliance with environmental laws, the ongoing need for capital
improvements (particularly in older structures), changes in real estate tax
rates and other operating expenses, adverse changes in governmental rules and
fiscal policies, civil unrest, acts of God, including earthquakes, hurricanes
and other natural disasters (which may result in uninsured or underinsured
losses), acts of war, adverse changes in zoning laws and other factors that will
be beyond the control of the Company.
Although the Company's insurance will not cover all losses, the Company
intends to maintain comprehensive casualty insurance on its real property,
including liability and fire and extended coverage, in amounts sufficient to
permit replacement in the event of a total loss, subject to applicable
deductibles. The Company will endeavor to obtain coverage of the type and in the
amount customarily obtained by owners of properties similar to its real estate.
There are certain types of losses, however, generally of a catastrophic nature,
such as earthquakes, floods and hurricanes, that may be uninsurable or not
economically insurable. Inflation, changes in building codes and ordinances,
environmental considerations, provisions in loan documents encumbering
properties that have been pledged as collateral security for loans, and other
factors also might make it economically impractical to use insurance proceeds to
replace a property if it is damaged or destroyed. Under such circumstances, the
insurance proceeds received by the Company, if any, might not be adequate to
restore the Company's investment with respect to the affected property.
All real property owned by the Company will be subject to real property
taxes and, in some instances, personal property taxes. Such real and personal
property taxes may increase or decrease as property tax rates change and as the
properties are assessed or reassessed by taxing authorities. An increase in
property taxes on the Company's real property could affect adversely the
Company's income and ability to make distributions to its stockholders and could
decrease the value of the real property.
COMPLIANCE WITH AMERICANS WITH DISABILITIES ACT AND COMPLIANCE WITH OTHER
LAWS. Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
properties are required to meet certain
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federal requirements related to access and use by disabled persons. Certain real
property that the Company acquires may not be in compliance with the ADA. If
such real property is not in compliance, the Company may be required to make
modifications to bring it into compliance or face the possibility of an
imposition of fines or an award of damages to private litigants. In addition,
changes in governmental rules and regulations or enforcement policies affecting
the use and operation of the Company's real property, including changes to
building codes and fire and life-safety codes, may occur. If the Company is
required to make substantial modifications at its real property to comply with
the ADA or other changes in governmental rules and regulations, the Company's
income could be adversely affected.
The Company may obtain engineering reports on real property prior to their
acquisition. The purpose of engineering reports is, among other things, to
identify existing and potential violations of the ADA. However, the Company will
exercise judgment on this issue and may choose not to obtain engineering reports
on certain real property prior to its acquisition and to purchase mortgage loans
without engineering reports on the underlying mortgaged property if it deems
that to do so is prudent.
LENDING ON COMMERCIAL PROPERTIES INVOLVES CERTAIN RISKS. Repayment of loans
made on the security of income-producing real property depends upon the ability
of the related real estate project (i) to generate income sufficient to pay
operating expenses and leasing commissions to make necessary repairs, tenant
improvements and capital improvements and to pay debt service and (ii) in the
case of loans that do not fully amortize over their terms, to retain sufficient
value to permit the borrower to pay off the loan at maturity by sale or
refinancing. A number of factors, many beyond the control of the property owner,
can affect the ability of an income-producing real estate project to generate
sufficient net operating income to pay debt service and/or to maintain its
value. Among these factors are economic conditions in the area of the project,
the age, quality and design of the project and the degree to which it competes
with other projects in the area, changes or continued weakness in specific
industry segments, increases in operating costs, the willingness and ability of
the owner to provide capable property management and maintenance and, in the
case of retail mortgaged properties, industrial/warehouse or office properties,
the degree to which the project's revenue is dependent upon a single tenant or
use, a small group of tenants, tenants concentrated in a particular business or
industry and the competition to any such tenants. If leases are not renewed or
replaced, if tenants default and/or if rental rates fall and/or if operating
expenses increase, the borrower's ability to repay the loan may be impaired and
the resale value of the property, which is substantially dependent upon the
property's ability to generate income, may decline. In addition, there are other
factors, including changes in zoning or tax laws, the availability of credit for
refinancing, and changes in interest rate levels that my adversely affect the
value of a project (and thus the borrower's ability to sell or refinance)
without necessarily affecting the ability to generate current income.
In addition, particular types of income properties are exposed to particular
risks. For instance, office properties may require their owners to expend
significant amounts of cash to pay for general capital improvements, tenant
improvements and costs of re-leasing space. Also, office properties that are not
equipped to accommodate the needs of modern business may become functionally
obsolete and thus non-competitive. Multifamily projects are part of a market
that, in general, is characterized by low barriers to entry. Thus, a particular
apartment market with historically low vacancies could experience substantial
new construction, and a resultant oversupply of units, in a relatively short
period of time. Since multifamily apartment units are typically leased on a
short-term basis, the tenants who reside in a particular project within such a
market may easily move to alternative projects with more desirable amenities or
locations.
In the case of retail properties, the failure of an anchor tenant to renew
its lease, the termination of an anchor tenant's lease, the bankruptcy or
economic decline of an anchor tenant can have a particularly negative effect on
the economic performance of a shopping center property given the importance of
anchor tenants in attracting traffic to other stores within the same shopping
center. In addition, the failure of one or more major tenants, such as an anchor
tenant, to operate from its premises may entitle other tenants to rent
reductions or the right to terminate their leases. Shopping centers, in general,
are affected by the health of the retail industry, which is currently undergoing
a consolidation and is experiencing changes due to the growing market share of
"off-price" retailing, and a particular shopping center may be
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adversely affected by the bankruptcy or decline in drawing power of an anchor
tenant, a shift in consumer demand due to demographic changes (for example,
population decreases or changes in average age or income) and/or changes in
consumer preference (for example, to discount retailers). Industrial properties
may be adversely affected by reduced demand for industrial space occasioned by a
decline in a particular industry segment (for example, a decline in defense
spending), and a particular industrial property that suited the needs of its
original tenant may be difficult to re-let to another tenant or may become
functionally obsolete relative to newer properties.
Retail properties also are directly affected by the strength of retail sales
generally. The retailing industry is currently undergoing consolidation due to
may factors, including growth in discount retailing and mail order
merchandising. If the sales by tenants in mortgaged properties that contain
retail space were to decline, the rents that are based on a percentage of
revenues may decline and tenants may be unable to pay the fixed portion of their
rents or other occupancy costs.
Various factors, including location, quality and franchise affiliation (or
lack thereof), affect the economic viability of a hotel. Adverse economic
conditions, either local, regional or national, may limit the amount that may be
charged for a room and may result in a reduction in occupancy levels. The
construction of competing hotels or motels can have similar effects. Because
hotel rooms generally are rented for short periods of time, hotel properties
tend to respond more quickly to adverse economic conditions and competition than
do other commercial properties. The successful operation of a hotel with a
franchise affiliation may depend in part upon the strength of the franchisor,
the public perception of the franchise service mark and the continued existence
of any franchise license agreement. The transferability of a franchise license
agreement may be restricted, and a lender or other person that acquires title to
a hotel property as a result of foreclosure may be unable to succeed to the
borrower's rights under any franchise license agreement. Furthermore, the
ability of a hotel to attract customers, and some of such hotel's revenues, may
depend in large part on its having a liquor license. Such a license may not be
transferable (for example, in connection with a foreclosure).
In addition to risks generally associated with income-producing real estate,
retail properties are also affected significantly by adverse changes in consumer
spending patterns, local competitive conditions (such as the supply of retail
space or the existence or construction of new competitive shopping centers or
shopping malls), alternative forms of retailing (such as direct mail and video
shopping networks which reduce the need for retail space by retail companies),
the quality and philosophy of management, the attractiveness of the properties
to tenants and their customers or clients, the public perception of the safety
of customers at shopping malls and shopping centers, and the need to make major
repairs or improvements to satisfy the needs of major tenants.
PROPERTY LOCATION AND CONDITION. The location and construction quality of a
particular building may affect the occupancy level, the rents that may be
charged and/or the performance of the occupants' businesses. The characteristics
of an area or neighborhood in which a mortgaged property is located may change
over time in the form of increased maintenance and capital improvements. Even
good construction will deteriorate over time if the management company does not
schedule and perform adequate maintenance in a timely fashion.
COMPETITION. Comparable multifamily/commercial properties located in the
same areas compete with other mortgaged properties to attract residents, retail
sellers, tenants, customers and/or guests. The leasing of real estate is highly
competitive. The principal means of competition are price, location and the
nature and condition of the facility to be leased. A borrower competes with all
lessors and developers of comparable types of real estate in the area in which
mortgaged property is located. Such lessors or developers could have lower
rents, lower operating costs, more favorable locations or better facilities.
While a borrower may renovate, refurbish or expand mortgaged property to
maintain it and remain competitive, such renovation, refurbishment or expansion
may itself entail significant risks. Increased competition could adversely
affect income from, and the market value of mortgaged properties. In
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addition, the business conducted at each mortgaged property may face competition
from other industries and industry segments.
GEOGRAPHIC CONCENTRATION. Repayments by the borrowers and the market value
of mortgaged properties could be affected by economic conditions in regions
where the mortgaged properties are located, conditions in the real estate market
where the mortgaged properties are located, changes in the governmental rules
and fiscal policies, acts of nature (which may result in uninsured losses) and
other factors particular to the locales of the respective mortgaged properties.
The Company has no established limits with respect to the geographic
concentraiton of the properties securing its Commercial Mortgage loans.
POSSIBLE ENVIRONMENTAL LIABILITIES. The Company may become subject to
environmental risks when it acquires equity or security interests in properties
that encounter environmental problems. Such environmental risks include the risk
that operating costs and values of these assets may be adversely affected by the
obligation to pay for the cost of complying with existing environmental laws,
ordinances and regulations, as well as the cost of complying with future
legislation. Such laws often impose liability regardless of whether the owner,
operator or, in certain cases, mortgagee knows of, or was responsible for, the
presence of such hazardous or toxic substances. The costs of investigation,
remediation or removal of hazardous substances could exceed the value of the
property. The Company's income and ability to make distributions to its
stockholders could be affected adversely by the existence of an environmental
liability with respect to its properties.
INTEREST RATE FLUCTUATIONS WILL ADVERSELY AFFECT THE VALUE OF THE COMPANY'S CMBS
AND COMMERCIAL MORTGAGE LOANS
GENERAL. Interest rates are highly sensitive to many factors, including
governmental monetary, fiscal and tax policies, domestic and international
economic and political considerations, and other factors beyond the control or
anticipation of the Company. Interest rate fluctuations can adversely affect the
income and value of the Common Stock in many ways and present a variety of
risks, including the risk of a mismatch between asset yields and borrowing rates
and changing prepayment rates.
INTEREST RATE MISMATCH BETWEEN ASSET YIELDS AND BORROWING COSTS MAY RESULT
IN DECREASED YIELD. The Company's strategy is to leverage its investments by
borrowing against them, investing the net proceeds of those borrowings in
additional Real Estate Investments and borrowing against those additional
assets. See "INVESTMENT OBJECTIVES AND POLICIES." The Company will be required
to bear interest costs, transaction costs and other fees, costs and expenses
related to its anticipated borrowings. The Company intends to fund a substantial
portion of its assets with borrowings which have interest rates that reset
relatively rapidly, such as monthly or quarterly. The Company anticipates that,
in most cases, the income from its assets will respond more slowly to interest
rate fluctuations than the cost of its borrowings, creating a potential mismatch
between asset yields and borrowing rates. The Company's operating results depend
in part on the difference between the income earned on the Company's
income-generating assets (net of credit losses) and the interest expense
incurred in connection with its borrowings. See "--Leverage May Increase
Exposure to Loss." As the positive spread between the two increases, the
Company's net income should increase. Conversely, as the positive spread between
the two decreases, the Company's net income should decrease. Accordingly,
changes in the general level of interest rates, particularly short-term interest
rates, may significantly affect the Company's income by affecting the spread
between the Company's income-earning assets and interest-bearing liabilities, as
well as, among other things, the value and the average life of the Company's
interest-earning assets and its ability to realize gains from the sale of its
assets.
INDEXING MISMATCH BETWEEN ASSET YIELDS AND BORROWING RATES MAY ADVERSELY
AFFECT THE COMPANY'S NET INCOME. The Company's borrowings may be at interest
rates based on indices and repricing terms similar to, but of somewhat shorter
maturities than, the interest rate indices and repricing terms of various of the
Company's variable rate assets. While the historical spread between relevant
short-term interest rate
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indices has been relatively stable, there have been periods, such as 1979
through 1982, when the spread between those indices was volatile. Furthermore,
certain of the Company's assets will bear fixed rates of interest and have
long-term maturities. There can be no assurance that such fixed rates of
interest will exceed the variable rates of interest on related borrowings.
Interest rate mismatches could impact the Company's financial condition in a
material way, and could affect adversely the Company's income and ability to
make distributions to its stockholders, dividend yield and the market price of
the Common Stock. See "--Leverage May Increase Exposure to Loss" and "--The
Company May Not be Able to Borrow Money on Favorable Terms."
INCREASE IN PREPAYMENT RATE MAY ADVERSELY AFFECT YIELD. The value of the
Company's commercial mortgage loans and of the Mortgage Collateral for the CMBS
owned by the Company will be affected by the prepayment rates on such mortgage
loans and Mortgage Collateral. Although most of such mortgage loans and Mortgage
Collateral will provide for yield maintenance or other prepayment premiums or
penalties which reduce the risk of prepayment, there can be no assurance that
such premiums or penalties will deter prepayments or fully compensate the
Company for the opportunity costs suffered by the Company in connection with
such prepayments. Prepayment rates on commercial mortgage loans and CMBS are
influenced by changes in current interest rates and a variety of economic,
geographic and other factors and cannot be predicted with certainty. In periods
of declining mortgage interest rates, prepayments on mortgage loans and CMBS
generally increase. If general interest rates also decline, the funds available
for reinvestment by the Company during such periods are likely to be reinvested
at lower interest rates than the Company was earning on the mortgage loans and
CMBS that were prepaid. Mortgage loans and CMBS may decrease in value as a
result of increases in interest rates and may benefit less than other
fixed-income securities from declining interest rates because of the risk of
prepayment. In general, changes in both interest rates and prepayment rates will
affect the total return on the Company's mortgage loans and CMBS, which in turn
will affect the amount available for distribution to the Company's stockholders.
The value of mortgage loans and CMBS paying fixed coupon rates, which the
Company may acquire, generally will vary inversely with changes in prevailing
interest rates.
MATURITY MISMATCH BETWEEN ASSET MATURITIES AND BORROWING MATURITIES MAY
AFFECT ADVERSELY THE COMPANY'S NET INCOME. The Company's use of short-term
floating rate borrowings to acquire long-term assets, including mortgage loans
and CMBS, some of which will bear a fixed rate of interest, may expose the
Company to a maturity mismatch. As a consequence, the Company's borrowing costs
could exceed the income earned on the Company's assets acquired with the
borrowed funds, thereby reducing the Company's income and ability to make
distributions to its stockholders. In addition, if renewals of, or substitutes
for, maturing or called short-term borrowings are unavailable to the Company for
any reason, the Company may be required to sell assets quickly to repay those
borrowings. The Company's CMBS is likely to be illiquid and a sale associated
with a short marketing period generally would result in the Company receiving a
lower price than otherwise would be available. There can be no assurance that
the Company will not incur losses associated with forced sales of illiquid
collateral to repay borrowings. Furthermore, the use of leverage will magnify
the Company's exposure to losses.
SIGNIFICANT COMPETITION MAY ADVERSELY AFFECT THE COMPANY'S ABILITY TO ACQUIRE
ASSETS AT FAVORABLE SPREADS RELATIVE TO BORROWING COSTS
The Company will engage in a business that is highly competitive and which
may become increasingly competitive as more investors enter the market, which
may adversely affect the Company's ability to achieve its investment objectives.
In acquiring Real Estate Investments, the Company will compete with other REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, governmental bodies
and other entities purchasing similar assets, many of which have established
operating histories and procedures, may have access to greater capital and other
resources and may have other advantages over the Company in conducting certain
businesses and providing certain services. In addition, several mortgage REITs
have asset acquisition objectives similar to the Company and others may be
organized in the future. The effect of the existence of additional REITs
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may be to increase competition for the available supply of Real Estate
Investments contemplated to be acquired by the Company. The Company's net income
will depend, in large part, on the Company's ability to originate and acquire
mortgage loans and CMBS having yields that produce favorable spreads over the
Company's borrowing costs. Increased competition for the acquisition of mortgage
loans and CMBS or a reduction in the available supply could result in higher
prices and thus lower yields on such mortgage loans and CMBS, which could narrow
(or make negative) the yield spread relative to the Company's borrowing costs.
In addition, the Company's competitors may seek to establish relationships with
the financial institutions and other firms from whom the Company intends to
acquire such assets. There can be no assurance that the Company will be able to
acquire sufficient Real Estate Investments at favorable spreads relative to the
Company's borrowing costs to achieve the Company's objectives. In addition,
there can be no assurance that a supply of Real Estate Investments suitable for
acquisition by the Company will continue to be available, or that changes in
market conditions or applicable laws will not affect the availability of
suitable Real Estate Investments.
HEDGING TRANSACTIONS CAN LIMIT GAINS AND INCREASE EXPOSURE TO LOSSES
The Company intends to enter into hedging transactions primarily to protect
itself from the effect of interest rate fluctuations on its floating rate debt
and also to protect its portfolio of mortgage assets from interest rate and
prepayment rate fluctuations. There can be no assurance that the Company's
hedging activities, including use of U.S. Treasury securities, swaps, options on
such instruments and caps and floors will have the desired beneficial impact on
the Company's results of operation or financial condition. Moreover, no hedging
activity can completely insulate the Company from the risks associated with
changes in interest rates and prepayment rates. The Company's performance may be
affected adversely if the Company fails to limit the effects of changes in on
its operations by employing an effective hedging strategy.
Hedging involves risk and typically involves costs, including transaction
costs. Such costs increase dramatically as the period covered by the hedging
increases and during periods of rising or volatile interest rates. The Company
may increase its hedging activities, and, thus, increase its hedging costs,
during such periods when interest rates are volatile or rising. Losses on a
hedge position may reduce the funds available for distribution to stockholders,
and such losses may exceed the amount invested in such instruments. There may be
no perfect hedge for any investment and a hedge may not perform its intended
purpose of offsetting losses on an investment. For example, the Company will
attempt to match the interest rate indexes and repricing terms of its mortgage
loans ("basis risk") with those of its borrowings, but will most likely be
unable to achieve a perfect match. During periods of volatile interest rates,
such interest rate mismatches could affect adversely the Company's ability to
hedge effectively its interest rate risk. The Company may enter into
over-the-counter hedging transactions in which the protections afforded to
participants in an organized exchange and in a regulated environment may not be
available, which will expose the Company to credit risks due to counterparty and
legal enforceability risks. Although the Company intends to enter into such
contracts only with counterparties the Company believes to be financially sound
and to monitor the financial soundness of such parties on a periodic basis, the
Company may be exposed to the risk that the counterparties with which the
Company trades may become financially unsound or insolvent. If a counterparty
ceases making markets and quoting prices in such instruments, which may render
the Company unable to enter into an offsetting transaction with respect to an
open position, the Company may be forced to unwind its position, which may
result in a loss on the hedge position and could cause the Company to suffer the
adverse consequences against which the hedging transaction was designed to
protect. In addition, if any of the hedging instruments acquired by the Company
are traded on exchanges, the Company may be subject to the risk of trading
halts, suspensions, exchange or clearing house equipment failure, insolvency of
a brokerage firm or other disruptions of normal trading activities. The Company
has not established specific policies addressing hedging transactions in which
it will engage; however, the Independent Directors will be responsible for
reviewing at their regular meetings the extent and effect of hedging activities.
The amount of income the Company may earn from its hedging instruments is
subject to certain limitations under the REIT Provisions of the
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Code. See "FEDERAL INCOME TAX CONSISDERATIONS--Requirements for Qualification."
These limitations may result in the Manager electing to have the Company bear a
level of interest rate risk that could otherwise be hedged when the Manager
believes, based on all relevant facts, that bearing such risk is advisable
solely to maintain the Company's status as a REIT. See "INVESTMENT OBJECTIVES
AND POLICIES--Investment Management--Hedging and Leveraging."
LEVERAGE MAY INCREASE EXPOSURE TO LOSS
The Company intends to leverage its assets through securitizations, reverse
repurchase agreements, bank credit facilities, warehouse lines of credit and
other borrowings. The Company will leverage its assets only when it expects that
such leverage will enhance returns, although there can be no assurance that the
Company's use of leverage will prove to be beneficial. The extent to which the
Company uses leverage will be determined by the Manager and, ultimately, by the
Board of Directors, who may act at any time without the approval of or notice to
the stockholders. The amount of leverage used will vary depending on, among
other things, the Company's estimate of the cash flow that its assets will
generate and the stability of that cash flow. The Charter and Bylaws do not
limit the amount of indebtedness the Company can incur.
Leverage may reduce the net income available for distributions to
stockholders. If the interest income on the assets purchased with borrowed funds
fails to cover the cost of the borrowings, the Company will experience net
interest losses and may experience net losses and erosion or elimination of its
equity.
The ability of the Company to achieve its investment objectives depends to a
significant extent on its ability to borrow money in sufficient amounts and on
sufficiently favorable terms to earn incremental returns. The Company may not be
able to achieve the degree of leverage it believes to be optimal due to
decreases in the proportion of the value of its assets that it can borrow
against, decreases in the market value of the Company's assets, increases in
interest rates, changes in the availability of financing in the market,
conditions then applicable in the lending market and other factors. This may
cause the Company to experience losses or less profits than would otherwise be
the case.
In addition, collateralized investments and borrowings (such as repurchase
agreements and reverse repurchase agreements) expose the Company to risks
relating to the Company's ability to (i) assess the solvency and financial
well-being of its counterparties, (ii) evaluate the value of applicable
securities and monitor (and if necessary take possession of) such securities and
(iii) operate under, and perform the terms of, such agreements. Defaults under
repurchase agreements or reverse repurchase agreements by either the Company's
counterparties or the Company could also have a material adverse effect on the
Company's investment portfolio and cash position, and could expose the Company
to unanticipated litigation. See "INVESTMENT OBJECTIVES AND POLICIES--Investment
Management--Hedging and Leveraging."
REVERSE REPURCHASE AGREEMENTS. Substantial portions of the Company's assets
are expected to be pledged to secure reverse repurchase agreements, bank
borrowings or other credit arrangements used to finance the acquisition of such
assets. Reverse repurchase agreements involve the risk that the market value of
the securities retained by the Company may decline below the price of the
securities the Company has sold but is obligated to repurchase under the
agreement. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Company's use of the
proceeds of the agreement may be restricted pending a determination by the other
party or its trustee or receiver whether to enforce the Company's obligation to
repurchase the securities.
Reverse repurchase agreements involve sales by the Company of portfolio
assets, concurrently with an agreement by the Company to repurchase such assets
at a later date at a fixed price. During the reverse repurchase agreement
period, the Company continues to receive principal and interest payments on such
portfolio assets and also has the opportunity to earn a return on the collateral
furnished by the counterparty to secure its obligation to redeliver the
securities.
Reverse repurchase agreements may require the Company to deposit additional
collateral (a "margin call") or reduce its borrowings thereunder if the market
value of the pledged collateral declines. This may
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require the Company to sell assets to provide such additional collateral or to
reduce the amount borrowed. If these sales were made at prices lower than the
carrying value of such assets, the Company would experience losses. The Company
intends to maintain an equity level sufficient to provide liquidity in the event
of interest rate movements and other market conditions affecting the market
value of the pledged assets. However, there can be no assurance that the Company
will be able to safeguard against being required to sell assets in the event of
a change in market conditions. If the Company were forced to liquidate assets,
there can be no assurance that it would be able to maintain compliance with the
REIT Provisions of the Code regarding assets and sources of income. See "FEDERAL
INCOME TAX CONSIDERATIONS--Requirements for Qualification."
THE COMPANY MAY NOT BE ABLE TO BORROW MONEY ON FAVORABLE TERMS. The ability
of the Company to achieve its investment objectives through leverage will depend
on the Company's ability to borrow money on favorable terms. The Company has not
entered into any borrowing arrangements at the present time, and there can be no
assurance that the Company will be able to enter into arrangements enabling it
to borrow money on favorable terms. See "--No Operating History; No Prior Market
for Common Stock; No Established Lines of Credit."
FAILURE TO MAINTAIN REIT STATUS WOULD SUBJECT THE COMPANY TO CORPORATE TAXATION
The Company intends to operate in a manner so as to qualify as a REIT for
federal income tax purposes. Although the Company does not intend to request a
ruling from the Service as to its REIT status, the Company has received an
opinion of its legal counsel that, based on certain assumptions and
representations, it will so qualify. Investors should be aware, however, that
opinions of counsel are not binding on the Service or any court. The REIT
qualification opinion only represents the view of counsel to the Company based
on counsel's review and analysis of existing law. Furthermore, both the validity
of the opinion and the continued qualification of the Company as a REIT will
depend on the Company's satisfaction of certain asset, income, organizational,
distribution and stockholder ownership requirements on a continuing basis. If
the Company were to fail to qualify as a REIT in any taxable year, the Company
would be subject to federal income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate rates, and distributions
to stockholders would not be deductible by the Company in computing its taxable
income. Any such corporate tax liability could be substantial and would reduce
the amount of cash available for distribution to stockholders, which in turn
could have an adverse impact on the value of, and trading prices for, Common
Stock. Unless entitled to relief under certain Code provisions, the Company also
would be disqualified from taxation as a REIT for the four taxable years
following the year during which the Company ceased to qualify as a REIT.
REIT ASSET AND INCOME REQUIREMENTS MAY LIMIT THE COMPANY'S INVESTMENTS
In order to qualify as a REIT, the Company must satisfy certain requirements
concerning the nature of its assets and income, which may restrict the Company's
ability to invest in various types of assets. See "FEDERAL INCOME TAX
CONSIDERATIONS--Requirements for Qualification." Without limiting the generality
of the foregoing, in order to satisfy such requirements, the Company will not be
able to acquire securities (other than Government securities and securities,
such as interests in mortgages, shares of other REITs, and interests in certain
real estate mortgage investment conduits ("REMICs") and financial asset
securitization investment trusts ("FASITs"), that are treated as an interest in
real property and (for a one-year period) stock and debt obligations producing
qualifying temporary investment income) of any single issuer which would
represent either more than 5% of the total value of the Company's assets or 10%
of the voting securities of such issuer. In addition, under such requirements,
the Company generally will be restricted to acquiring assets which generate
qualifying income for purposes of certain income tests. See "FEDERAL INCOME TAX
CONSIDERATIONS--Requirements for Qualification--Income Test."
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CERTAIN INVESTMENT TECHNIQUES MAY BE SUBJECT TO CORPORATE TAXATION
Certain hedging and other investment techniques (e.g., short sales, swaps,
caps and floors), if employed, may be required to be conducted in one or more
entities taxable as regular ("C") corporations in which the Company owns 95% of
the nonvoting stock but none (or 10% or less) of the voting stock, or may be
otherwise constrained. The ability of the Company to employ such investment
techniques may be curtailed in the event that certain proposals included in
President Clinton's February 1998 Budget Proposal (the "1998 Budget Proposal")
are introduced into legislation and enacted into law.
Gain from the disposition of any asset held by the Company primarily for
sale to customers in the ordinary course of business generally will be subject
to a 100% tax. If the Company (contrary to its present intention) were to sell
securities that it created through securitization of mortgage loans or CMBS
(rather than structure such transactions as issuances of debt securities of a
special purpose entity wholly owned by it), or were to sell to customers assets
or hedging instruments on a regular basis, there would be a risk that the
profits from such sales would be subject to tax at the rate of 100% as income
from prohibited transactions.
REIT DISTRIBUTION REQUIREMENTS MAY LIMIT THE COMPANY'S OPERATIONS
Under REIT qualification requirements, the Company must distribute annually
at least 95% of its taxable income (excluding any net capital gain) in order to
avoid corporate income taxation of the earnings that it distributes, and must
distribute at least 100% of its taxable income in order to avoid corporate
income taxation on all of its earnings. In addition, the Company will be subject
to a 4% nondeductible excise tax on the amount, if any, by which certain
distributions paid by it with respect to any calendar year are less than the sum
of (i) 85% of its ordinary income for that year, (ii) 95% of its net capital
gain for that year and (iii) 100% of its undistributed taxable income from prior
years. See "FEDERAL INCOME TAX CONSIDERATIONS--Requirements for Qualification."
The Company intends to make distributions to its stockholders to comply with
the 95% distribution requirement and to avoid the nondeductible excise tax.
However, as illustrated below, there may be differences in timing between the
recognition of taxable income and the actual receipt of cash, requiring the
Company to borrow funds, issue capital stock or sell assets on a short-term
basis to meet the 95% distribution requirement and to avoid the nondeductible
excise tax. The requirement to distribute a substantial portion of the Company's
taxable income could cause the Company (i) to sell assets in adverse market
conditions or (ii) to distribute amounts that would otherwise be spent on future
acquisitions, capital expenditures or repayment of debt. See "FEDERAL INCOME TAX
CONSIDERATIONS."
The Company expects to acquire certain CMBS and other debt obligations that
are deemed to have original issue discount ("OID") for federal income tax
purposes, which generally is equal to the difference between an obligation's
issue price and its redemption price. The Company will be required to recognize
as income each year the portion of the OID that accrues during that year, which
will increase the amount required to be distributed for that year so as to avoid
REIT-level taxation, notwithstanding the fact that there may be no corresponding
contemporaneous receipt of cash by the Company.
The Company's planned investment in various types of subordinate obligations
also could result in the recognition of taxable income, in addition to OID, in
excess of the Company's cash receipts. The payment of interest on certain types
of subordinate obligations may be deferred (or placed into a reserve account)
until after the payment of all or a substantial portion of the interest or
principal (or both) on senior debt obligations, or until the
overcollateralization or reserve balance reaches a specified level. As a result
of its ownership of such subordinate obligations, the Company would recognize
interest income, which could exceed cash received from such obligations and
related tax deductions, and require an additional distribution.
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Although the Company does not presently intend to purchase a material amount
of REMIC residual interests, REMIC residual interests and retained interests in
non-REMIC securitization transactions also may generate taxable income in excess
of cash flow. In addition, certain taxable income produced by a REMIC residual
interest ("excess inclusion") may cause the Company's stockholders to suffer
certain adverse tax consequences. See "FEDERAL INCOME TAX CONSIDERATIONS."
The Company may acquire at less than their face amount CMBS and other debt
obligations that are deemed to have market discount for federal income tax
purposes, which generally is equal to the excess of an obligation's redemption
price over the holder's basis in the obligation at the time of acquisition. All
or a portion of the gain recognized by the Company from the disposition of, or
principal payments on, an obligation which has market discount would be treated
as ordinary income and not capital gain, so that the Company would be required
to make a distribution to its stockholders in order to satisfy the requirement
that a REIT distribute 95% of its taxable income to its stockholders each
taxable year.
PHANTOM INCOME MAY RESULT IN DISTRIBUTION OF CAPITAL
Certain of the Company's investments, particularly investments in
subordinate CMBS, and certain securitizations performed by the Company may,
under certain circumstances, cause the Company to recognize taxable income in
excess of its economic income ("phantom income") and to experience an offsetting
excess of economic income over its taxable income in later years. This mismatch
may result from the Company's inability to deduct losses on CMBS until they
occur. Accordingly, if the Company recognizes phantom income, its stockholders
may be required to pay federal income tax on cash distributions of such income
on an accelerated basis (I.E., without regard to cash received by the Company or
changes in value of the Company's investments). In order to maintain its REIT
qualification, the Company will be required to make distributions that
represent, in part, a return of capital to the stockholders. See "FEDERAL INCOME
TAX CONSIDERATIONS--Taxation of Taxable U.S. Stockholders."
TAXABLE MORTGAGE POOL RISK; INCREASED TAXATION TO STOCKHOLDERS
A REIT (or qualified REIT subsidiary) that incurs debt obligations with two
or more maturities and which are secured by assets such as mortgage loans may be
classified as a "taxable mortgage pool" under the Code if, under the terms of
the arrangement, the timing and amount of payments required to be made on such
debt obligations are in large part determined by the timing and amount of
payments or expected payments on such assets. If the Company (or a qualified
REIT subsidiary of the Company) were to be subject to the taxable mortgage pool
rules, the Company's status as a REIT would not be impaired but a portion or all
of the taxable income (in excess of a specified return to investors) generated
by the mortgage assets constituting a taxable mortgage pool may, under
regulations to be issued by the Treasury Department, be characterized as "excess
inclusion" income and allocated to the stockholders. Any such excess inclusion
income (i) would not be allowed to be offset by the net operating losses of a
stockholder, (ii) would be subject to tax as UBTI to a tax-exempt stockholder,
and (iii) would be subject to a 30% withholding tax in the case of a Non-U.S.
Stockholder. See "FEDERAL INCOME TAX CONSIDERATIONS."
While the Company will incur debt obligations, including under reverse
repurchase agreements, the Company intends to structure its borrowings to avoid,
to the extent practicable, application of the taxable mortgage pool rules. No
assurance can be given that the Company will be able to so structure its
borrowings.
FAILURE TO MAINTAIN INVESTMENT COMPANY ACT EXEMPTION WOULD RESTRICT THE
COMPANY'S OPERATING FLEXIBILITY
The Company believes that it will not be, and at all times intends to
conduct its business so as not to become, regulated as an investment company
under the Investment Company Act of 1940 (the "Investment Company Act").
Accordingly, the Company does not expect to be subject to the restrictive
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provisions of the Investment Company Act. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under the current interpretation of the staff of the
SEC, in order to qualify for this exemption, the Company, among other things,
must maintain at least 55% of its assets in Qualifying Interests and may also be
required to maintain an additional 25% in Qualifying Interests or other real
estate related assets. The assets that the Company may acquire therefore may be
limited by the provisions of the Investment Company Act. In connection with its
acquisition of CMBS, the Company intends, where appropriate, to obtain
foreclosure rights by obtaining the Special Servicing Rights with respect to the
Mortgage Collateral. There can be no assurance, however, that the Company will
be able to obtain such Special Servicing Rights on acceptable terms. As a result
of obtaining the Special Servicing Rights, the Company believes that the related
CMBS will constitute Qualifying Interests for purposes of the Investment Company
Act. The Company does not intend, however, to seek an exemptive order, no-action
letter or other form of interpretive guidance from the SEC or its staff on this
position. If the SEC, or its staff, adopts a contrary interpretation with
respect to CMBS, the Company could be required to restructure its investments to
the extent its assets do not comply with the interpretation. Such a
restructuring could require the sale of a substantial amount of investments held
by the Company at a time it would not otherwise do so. Further, in order to
insure that the Company at all times continues to qualify for the above
exemption from the Investment Company Act, the Company may be required at times
to adopt less efficient methods of financing certain of its securities than
would otherwise be the case and may be precluded from acquiring certain types of
such mortgage assets whose yields are somewhat higher than the yields on assets
that could be purchased in a manner consistent with the exemption. The net
effect of these factors would be to lower at times the Company's net interest
income. If the Company fails to qualify for exemption from registration as an
investment company, its ability to use leverage would be substantially reduced,
and it would be unable to conduct its business as described herein. Therefore,
any such failure to qualify for such exemption could have a material adverse
effect on the Company and the market price for the Common Stock.
RESTRICTIONS ON OWNERSHIP OF COMMON STOCK
For the Company to maintain its qualification as a REIT, not more than 50%
in value of its outstanding shares of capital stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). For the purpose, among others, of preserving the Company's
REIT status, the Charter generally prohibits direct or indirect ownership by any
person of more than 9.9% of the number of outstanding shares of Common Stock
(the "Ownership Limit"). For this purpose, the term "ownership" is defined as
either direct ownership or constructive ownership in accordance with the
constructive ownership provisions of Section 544 of the Code. Any transfer of
shares of capital stock that would result in disqualification of the Company as
a REIT or that would (a) create a direct or constructive ownership of shares of
stock in excess of the Ownership Limit, (b) result in the shares of stock being
beneficially owned (within the meaning Section 856(a) of the Code) by fewer than
100 persons (determined without reference to any rules of attribution), or (c)
result in the Company being "closely held" within the meaning of Section 856(h)
of the Code (a "purported transfer"), will be null and void, and the intended
transferee (the "purported transferee") will acquire no rights to such shares.
Any purported transfer of shares that would result in a person owning (directly
or constructively) shares in excess of the Ownership Limit (except as otherwise
waived by the Board of Directors) due to the unenforceability of the transfer
restrictions set forth above will constitute "Shares-in-Trust." Shares-in-Trust
will be transferred by operation of law to a trust to be established by the
Company for the exclusive benefit of a charitable organization, until such time
as the trustee of the trust, which shall be a banking institution designated as
trustee by the Company, which is unaffiliated with either the Company or the
purported transferee, retransfers the Shares-in-Trust. Subject to the Ownership
Limit, Shares-in-Trust may be transferred by the trust to any person (if such
transfer would not result in Shares-in-Trust) at a price not to exceed the
lesser of (i) the price paid by the purported transferee or, if the purported
transferee did not
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give value for the shares in connection with the event causing the shares to be
held as Shares-in-Trust (e.g., in the event of a gift, demise or other such
transaction), the fair market value of the Shares-in-Trust on the date of the
purported transfer, and (ii) the price per share received from the sale or other
disposition of the Shares-in-Trust at which point the Shares-in-Trust will
automatically cease to be Shares-in-Trust. See "DESCRIPTION OF CAPITAL
STOCK--Restrictions on Transfer" and "FEDERAL INCOME TAX
CONSIDERATIONS--Requirements for Qualifications."
Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors has the right, in its sole
discretion and pursuant to the Charter, to waive the Ownership Limit for a
purchaser of the Common Stock. See "DESCRIPTION OF CAPITAL STOCK." In connection
with any such waiver, the Company may require that the stockholder requesting
such a waiver enter into an agreement with the Company providing for the
repurchase by the Company of shares from the stockholder under certain
circumstances to ensure compliance with the REIT Provisions of the Code. Such
repurchase would be at fair market value as set forth in the agreement between
the Company and such stockholder. The consideration received by the stockholder
in such repurchase might be characterized as the receipt by the stockholder of a
dividend from the Company, and any stockholder entering into such an agreement
with the Company should consult its tax advisor in connection with its entering
into such an agreement.
The Charter authorizes the Board of Directors to issue up to 25,000,000
shares of preferred stock and to establish the preferences and rights of any
shares of preferred stock issued. Although the Company has no current intention
to issue any series of preferred stock, the issuance of any series of preferred
stock could have the effect of delaying or preventing a change in control of the
Company even if a majority of the holders of the Company's Common Stock believed
such change of control was in their best interest. See "DESCRIPTION OF CAPITAL
STOCK--Preferred Stock."
The provisions of the Company's Charter or relevant Maryland law may inhibit
market activity and any takeover or other transaction in which holders of some
or a majority of the Company's capital stock might receive a premium for their
shares or which such holders might believe to be otherwise in their best
interests. Such provisions also may make the Company an unsuitable investment
vehicle for any person seeking to obtain ownership of more than 9.9% of the
outstanding shares of capital stock. See "DESCRIPTION OF CAPITAL
STOCK--Restrictions on Transfer."
In addition, material provisions of the Maryland General Corporation Law
(the "MGCL") relating to "business combinations" and a "control share
acquisition" and of the Charter and Bylaws may also have the effect of delaying,
deterring or preventing a takeover attempt or other change in control of the
Company that would be beneficial to stockholders and might otherwise result in a
premium over then prevailing market prices. See "CERTAIN PROVISIONS OF MARYLAND
LAW AND THE COMPANY'S CHARTER AND BYLAWS."
LIMITATION ON LIABILITY OF DIRECTORS AND OFFICERS
The Charter contains a provision which, subject to certain exceptions,
limits the liability of a director or officer to the Company or its stockholders
for monetary damages for any breach of duty as a director or officer. This
provision does not eliminate such liability to the extent that it is proved that
the director or officer actually received an improper benefit or profit or to
the extent that it is found that the act or omission of the director or officer
resulted from active or deliberate dishonesty. See "CERTAIN PROVISIONS OF
MARYLAND LAW AND THE COMPANY'S CHARTER AND BYLAWS--Limitation of Liability."
COMMON STOCK PRICE MAY BE ADVERSELY AFFECTED BY INTEREST RATE VOLATILITY AND THE
PERFORMANCE OF OTHER REITS
It is likely that the market price of the Common Stock will be influenced by
any variation between the net yield on the Company's investment portfolio and
prevailing market interest rates and by the market's
33
<PAGE>
perception of the Company's ability to achieve earnings growth. The Company's
earnings will be derived in large part from any positive spread between the
yield on the Company's investment portfolio and the cost of the Company's
borrowings. The positive spread between the yield on the Company's investment
portfolio and the cost of borrowings will not necessarily be larger in high
interest rate environments than in low interest rate environments. Accordingly,
in periods of high interest rates, the net income of the Company, and therefore
the dividend yield on the Common Stock, may be less attractive compared with
alternative investments, which could adversely affect the price of the Common
Stock. If the anticipated or actual net yield on the Company's investment
portfolio declines or if prevailing market interest rates rise, thereby
decreasing the positive spread between the net yield on the investment portfolio
and the cost of the Company's borrowings, the market price of the Common Stock
may be adversely affected. In addition, if the market prices of the stocks of
public REITs with similar investment objectives decline for any reason, or the
value of the Company's Real Estate Investments declines, the market price of the
Common Stock may be adversely affected. During any period when the market price
of the Common Stock has been adversely affected due to any of the foregoing
reasons, the liquidity of the Common Stock may be negatively impacted and
investors who may desire or be required to sell their shares may experience
losses.
POTENTIAL FUTURE OFFERINGS MAY DILUTE STOCKHOLDERS' INTERESTS
The Company, in the future, may increase its capital resources by making
offerings of additional equity and debt securities, including classes and series
of preferred stock, additional classes and series of common stock, commercial
paper, medium-term notes and senior or subordinated notes. All debt securities
and classes of preferred stock will be senior to the Common Stock in a
liquidation of the Company. The effect of additional equity offerings (including
issuances under any dividend reinvestment plan adopted by the Company) may be to
dilute the equity of stockholders of the Company or to reduce the price of
shares of the Common Stock, or both. See "THE COMPANY--Dividend Reinvestment
Plan." The Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and other
factors.
YEAR 2000 COMPLIANCE
As the year 2000 approaches, an issue has emerged regarding how existing
application software programs and operating systems can accomodate this date
value. Failure to adequately address this issue could have potentially serious
repercussions. The Manager is in the process of working with the Company's
service providers to prepare for the year 2000. Based on information currently
available, the Company does not expect that it will incur significant operating
expenses or be required to incur material costs to be year 2000 compliant.
34
<PAGE>
USE OF PROCEEDS
All of the approximately $184.5 million (or $212.4 million, if the
Underwriters' over-allotment option is exercised in full) of net proceeds of the
Offering and all of the approximately $20 million of net proceeds of the Private
Placement will be used to purchase all of the Units in the Operating
Partnership. The Company, through the Operating Partnership, has contracted,
subject to the approval of the Independent Directors, to purchase the Initial
Investments from Affiliated Funds for their fair market value (estimated, as of
March 31, 1998, to be $212.2 million). In order to close its purchase of the
Initial Investments, the Company will be required to obtain additional
financing. See "INVESTMENT OBJECTIVES AND POLICIES-- Initial Investments."
CAPITALIZATION
The capitalization of the Company, as of February 28, 1998, and as adjusted
to reflect the sale of the shares of Common Stock offered hereby (rounded to the
nearest dollar), is as follows:
<TABLE>
<CAPTION>
AS
ACTUAL ADJUSTED(1)(2)(3)
--------- ----------------
<S> <C> <C>
Preferred Stock, par value $.01...................................................... $ 0 $ 0
Authorized--25,000,000 shares
Outstanding--0 shares; 0 shares, as adjusted
Class A Common Stock, par value $.001................................................ 1 11,001
Authorized--74,000,000 shares
Outstanding--750 shares; 11,000,750 shares, as adjusted
Class B Common Stock, par value $.001................................................ 0 200
Authorized--1,000,000 shares
Outstanding--0 shares; 200,000 shares, as adjusted
Additional Paid-in Capital........................................................... 14,999
--------- -------
Total.............................................................................. $ 15,000 $
--------- -------
--------- -------
</TABLE>
- ------------------------
(1) Assumes Underwriters' over-allotment option to purchase up to an additional
1,500,000 shares of Common Stock is not exercised.
(2) Does not include 1,300,000 shares (1,495,000 shares if the Underwriters'
over-allotment option is exercised in full) of Common Stock reserved for
issuance upon exercise of options authorized under the Company's Stock
Incentive Plan. See "THE COMPANY--Stock Incentive Plan."
(3) Includes 1,000,000 shares of Common Stock subscribed for by Mr. Heflin,
Clarion Partners (which includes Mr. Sullivan) and an Affiliated Fund in the
Private Placement. See "PRIVATE PLACEMENT."
35
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The Company intends to pursue policies and strategies for acquiring Real
Estate Investments in an attempt to provide a high rate of return to its
stockholders without incurring risk deemed unacceptable by the Manager or
compromising the Company's REIT qualification. The Company's income will result
primarily from the spread between the earnings generated by the Company's
assets, investment income thereon and related income over the cost of financing
and hedging these assets. The Company will also realize capital gains or losses
upon the disposition of its assets. The Company will leverage its investments in
such assets primarily through securitizations, bank borrowings and other types
of collateralized financings. The Company may also engage in a variety of
interest rate risk management techniques for the purpose of managing the
interest rate risk of its assets or liabilities. Any such transaction is subject
to risks or to limiting the potential earnings from the Company's investments.
The Company intends to hold its assets as investments with an intent and for a
period of time sufficient to avoid such assets becoming characterized as held
"primarily for sale to customers in the ordinary course of trade or business,"
gain from which would be treated as income from a prohibited transaction that is
subject to a 100% penalty tax under the Code. See "FEDERAL INCOME TAX
CONSIDERATIONS--Taxation of the Company."
The Company has not established specific policies addressing hedging
transactions in which it will engage. The amount of income the Company may earn
from its hedging instruments is subject to certain limitations under the REIT
Provisions of the Code. See "FEDERAL INCOME TAX CONSIDERATIONS-- Requirements
for Qualification--Income Tests." These limitations may result in the Manager
electing to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts, that
bearing such risk is advisable to maintain the Company's status as a REIT. The
Board of Directors may adopt policies with respect to hedging and revise them
without the consent of the Company's stockholders.
PROPOSED INVESTMENTS
The Company intends to invest principally in the following types of assets:
CMBS. The Company intends to originate and acquire various classes
(primarily subordinate, including "first loss") of CMBS. CMBS are generally
multi-class debt or pass-through securities backed by a commercial mortgage loan
or a pool of commercial mortgage loans secured by Commercial Property. CMBS
include, but are not limited to, regular and residual interests in REMICs and
regular interests in certain FASITs and may be issued in public (registered) or
private transactions by either governmental or private entities. Private issuers
include investment banks, commercial banks, insurance companies and owners of
Commercial Property.
Of the interests in CMBS that the Company originates or acquires, most will
be in subordinate classes; however, the Company may also purchase more senior
classes or combined classes of subordinate and more senior classes. Subordinate
CMBS are generally not registered with the SEC and are traded in the private
market. However, a significant number of U.S. investment banks are active
dealers in this market as well as principal underwriters of new issues.
Consequently, an investment manager's experience with the dealer market and
valuation skills are important.
Generally, investors in senior securities are protected against potential
losses on underlying mortgage loans through priorities as to payment of
principal and interest. Although protections against loss to investors in
subordinate securities may include investor guarantees, reserve funds, excess
interest, cross-collateralization and over-collateralization, subordinate
securities may lack sufficient credit protection and are thus more sensitive to
the default of underlying mortgage loans than senior securities of the same
issuer.
The yield-to-maturity on subordinate CMBS may be extremely sensitive to the
default and loss experience of the underlying Mortgage Collateral and the timing
of any such defaults or losses. Because
36
<PAGE>
the subordinate classes generally have no credit support, to the extent there
are realized losses on the Mortgage Collateral, the Company will experience a
concurrent loss and may not recover the full amount, or any, of its investment
in such subordinate CMBS.
In evaluating the Mortgage Collateral securing the CMBS, the Company will
use screening techniques to determine which loans will undergo a full-scope
review and which loans will undergo a more streamlined review process. Although
the screening process is a subjective one, considerations that influence the
choice for scope of review often include loan size, debt service coverage ratio,
loan-to-value ratio, loan maturity, lease rollover, property type and geographic
location. A full-scope review may include, among other factors, and to the
extent available, a property site inspection, tenant-by-tenant rent roll
analysis, review of historical income and expenses for each property securing
the loan, a review of major leases for each property; recent appraisals,
engineering and environmental reports and broker price opinions (opinions as to
the market value of a property given by local real estate brokers, based on
recent sales of similar properties in the same geographic area and, in many
cases, visits to the subject property). For those loans that are selected for
the more streamlined review process, the Company's evaluation may include a
review of the property operating statements, summary loan level data, third
party reports, and broker price opinions, each as available. If the Company's
review of such information does not reveal any unusual or unexpected
characteristics or factors, the Company may elect not to perform any additional
due diligence.
Ratings may be assigned to CMBS by the rating agencies such as S&P, Moody's,
Fitch IBCA and Duff & Phelps Credit Rating Co. ("Duff & Phelps"). These ratings
are substantially determined by the debt service coverage and loan-to-value
ratios of the pool and are relative, representing the subjective opinions of the
agencies. It is possible that an agency may not change its rating, after its
initial evaluation, to reflect subsequent events, both negative and positive.
Therefore, although these ratings will be used by the Manager as one piece of
important data in its selection process, the Manager will rely principally upon
its own credit analysis.
COMMERCIAL MORTGAGE LOANS. The Company intends to originate and acquire
commercial mortgage loans. Although such mortgage loans will be acquired
primarily through the Manager's relationship with CLARION, mortgage loans may
also be acquired from entities such as commercial banks, mortgage bankers,
insurance companies and other mortgage lenders.
In considering whether to originate or acquire a mortgage loan, the Company
will request that the Manager underwrite, and perform certain due diligence
tasks with respect to, such mortgage loan in order to ascertain material
information as to the value of such mortgage loan. The Manager will review and
analyze many factors, including market conditions (market interest rates, the
availability of mortgage credit and economic, demographic, geographic, tax,
legal and other factors), the yield to maturity of the mortgage loan, the
liquidity of the mortgage loan, in the case of an acquisition of a mortgage loan
the limitations on the obligations of the seller with respect to the mortgage
loan, the rate and timing of payments to be made with respect to the mortgage
loan, the value and quality of the mortgaged property underlying the mortgage
loan, the risk of adverse fluctuations in the market values of that mortgaged
property as a result of economic events or governmental regulations, the
historical performance and other attributes of the property manager responsible
for managing the mortgaged property, relevant laws limiting actions that may be
taken with respect to loans secured by real property and limitations on recourse
against the obligors following realization on the collateral through various
means, risks associated with geographic concentration of underlying assets
constituting the mortgaged property for the relevant mortgage loan,
environmental risks, pending and threatened litigation, junior liens and other
issues relating to title and a prior history of default by affiliated parties on
their similar obligations. The Board of Directors of the Company has not
established any limits upon the geographic concentration of the commercial
mortgage loans to be originated or acquired by the Company or the credit quality
of the borrowers under such mortgage loans. Instead, the Company intends to make
origination and acquisition decisions through asset and credit analysis on a
case-by-case basis.
37
<PAGE>
SECURITIZATIONS. The Company intends to originate, acquire and accumulate
commercial mortgage loans for securitization as part of its investment strategy.
Upon securitization, the Company will generally sell the senior classes of the
new securities and retain the subordinate classes. By performing such
origination and securitization itself, the Company expects to achieve higher
returns than from purchasing subordinate CMBS classes from third parties.
Securitization is the process of pooling loans in a trust or other special
purpose vehicle and issuing securities, such as CMBS, from such trust or special
purpose vehicle. The Company intends to securitize commercial mortgage loans by
issuing structured debt. Under this approach, for accounting purposes, the
securitized commercial mortgage loans will remain on the Company's balance sheet
as assets and the debt obligations will appear as liabilities, in contrast with
off-balance sheet sale treatment. Issuing structured debt in this manner locks
in potentially less expensive, long-term, non-recourse financing that generally
better matches the terms of the commercial mortgage loans serving as collateral
for such debt than such preexisting borrowings. Each series of CMBS created by
securitization is expected to be fully payable from the Mortgage Collateral.
Except upon a breach of the standard representations and warranties made by the
Company when loans are securitized, the debt obligations created in the
securitization will be non-recourse to the Company.
The Manager, in its discretion, will determine the quantity of commercial
mortgage loans sufficient for securitization, after discussions with potential
underwriters, rating agencies and an evaluation of the costs of securitization.
The Company anticipates that the proceeds from its securitizations will be
used first to repay preexisting borrowings against the applicable Mortgage
Collateral (e.g., under reverse repurchase agreements) and then to acquire
additional Real Estate Investments.
The Company expects that its retained interests in the securitizations will
be subordinated with respect to payments of principal and interest on the
underlying mortgage loans to the classes of securities issued to investors in
such securitizations. Accordingly, any losses incurred on the underlying
mortgage loans will be applied first to reduce the remaining amount of the
Company's retained interest, until reduced to zero. Thereafter, any further
losses would be borne by investors in the more senior classes of CMBS.
Typically, in connection with the creation of a new mortgage loan
securitization, the issuer will be required to enter into a master servicing
agreement with respect to such series of mortgage securities with an entity
acceptable to the Rating Agencies that regularly engages in the business of
servicing mortgage loans (the "Master Servicer"). If, in the future, the Company
decides to service its own securitized mortgage loans, it will do so only
through noncontrolled REIT subsidiaries designed not to endanger the Company's
REIT qualification. See "FEDERAL INCOME TAX CONSIDERATIONS--Noncontrolled
Taxable Subsidiaries."
The Company presently intends to structure its securitizations so as to
avoid the attribution of any excess inclusion income to the Company's
stockholders. See "FEDERAL INCOME TAX CONSIDERATIONS-- Taxation of Taxable U.S.
Stockholders."
MEZZANINE INVESTMENTS. The Company intends to make Mezzanine Investments,
primarily in the form of preferred equity, leveraged joint venture equity and
subordinate and participating mortgage loans. Such investments may involve
development, rehabilitation or renovation projects. A preferred equity
investment is an ownership interest in real property that is generally entitled
to receive preferential treatment with respect to distributions of income
generated by such property. Leveraged joint venture equity involves an equity
investment in real property that is encumbered by mortgage debt, which will
generally provide the investor with preferential returns and/or conversion
rights into equity of another partner in the venture. A subordinate mortgage
loan is a loan secured by a subordinated lien on real property. A participating
mortgage may be a senior or junior lien and will entitle the mortgagee to
mortgage interest plus a participation in the property's operating cash flows or
residual value. To the extent the Company invests in participating mortgages, it
will attempt to ensure that the participating income satisfies the REIT income
38
<PAGE>
tests for qualification. See "FEDERAL INCOME TAX CONSIDERATIONS--Requirements
for Qualification-- Income Tests."
There are no particular characteristics which determine the type or
structure of a Mezzanine Investment to be made by the Company. The Company will
determine such type and structure after considering all of the characteristics
of the underlying property, including lease expirations, tenant credit quality,
appraisals and borrower evaluations. The structure of each Mezzanine Investment
will be chosen in an effort to provide a high rate of return to its stockholders
without incurring risk deemed unacceptable by the Manager or compromising the
Company's REIT qualification or the maintenance of its exemption under the
Investment Company Act.
Mezzanine Investments will generally provide the Company with interest at a
higher rate than generally paid on the senior mortgage plus, in most cases, a
percentage of gross revenues or, to the extent consistent with REIT
qualification, net operating income from the underlying property, payable to the
Company on an ongoing basis, and a percentage of any increase in value of the
property, payable upon maturity or refinancing. In other instances, the Company
may receive an interest rate that provides an attractive risk-adjusted return.
Alternatively, the Mezzanine Investments could take the form of a non-voting
preferred equity investment in a single purpose entity borrower with the terms
of the preferred equity substantially the same as described above. As a result
of REIT qualification requirements, such a preferred equity investment in a
taxable corporation would be limited to not more than 5%, measured by fair
market value, of the total assets of the Company.
As an example of a Mezzanine Investment, the Company may lend to, or invest
as preferred equity in, the owner of a Commercial Property that is subject to a
first mortgage lien equal to 70% of its value an additional 20% to 25% of the
value of the property. Typically, in the case of a loan, either the owner would
pledge to the Company, as security for its debt to the Company, the property
subject to the first lien (giving the Company a second lien position), or,
subject to REIT qualification requirements, partners (or members) of the owner
would pledge a partnership or limited liability company ("LLC") interest in the
owner (with, in either case, covenants by the partnership or LLC in favor of the
Company). If a partnership or LLC interest is pledged, then the Company may be
in a position to make decisions with respect to the operations of the property
in the event of a default on the loan.
The Company may also create mezzanine debt investments by originating first
mortgage loans and Mezzanine Investments using warehouse lines of credit and
securitizing such loans and issuing and selling senior securities while
retaining subordinate securities and Mezzanine Investments.
REAL PROPERTY. The Company may also invest in real property, including
underperforming real property and development and rehabilitation projects.
Underperforming real property and development and rehabilitation projects can be
risky investments because they generally do not generate sufficient cash flow to
provide a current cash return on the investment after meeting operating expenses
and debt service. The Company, however, will seek opportunities to purchase such
real property at attractive prices. The Company's general goal with respect to
each real property will be to purchase it at a favorably low price and to
reposition or convert the use of the property if required to improve its cash
flow by proper management.
If the Company is offered the opportunity to acquire any real property that
is likely to be characterized as held "primarily for sale to customers in the
ordinary course of trade or business," gain from which would be treated as
income from a prohibited transaction that is subject to a 100% penalty tax under
the Code, the Company may establish a taxable corporation in which the Company,
through the Operating Partnership, will hold a 95% non-voting ownership interest
to make the acquisition. See "FEDERAL INCOME TAX CONSIDERATIONS--Taxation of the
Company." Such a corporation would not be eligible for taxation as a qualified
REIT subsidiary, and any profits that it earns on its activities would be
subject to federal corporate income tax before they are distributable to the
Company. The fair market value of the Company's interest in such corporation
would have to represent not more than 5% of the total assets of the Company. See
"FEDERAL INCOME TAX CONSIDERATIONS--Noncontrolled Taxable Subsidiaries."
39
<PAGE>
DOMESTIC AND FOREIGN REAL ESTATE INVESTMENTS. The Company may invest in
both U.S. Dollar-denominated and non-U.S. Dollar-denominated Real Estate
Investments located within and outside the United States.
REAL ESTATE COMPANIES. The Company may invest in companies that have
substantial holdings of Real Estate Investments. In the case of an investment in
a taxable corporation, any such investment generally may represent neither (i)
more than 5%, measured by fair market value, of the total assets of the Company
nor (ii) more than 10% of the voting securities of such taxable corporation. The
ability of the Company to make such an investment may be curtailed in the event
that certain proposals included in President Clinton's February 1998 Budget
Proposal are introduced into legislation and enacted into law.
OTHER ELIGIBLE INVESTMENTS. Consistent with its investment objectives,
policies and restrictions and the strategies described in "--Investment
Management," the Company may also make investments in U.S. Government securities
(including U.S. Treasury securities and securities issued by agencies or
instrumentalities of the U.S. Government), asset-backed securities (including,
but not limited to, securities backed by consumer receivables, business
receivables, corporate obligations, insurance premiums, etc.), mortgage-backed
securities (agency and non-agency), corporate debt securities, commercial paper,
money market instruments, non-contingent interest bearing deposits in banks
chartered by or within the U.S. and money market mutual funds.
INITIAL INVESTMENTS
The Company, through the Operating Partnership, has contracted (subject to
the approval of the Independent Directors) with certain Affiliated Funds to
purchase, on the Closing Date with the net proceeds of the Offering and the
Private Placement and additional financing to be obtained prior to the Closing
Date, the following Initial Investments: (i) 22 classes of CMBS, (ii) two
commercial mortgage loans and (iii) one Mezzanine Investment. The Initial
Investments were selected by the Manager after analyzing various Real Estate
Investments for inclusion in the Company's portfolio, giving careful
consideration to the Company's investment objectives and the limitations
resulting from the Company's REIT qualification and the maintenance of its
exemption from the Investment Company Act. The Company will be purchasing the
Initial Investments at fair market value, determined as of the Closing Date. On
March 31, 1998, the fair market value of the Initial Investments was estimated
to be $212.2 million, which exceeds the expected net proceeds of the Offering
and the Private Placement. The fair market value for the CMBS and the commercial
mortgage loans included in the Initial Investments has and will be based on bids
solicited from investment banks for each such Initial Investment plus one-half
of the bid/offer price spread for similar securities. The fair market value of
the Mezzanine Investment included in the Initial Investments will equal the sum
of the unpaid principal balance of such Mezzanine Investment as of the Closing
Date plus any accrued interest thereon and associated acquisition costs. Such
purchase price will be adjusted to reflect any change in fair market value
between March 31, 1998 and the date of the closing of such purchase.
The fair market value of the Initial Investments will be derived by
considering a number of factors, including market quotes, the amount and timing
of potential net cash flows on the Initial Investments, the range of possible
returns on such purchases and the risks associated with such purchases,
including the risk that the ultimate return will be significantly affected by
losses, if any, realized on the Mortgage Collateral underlying the CMBS and on
the commercial mortgage loans and Mezzanine Investment themselves and other
factors that are outside the control of the Company.
CMBS. Tables I and II on the following pages contain a summary of the
material terms of the portion of the Initial Investments comprised of CMBS (the
"Initial CMBS"). The Initial CMBS consist of securities that have been issued
by, and are backed by Mortgage Collateral originated by, unaffiliated, non-
governmental third parties. The information set forth therein was derived from
the information provided to the Company by the trustees of the applicable series
of CMBS.
40
<PAGE>
TABLE I
CHARACTERISTICS OF THE INITIAL CMBS
(INFORMATION IS PROVIDED AS OF MARCH 31, 1998, UNLESS OTHERWISE INDICATED)
<TABLE>
<CAPTION>
TOTAL FOR
THIS CLASS
OF SECURITY
-----------
<S> <C> <C> <C> <C> <C> <C>
PERCENT TOTAL
RATING OF POOL ORIGINAL
ISSUE NAME CLASS (D/S/M/F)+ ISSUE DATE PAID DOWN PAR BALANCE
- ---------------------------------------------------- --------- ------------------- ----------- ------------- -----------
Bankers Trust Company, BTC Commercial Mortgage F -/-/Ba2/- 1/28/98 1.7% 4$2,275,166
Pass-Through Certificates, Series BTR Trust 1998-S1
(BT 1998-S1)#......................................
CS First Boston Mortgage Securities Corp., E BB/BB-/-/- 12/1/95 12.3 19,510,000
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)....................
CS First Boston Mortgage Securities Corp., F B/B-/-/- 12/1/95 12.3 9,756,000
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)#...................
DLJ Mortgage Acceptance Corp., Commercial Mortgage B3 BB/BB/Ba2/BB 5/17/96 2.6 30,600,000
Pass-Through Certificates, Series 1996-CF1 (DLJ
1996-CF1)..........................................
DLJ Mortgage Acceptance Corp., Commercial Mortgage B2 -/BBB-/-/BBB- 11/1/96 3.2 12,700,000
Pass-Through Certificates, Series 1996-CF2 (DLJ
1996-CF2)..........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage B6 -/B/-/- 3/1/98 0.0 15,000,000
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage B7 -/-/-/B- 3/1/98 0.0 6,300,000
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage C NR 3/1/98 0.0 16,796,331
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage J -/-/-/B- 9/1/97 0.6 16,969,000
Pass-Through Certificates, Series 1997-C1 (GMAC
1997-C1)#..........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage J -/-/B3/- 12/1/97 0.2 5,363,000
Pass-Through Certificates, Series 1997-C2 (GMAC
1997-C2)#..........................................
GS Mortgage Securities Corporation II, Commercial H -/-/-/BB 8/1/97 0.5 34,208,999
Mortgage Pass-Through Certificates, Series 1997-GL
I (GS 1997-GL1)#...................................
J.P. Morgan Commercial Mortgage Finance Corp., F -/BB/-/BB 9/1/97 0.6 51,688,000
Mortgage Pass-Through Certificates, Series 1997-C5
(JPM 1997-C5)......................................
KMART CMBS Financing, Inc., Commercial Mortgage D BBB/-/Baa2/- 3/4/97 4.1 48,000,000
Pass-Through Certificates, Series 1997-1 (KMART
1997-1)............................................
Mortgage Capital Funding, Inc., G -/BB/-/BB 7/1/96 9.3 32,559,000
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1996-MC1 (MCF 1996-MC1).......
Mortgage Capital Funding, Inc., F -/-/-/BB 11/1/97 0.4 43,528,864
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1997-MC2 (MCF 1997-MC2).......
Midland Realty Acceptance Corp., Commercial Mortgage E -/-/-/BBB- 12/1/96 2.7 7,682,000
Pass-Through Certificates, Series 1996-C2 (MRAC
1996-C2)#..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage F -/-/-/BB 6/1/97 1.1 41,742,000
Pass-Through Certificates, Series 1997-HF1 (MSC
1997-HF1)..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage G -/BB/Ba3/BB 10/1/97 0.4 26,408,000
Pass-Through Certificates, Series 1997-XL1 (MSC
1997-XL1)..........................................
Firststreet Investment, L.L.C. NB Commercial E -/-/-/BB 8/1/96 37.1 9,767,539
Mortgage Pass-Through Certificates, Series FSI
(NBCM FSI).........................................
Structured Asset Securities Corporation, Multiclass F -/B/-/B 11/1/95 29.7 11,664,755
Pass-Through Certificates, Series 1995-C4 (SASCO
1995-C4)#..........................................
Structured Asset Securities Corporation, Multiclass G -/B/-/B 2/1/96 28.9 96,005,662
Pass-Through Certificates, Series 1996-CFL (SASCO
1996-CFL)..........................................
Structured Asset Securities Corporation, Multiclass E -/-/-/BBB- 9/25/97 19.5 51,984,000
Pass-Through Certificates, Series 1997-C1 (SASCO
1997-C1)...........................................
<CAPTION>
THE
COMPANY'S
INVESTMENT
-----------
<S> <C> <C>
PAR AMOUNT CURRENT BALANCE
OF CLASS AS A PERCENTAGE
AS OF OF CURRENT POOL SUBORDINATION INVESTMENT
ISSUE NAME 3/31/98 COUPON AMOUNT PERCENTAGE* PAR BALANCE
- ---------------------------------------------------- ----------- ----------- ------------------- ----------------- -----------
Bankers Trust Company, BTC Commercial Mortgage 4$2,275,166 8.62% 10.17% 14.2% 2$1,137,583
Pass-Through Certificates, Series BTR Trust 1998-S1
(BT 1998-S1)#......................................
CS First Boston Mortgage Securities Corp., 19,510,000 8.30 9.12 8.0 5,000,000
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)....................
CS First Boston Mortgage Securities Corp., 9,756,000 8.30 4.56 3.4 9,756,000
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)#...................
DLJ Mortgage Acceptance Corp., Commercial Mortgage 30,600,000 8.27 6.68 9.2 8,900,000
Pass-Through Certificates, Series 1996-CF1 (DLJ
1996-CF1)..........................................
DLJ Mortgage Acceptance Corp., Commercial Mortgage 12,700,000 7.83 2.58 13.4 3,000,000
Pass-Through Certificates, Series 1996-CF2 (DLJ
1996-CF2)..........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 15,000,000 6.41 1.79 2.8 13,500,000
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 6,300,000 6.41 0.75 2.0 6,300,000
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 16,796,331 6.41 2.00 0.0 16,796,331
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage 16,969,000 6.60 1.01 2.0 8,654,190
Pass-Through Certificates, Series 1997-C1 (GMAC
1997-C1)#..........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage 5,363,000 6.75 0.50 2.8 5,363,000
Pass-Through Certificates, Series 1997-C2 (GMAC
1997-C2)#..........................................
GS Mortgage Securities Corporation II, Commercial 34,208,999 7.61 3.52 0.0 21,000,000
Mortgage Pass-Through Certificates, Series 1997-GL
I (GS 1997-GL1)#...................................
J.P. Morgan Commercial Mortgage Finance Corp., 51,688,000 7.56 5.03 6.0 7,500,000
Mortgage Pass-Through Certificates, Series 1997-C5
(JPM 1997-C5)......................................
KMART CMBS Financing, Inc., Commercial Mortgage 48,000,000 6.73 14.91 0.0 18,000,000
Pass-Through Certificates, Series 1997-1 (KMART
1997-1)............................................
Mortgage Capital Funding, Inc., 32,559,000 7.15 7.44 8.0 7,750,000
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1996-MC1 (MCF 1996-MC1).......
Mortgage Capital Funding, Inc., 43,528,864 7.21 5.02 6.5 10,000,000
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1997-MC2 (MCF 1997-MC2).......
Midland Realty Acceptance Corp., Commercial Mortgage 7,682,000 8.03 1.54 13.4 7,682,000
Pass-Through Certificates, Series 1996-C2 (MRAC
1996-C2)#..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage 41,742,000 6.86 6.83 4.8 5,580,000
Pass-Through Certificates, Series 1997-HF1 (MSC
1997-HF1)..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage 26,408,000 7.69 3.51 3.0 2,400,000
Pass-Through Certificates, Series 1997-XL1 (MSC
1997-XL1)..........................................
Firststreet Investment, L.L.C. NB Commercial 9,767,539 8.73 20.66 26.2 3,767,539
Mortgage Pass-Through Certificates, Series FSI
(NBCM FSI).........................................
Structured Asset Securities Corporation, Multiclass 11,664,755 8.70 7.11 14.2 8,664,755
Pass-Through Certificates, Series 1995-C4 (SASCO
1995-C4)#..........................................
Structured Asset Securities Corporation, Multiclass 96,005,662 7.75 7.01 12.6 6,000,000
Pass-Through Certificates, Series 1996-CFL (SASCO
1996-CFL)..........................................
Structured Asset Securities Corporation, Multiclass 47,010,409 6.53 3.37 28.8 16,984,000
Pass-Through Certificates, Series 1997-C1 (SASCO
1997-C1)...........................................
<CAPTION>
FAIR
PERCENTAGE MARKET
ISSUE NAME OF CLASS VALUE
- ---------------------------------------------------- ----------- ----------
Bankers Trust Company, BTC Commercial Mortgage 50.00% $21,130,988
Pass-Through Certificates, Series BTR Trust 1998-S1
(BT 1998-S1)#......................................
CS First Boston Mortgage Securities Corp., 25.63 5,109,460
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)....................
CS First Boston Mortgage Securities Corp., 100.00 8,925,472
Commercial Mortgage Pass-Through Certificates,
Series 1995-WF1 (CSFB 1995-WF1)#...................
DLJ Mortgage Acceptance Corp., Commercial Mortgage 29.08 9,148,007
Pass-Through Certificates, Series 1996-CF1 (DLJ
1996-CF1)..........................................
DLJ Mortgage Acceptance Corp., Commercial Mortgage 23.62 3,088,773
Pass-Through Certificates, Series 1996-CF2 (DLJ
1996-CF2)..........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 90.00 9,678,326
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 100.00 3,578,432
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
DLJ Commercial Mortgage Corp., Commercial Mortgage 100.00 7,557,879
Pass-Through Certificates, Series 1998-CF1 (DLJ
1998-CF1)#.........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage 51.00 5,065,020
Pass-Through Certificates, Series 1997-C1 (GMAC
1997-C1)#..........................................
GMAC Commercial Mortgage Securities, Inc., Mortgage 100.00 3,092,231
Pass-Through Certificates, Series 1997-C2 (GMAC
1997-C2)#..........................................
GS Mortgage Securities Corporation II, Commercial 61.39 20,668,389
Mortgage Pass-Through Certificates, Series 1997-GL
I (GS 1997-GL1)#...................................
J.P. Morgan Commercial Mortgage Finance Corp., 14.51 7,498,470
Mortgage Pass-Through Certificates, Series 1997-C5
(JPM 1997-C5)......................................
KMART CMBS Financing, Inc., Commercial Mortgage 37.50 18,040,950
Pass-Through Certificates, Series 1997-1 (KMART
1997-1)............................................
Mortgage Capital Funding, Inc., 23.80 7,377,512
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1996-MC1 (MCF 1996-MC1).......
Mortgage Capital Funding, Inc., 22.97 9,396,670
Multifamily/Commercial Mortgage Pass-Through
Certificates, Series 1997-MC2 (MCF 1997-MC2).......
Midland Realty Acceptance Corp., Commercial Mortgage 100.00 8,026,269
Pass-Through Certificates, Series 1996-C2 (MRAC
1996-C2)#..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage 13.37 5,138,985
Pass-Through Certificates, Series 1997-HF1 (MSC
1997-HF1)..........................................
Morgan Stanley Capital I Inc., Commercial Mortgage 9.09 2,399,522
Pass-Through Certificates, Series 1997-XL1 (MSC
1997-XL1)..........................................
Firststreet Investment, L.L.C. NB Commercial 38.57 3,521,033
Mortgage Pass-Through Certificates, Series FSI
(NBCM FSI).........................................
Structured Asset Securities Corporation, Multiclass 74.28 8,067,138
Pass-Through Certificates, Series 1995-C4 (SASCO
1995-C4)#..........................................
Structured Asset Securities Corporation, Multiclass 6.25 5,690,826
Pass-Through Certificates, Series 1996-CFL (SASCO
1996-CFL)..........................................
Structured Asset Securities Corporation, Multiclass 36.13 15,376,619
Pass-Through Certificates, Series 1997-C1 (SASCO
1997-C1)...........................................
</TABLE>
- ------------------------
+ Duff & Phelps, S&P, Moody's and Fitch IBCA. '-' means not rated.
* Represents the principal amount of securities of the related series that are
subordinate in right of payment to the indicated class of Initial CMBS,
expressed as a percentage of the entire outstanding amount of securities of
such series.
# Includes Special Servicing Rights.
41
<PAGE>
TABLE II
DISTRIBUTION OF THE INITIAL CMBS BY GEOGRAPHIC LOCATION
AND TYPE OF UNDERLYING PROPERTY
(AS OF THE ISSUE DATE FOR EACH SECURITY)
<TABLE>
<CAPTION>
ISSUE NAME CLASS ISSUE DATE GEOGRAPHIC CONCENTRATIONS OF 10% OR GREATER
- ---------------------- ----------- ----------- ---------------------------------------------------------------------
<S> <C> <C> <C>
BT 1998-S1............ F 1/28/98 California (30%), Texas (20%), Florida (14%)
CSFB 1995-WF1......... E 12/1/95 California (76%), Texas (11%)
CSFB 1995-WF1......... F 12/1/95 California (76%), Texas (11%)
DLJ 1996-CF1.......... B3 5/17/96 Texas (26%), California (15%), Michigan (11%), Florida (10%)
DLJ 1996-CF2.......... B2 11/1/96 Texas (24%), California (16%)
DLJ 1998-CF1.......... B6 3/1/98 New Jersey (13%), California (10%)
DLJ 1998-CF1.......... B7 3/1/98 New Jersey (13%), California (10%)
DLJ 1998-CF1.......... C 3/1/98 New Jersey (13%), California (10%)
GMAC 1997-C1.......... J 9/1/97 California (17%), New York (12%)
GMAC 1997-C2.......... J 12/1/97 California (25%), Florida (13%)
GS 1997-GL1........... H 8/1/97 California (28%), New York (23%), Virginia (11%)
JPM 1997-C5........... F 9/1/97 California (19%)
KMART 1997-1.......... D 3/4/97 New York (13%), Ohio (11%)
MCF 1996-MC1.......... G 7/1/96 New York (14%), California (13%)
MCF 1997-MC2.......... F 11/1/97 California (13%), Texas (10%)
MRAC 1996-C2.......... E 12/1/96 Texas (23%), California (11%), Florida (10%)
MSC 1997-HF1.......... F 6/1/97 California (27%), New York (15%)
MSC 1997-XL1.......... G 10/1/97 New York (26%), California (13%)
NBCM FSI.............. E 8/1/96 Florida (25%), Pennsylvania (23%), Texas (19%), Georgia (11%)
SASCO 1995-C4......... F 11/1/95 California (20%), Connecticut (14%), Pennsylvania (12%),
Massachusetts (10%)
SASCO 1996-CFL........ G 2/1/96 California (23%), New Jersey (13%)
SASCO 1997-C1......... E 9/25/97 California (32%), New York (14%), Michigan (12%)
<CAPTION>
ISSUE NAME PROPERTY TYPE CONCENTRATIONS OF 10% OR GREATER
- ---------------------- ---------------------------------------------------------------------
<S> <C>
BT 1998-S1............ Office (37%), Hotel (33%), Multifamily (25%)
CSFB 1995-WF1......... Retail (63%), Industrial (16%), Office (10%), Multifamily (10%)
CSFB 1995-WF1......... Retail (63%), Industrial (16%), Office (10%), Multifamily (10%)
DLJ 1996-CF1.......... Multifamily (39%), Retail (35%), Hotel (14%)
DLJ 1996-CF2.......... Multifamily (45%), Retail (24%), Mixed Use (15%), Office (11%)
DLJ 1998-CF1.......... Retail (32%), Multifamily (19%), Office (14%), Hotel (20%)
DLJ 1998-CF1.......... Retail (32%), Multifamily (19%), Office (14%), Hotel (20%)
DLJ 1998-CF1.......... Retail (32%), Multifamily (19%), Office (14%), Hotel (20%)
GMAC 1997-C1.......... Retail (26%), Multifamily (19%), Office (18%), Industrial (10%)
GMAC 1997-C2.......... Multifamily (28%), Retail (26%), Nursing Home (17%)
GS 1997-GL1........... Office (57%), Retail (33%)
JPM 1997-C5........... Retail (32%), Multifamily (27%), Office (15%)
KMART 1997-1.......... Retail (100%)
MCF 1996-MC1.......... Multifamily (45%), Retail (31%), Self-Storage (14%)
MCF 1997-MC2.......... Multifamily (41%), Retail (28%), Office (13%), Hotel (10%)
MRAC 1996-C2.......... Multifamily (39%), Retail (31%), Office (19%)
MSC 1997-HF1.......... Manufactured Housing (22%), Self-Storage (19%), Retail (17%),
Multifamily (15%), Office (14%)
MSC 1997-XL1.......... Retail (48%), Multifamily (19%), Office (17%), Hotel (17%)
NBCM FSI.............. Office (31%), Multifamily (24%), Hotel (22%), Retail (16%)
SASCO 1995-C4......... Office (29%), Retail (23%), Industrial (22%), Multifamily (19%)
SASCO 1996-CFL........ Retail (28%), Office (28%), Multifamily (24%), Warehouse (13%)
SASCO 1997-C1......... Office (51%), Multifamily (19%), Retail (18%)
</TABLE>
All of the Initial CMBS are subordinated in right of payment of
principal and interest to one or more senior classes of CMBS of the same series,
protecting such senior classes from losses on the related Mortgage Collateral.
In general, on any distribution date, prepayments of principal will typically be
distributed to the most senior class of securities, and not to such CMBS, as
long as the more senior securities are outstanding or certain
overcollateralization levels are not met. Generally, on any distribution date,
no interest is distributed to such CMBS until interest allocable to more senior
classes for that distribution date has been distributed. In addition, as losses
are incurred on the Mortgage Collateral, such losses will be borne by the most
junior class of CMBS then having an outstanding balance.
Substantially all of the Initial Investments consisting of CMBS have not
been registered under the Securities Act or any state securities laws, and,
accordingly, transfer of such CMBS is restricted. Moreover, such CMBS cannot be
transferred to an employee benefit plan (a "Plan") subject to Title I of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA") except in
certain limited circumstances. As a result, there may be no liquid market for
the Initial CMBS.
The ratings of the Rating Agencies on CMBS address the likelihood of the
receipt of all distributions to which such holders are entitled. The ratings do
not represent any assessment of (i) the likelihood or frequency of principal
prepayments on the Mortgage Collateral, (ii) the degree to which such
prepayments might differ from those originally anticipated or (iii) whether and
to what extent any yield maintenance payments may be received in connection with
such prepayments. Also, a security rating does not represent any assessment of
the yield to maturity that investors may experience on any security. A security
rating is not a recommendation to buy, sell or hold securities and may be
subject to revision or withdrawal at any time by the assigning rating agency.
42
<PAGE>
COMMERCIAL MORTGAGE LOANS. The following is a summary of the material terms
of the two commercial mortgage loans included in the Initial Investments.
THE HAMPTON INN & SUITES
The Company has contracted with an Affiliated Fund to purchase a first
mortgage loan secured by The Hampton Inn & Suites in Islamorada, Florida. This
mortgage loan was made on December 24, 1997 at a 67% loan-to-value ratio, is in
an original principal amount of $7.6 million and bears interest at a fixed rate
of 8.235% per annum. The loan matures on December 1, 2004 and amortizes over a
25-year schedule. The mortgage loan may not be prepaid until December 1, 2001,
and any prepayment thereafter will be subject to a yield maintenance premium.
The mortgaged property consists of 79 rentable guest rooms, 59 of which are
suites, in a five-story tower. The hotel is located on 5.35 acres with
improvements totaling 89,728 square feet, including space for a 7,500 square
foot restaurant. Other improvements include an outdoor bar and restaurant, a
boat dock with 18 slips, an on-site dive shop, a heated outdoor pool, a Jacuzzi,
a fitness center and a sauna. The property was built in 1972 and fully
re-developed in 1996.
As of March 31, 1998, the fair market of this Initial Investment was $7.9
million, determined in the manner described above.
THE OMNI NEWPORT NEWS HOTEL
The Company has contracted with an Affiliated Fund to purchase a first
mortgage loan secured by The OMNI Hotel in Newport News, Virginia. The mortgage
loan was made on December 18, 1997 at a 70% loan-to-value ratio, is in an
original principal amount of $12.6 million and bears interest at a fixed rate
equal to 7.885% per annum. The loan matures on December 1, 2004 and amortizes
over a 25-year schedule. The mortgage loan may not be prepaid until December 1,
2001, and any prepayment thereafter shall be subject to a yield maintenance
premium.
The mortgaged property consists of 183 rentable guest rooms, four of which
are suites, in a nine-story tower. The hotel is located on 5.85 acres with
improvements totaling 128,500 square feet, including 11,500 square feet of
meeting and pre-function space. Other improvements include a restaurant,
nightclub, fitness room, two saunas and an enclosed pool. The hotel was
constructed in 1989.
As of March 31, 1998, the fair market of this Initial Investment was $13.0
million, determined in the manner described above.
MEZZANINE INVESTMENT. The following is a summary of the Mezzanine
Investment included in the Initial Investments.
THE ALLWOOD BRIGHTON OFFICE CENTER
The Company has contracted with an Affiliated Fund to purchase a preferred
limited partnership interest in the owner of The Allwood Brighton Office Center
in Clifton, New Jersey. This investment is in the amount of $3.7 million and
will be entitled to an annual return of 11% per annum, plus an accrual of an
additional 3% per annum payable on August 1, 2002 or earlier to the extent of
available net cash flow from the property. With respect to this investment,
"available net cash flow" means cash flow after the payment of operating
expenses, tenant improvements, mortgage payments, the 11% annual return on this
investment and agreed upon reserves. In addition to such fixed returns, the
Company will be entitled to receive (i) 20% of "available net cash flow" after
payment of the 3% accrual described above and (ii) 20% of the "residual." With
respect to this investment, "residual" means net proceeds from the disposition
or refinancing of the property less the remaining balance of the senior
mortgage, less the principal amount of this investment and any unpaid or accrued
interest thereon, less any capital contributions made by the property owner,
such contributions not to exceed $300,000.
43
<PAGE>
The senior mortgage loan on the property is in an original principal amount
of $9.6 million and bears interest at a fixed rate of 7.875% per annum, which
rate will be reset by the mortgagee on August 1, 2002. In the event the property
owner accepts such rate reset, the senior loan will be extended for an
additional five years. If the property owner does not accept such rate reset,
the loan will mature on August 1, 2002.
The property consists of three suburban office buildings totaling 162,390
square feet of net rentable area. The first building contains 51,665 rentable
square feet and is 96.4% occupied by nine tenants. The second building contains
51,725 rentable square feet and is 92.2% occupied by twelve tenants. The third
building contains 59,000 rentable square feet and is 100% leased through
September 30, 2008 to Linens N' Things as its corporate headquarters.
As of March 31, 1998, the fair market value of this Initial Investment was
$3.8 million, determined in the manner described above.
INVESTMENT MANAGEMENT
INVESTMENT MANAGEMENT TECHNIQUES. To the extent consistent with REIT
qualification, the Company intends to use a variety of investment management
techniques to be used for duration management and other risk management in the
attempt to protect against possible changes in the market value of the Company's
portfolio resulting from fluctuations in the debt securities markets and changes
in interest rates, to protect the Company's unrealized gains in the value of its
portfolio securities, and to establish a position in the securities markets as a
temporary substitute for purchasing particular securities. There is no
particular strategy that requires use of one technique rather than another as
the decision to use any particular strategy or instrument is a function of
market conditions and the composition of the portfolio. Certain investment
management techniques may give rise to income that would not be qualifying
income for REIT purposes. Consequently, the REIT may invest in nonvoting shares
of a taxable subsidiary established to make such investments.
With respect to hedging and risk management, the variable degree of
correlation between price movements of hedge instruments and price movements in
the position being hedged creates the possibility that losses on the hedge may
be greater than gains in the value of the Company's position. The same is true
for such instruments entered into for income or gain. In addition, certain
instruments and markets may not be liquid in all circumstances. As a result, in
volatile markets, the Company may not be able to close out a position without
incurring losses substantially greater than the initial deposit. Although the
contemplated use of these instruments is predominantly for hedging and should
tend to minimize the risk of loss due to a decline in the value of the position,
at the same time they tend to limit any potential gain which might result from
an increase in the value of such position. The ability of the Company to
successfully utilize investment management techniques will depend on the
Manager's ability to predict pertinent market movements and sufficient
correlations, which cannot be assured. Losses due to the use of investment
management techniques will reduce the net asset value of the Company.
HEDGING AND LEVERAGING
HEDGING. The Company's hedging activities are intended to address both
income and capital preservation. Income preservation refers to maintaining a
stable spread between yields from Real Estate Investments and the Company's
borrowing costs across a reasonable range of adverse interest rate environments.
Capital preservation refers to maintaining a relatively steady level in the
market value of the Company's capital across a reasonable range of adverse
interest rate scenarios. To monitor and manage capital preservation risk, the
Company will measure the "duration" of its capital. The duration of capital is
the expected change in the market value of the Company's capital caused by a 1%
change in interest rates. To monitor duration and the related risks of
fluctuations in the liquidation value of the Company's equity, the Company will
model the impact of various economic scenarios on the market value of the
Company's Real Estate Investments, liabilities and hedging instruments.
44
<PAGE>
The Company intends to engage in hedging activities that will provide a
level of income and capital protection against reasonable interest rate risks.
However, no strategy can insulate the Company completely from such risks, and
certain of the federal income tax requirements that the Company must satisfy to
qualify as a REIT limit the Company's ability to hedge. The Company intends to
monitor its hedging activity carefully and may have to limit its hedging
strategies so that it does not realize excessive income from hedging activities
or hold hedging instruments having excess value in relation to total assets,
which would result in the Company's disqualification as a REIT or, in the case
of excess hedging income, the payment of a penalty tax for failure to satisfy
certain REIT income tests under the Code, provided such failure was for
reasonable cause. See "FEDERAL INCOME TAX CONSIDERATIONS--Requirements for
Qualification."
Hedging activity involves transaction costs, and such costs can increase
significantly as the period covered by such activity increases. Therefore, the
Company may be prevented from effectively hedging all of its interest rate risk.
Certain losses incurred in connection with hedging activities may be capital
losses that would not be deductible to offset ordinary REIT income. In such a
situation, the Company would have incurred an economic loss of capital that
would not be deductible to offset the ordinary income from which dividends must
be paid.
The Company may hedge asset values, foreign currency exposure or borrowing
costs against interest rate and other market movements through the use of U.S.
treasury securities, swaps, options on such instruments and caps and floors. The
Company expects to enter into these transactions, to the extent consistent with
its election to qualify as a REIT, to preserve a return or spread on a
particular investment or portion of its portfolio, to protect against increases
in the price of securities the Company anticipates purchasing at a later date or
to reduce interest rate risk with respect to the Company's liabilities. These
transactions will be used to hedge as much of the interest rate risk as the
Manager determines is in the best interest of the Company and its stockholders,
given the costs associated with such hedges and the need to maintain the
Company's REIT status. The Company has not established specific policies as to
the extent of the hedging transactions in which it will engage. The Manager may
elect to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts, that
bearing such risk is advisable.
The Company may purchase an interest rate cap which entitles the purchaser,
to the extent that a specified index exceeds a predetermined interest rate, to
receive payments of interest on a notional principal amount from the party
selling such interest rate cap. An interest rate floor would entitle the
purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional principal amount
from the party selling such interest rate floor.
The Company will usually enter into interest rate swaps on a net basis,
i.e., the two payment streams are netted out, with the Company receiving or
paying, as the case may be, only the net amount of the two payments on the
payment dates. The Company will accrue the net amount of the excess, if any, of
the Company's obligations over its entitlements with respect to each interest
rate swap on a regular basis. If there is a default by the other party to such a
transaction, the Company will have contractual remedies pursuant to the
agreements related to such transactions.
The Company may also purchase securities on a "when-issued" basis and may
purchase or sell securities on a "forward commitment" basis. When such
transactions are negotiated, the price, which is generally expressed in yield
terms, is fixed at the time the commitment is made, but delivery and payment for
the securities takes place at a later date. When-issued securities and forward
commitments may be sold prior to the settlement date. If the Company disposes of
the right to acquire a when-issued security prior to its acquisition or disposes
of its right to deliver or receive against a forward commitment, it may incur a
gain or loss. There is always a risk that the securities may not be delivered
and the Company may incur a loss.
45
<PAGE>
Hedging instruments often are not traded on regulated exchanges, guaranteed
by an exchange or its clearing house, or regulated by any U.S. or foreign
governmental authorities. Consequently, there are no requirements with respect
to record keeping, financial responsibility or segregation of customer funds and
positions. The business failure of a counterparty with which the Company has
entered into a hedging transaction will most likely result in a default. The
default of a counterparty with which the Company has entered into a hedging
transaction may result in the loss of unrealized profits and force the Company
to cover its resale commitments, if any, at the then current market price.
Although generally the Company will seek to reserve for itself the right to
terminate its hedging positions, it may not always be possible to dispose of or
close out a hedging position without the consent of the counterparty, and the
Company may not be able to enter into an offsetting contract in order to cover
its risk. There can be no assurance that a liquid secondary market will exist
for hedging instruments purchased or sold, and the Company may be required to
maintain a position until exercise or expiration, which could result in losses.
LEVERAGING. The Company's operations are expected to be leveraged. The
Company intends to finance its acquisition of the Initial Investments through
the proceeds of the Offering and the Private Placement and, thereafter,
primarily through securitizations, reverse repurchase agreements and bank
borrowings. The extent to which the Company uses leverage will be determined by
the Manager and, ultimately, by the Board of Directors, who may act at any time
without the approval of, or notice to, the stockholders. The amount of leverage
used will vary depending on, among other things, the Company's estimate of the
cash flow that its assets will generate and the stability of that cash flow.
Leverage can reduce the cash flow available for distributions to stockholders.
The Company intends to enter into reverse repurchase agreements which are
structured as sale and repurchase obligations which allow a borrower to pledge
purchased assets as collateral securing short-term loans to finance the purchase
of such assets. Typically, the lender in a reverse repurchase arrangement makes
a loan in an amount equal to a percentage of the market value of the pledged
collateral. At the maturity, the borrower is required to repay the loan and the
pledged collateral is released. Pledged assets under reverse repurchase
agreements continue to pay principal and interest to the borrower. The Company
intends to enter into reverse repurchase agreements with financially sound
institutions, including broker-dealers, commercial banks and other lenders,
which meet credit standards approved by the Board of Directors. See
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS--Leveraging."
Reverse repurchase agreements may require the Company to deposit additional
collateral (a "margin call") or reduce its borrowings thereunder if the market
value of the pledged collateral declines. This may require the Company to sell
assets to provide such additional collateral or to reduce the amount borrowed.
If these sales were made at prices lower than the carrying value of such assets,
the Company would experience losses. The Company intends to maintain an equity
cushion sufficient to provide liquidity in the event of interest rate movements
and other market conditions affecting the market value of the pledged assets.
However, there can be no assurance that the Company will be able to safeguard
against being required to sell assets in the event of a change in market
conditions. If the Company were forced to liquidate assets, there can be no
assurance that it would be able to maintain compliance with the REIT Provisions
of the Code regarding assets and sources of income. See "FEDERAL INCOME TAX
CONSIDERATIONS--Requirements for Qualification."
The Company may invest in repurchase agreements, which are agreements
pursuant to which assets are acquired by the Company from a third party with the
understanding that they will be repurchased by the seller at a fixed price on an
agreed date. Repurchase agreements may be characterized as loans secured by the
underlying securities. The use of repurchase agreements involves certain risks.
For example, if the seller of securities under a repurchase agreement defaults
on its obligation to repurchase the underlying securities, as a result of its
bankruptcy or otherwise, the Company will seek to dispose of such securities,
which could result in costs or delays. If such seller becomes insolvent and
subject to liquidation or reorganization under applicable bankruptcy or other
laws, the Company's ability to dispose of the
46
<PAGE>
underlying securities may be restricted. Finally, it is possible that the
Company may not be able to substantiate its interest in the underlying
securities. In each such case, the Company may suffer a loss to the extent its
proceeds from the sale of the underlying securities are less than the repurchase
price.
The Company also intends to borrow money through various bank credit
facilities, which will have varying fixed or adjustable interest rates and
varying maturities. Since the Company is newly-formed and has not commenced
operations, it has not yet established any lines of credit or collateralized
financing facilities.
47
<PAGE>
THE COMPANY
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information regarding the current
directors and executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH COMPANY
- --------------------------------------------------- --- -------------------------------------------------------
<S> <C> <C>
Daniel Heflin...................................... 34 Chief Executive Officer, President and Director
Frank L. Sullivan, Jr.............................. 52 Executive Vice President and Chairman of the Board
William Powell..................................... 38 Vice President and Treasurer
...................................... Independent Director
...................................... Independent Director
...................................... Independent Director
Joanne Vitale...................................... 41 Vice President and Secretary
</TABLE>
Daniel Heflin joined the Manager in 1995 and has over 10 years of fixed
income investment experience. Mr. Heflin has supervised the acquisition and/or
structuring of more than $2 billion of mortgages, debt securities and Mezzanine
Investments. Prior to joining the Manager, Mr. Heflin was head of the Structured
Finance Department at Ocwen Financial Corporation from 1993 to 1995 and served
in the Capital Markets Group of Credit Suisse First Boston Corporation in London
from 1990 to 1993 and the Asset Securitization Group of Arthur Andersen & Co. in
New York from 1986 to 1990. He is also a Certified Public Accountant in the
State of New York.
Frank L. Sullivan, Jr. is a Managing Director of Clarion Partners, Chairman
of the Manager and Chairman of the Company's Board of Directors. He joined
Clarion Partners in 1984 and has over 25 years of real estate experience and has
supervised the acquisition and/or structuring of more than $7 billion in
mortgages, Mezzanine Investments and direct equity. Prior to joining Clarion
Partners, Mr. Sullivan held investment positions with Citibank, N.A. and
Provident National Bank. He is also a Professor of Finance at the New York
University Graduate School of Business and a member of the board of directors of
GGP/ Homart, Inc., a private REIT controlled by General Growth Properties, Inc.
and New York State Common Retirement Fund.
William Powell joined the Manager in 1997 and has over 15 years of real
estate investment experience. Mr. Powell's background includes the management of
over $1 billion in commercial real estate investments as well as the workout and
restructuring of over $600 million in distressed equity and mortgage debt. Prior
to joining the Manager, Mr. Powell was a senior vice president for ARES Realty
Capital, Inc., a real estate investment manager, from 1995 to 1997 and co-head
of the Northeast Region for its parent company, Mutual of New York, from 1993 to
1995. He is a Certified Public Accountant in the State of New York.
Joanne Vitale joined the Manager in 1996 and has over 12 years of real
estate experience. Prior to joining the Manager, she was a manager in the real
estate group at Coopers & Lybrand LLC from 1991 to 1995 and was in the investor
relations department of Kidder Peabody Realty Advisors from 1981 to 1989. Ms.
Vitale has participated in the securitization of over $2 billion of commercial
real estate assets.
The Company's Board of Directors, upon the consummation of the Offering,
will consist of five directors, a majority of which shall at all times be
Independent Directors. The directors will be divided as evenly as possible into
three classes, denominated Class I, Class II and Class III, with the terms of
office of each class expiring at the 1999, 2000 and 2001 annual meeting of
stockholders, respectively. At each annual meeting following such initial
classification and election, directors elected to succeed those directors whose
terms expire will be elected for a term to expire at the third succeeding annual
meeting of stockholders
48
<PAGE>
after their election. The directors in each class are as follows: Class I--an
Independent Director, Class II-- Mr. Sullivan and an Independent Director, and
Class III--Mr. Heflin and an Independent Director. All officers are appointed
by, and serve at the discretion of, the Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors will have three standing committees: the Executive
Committee, the Compensation Committee and the Audit Committee. Messrs. Heflin
and Sullivan will serve on the Executive Committee which will be authorized to
exercise the powers of the Board of Directors between meetings. However, the
Executive Committee may not (i) amend the Charter or the Bylaws of the Company,
(ii) adopt an agreement of merger or consolidation, (iii) recommend to the
stockholders the sale, lease, or exchange of all or substantially all of the
Company's property and assets, (iv) recommend to the stockholders a dissolution
of the Company or revoke a dissolution, (v) elect a director, (vi) declare a
dividend or authorize the issuance of stock or (vii) agree to an amendment,
modification, renewal or termination of the Management Agreement.
Mr. Sullivan and two Independent Directors will serve on the Compensation
Committee which will be responsible for recommending to the Board of Directors
the Company's compensation policies for the executive officers of the Company
and for administering the Stock Incentive Plan. See "--Stock Incentive Plan."
Two Independent Directors will also serve on the Audit Committee which will be
responsible for recommending independent auditors, reviewing the audit plan, the
adequacy of internal controls, the audit report and any management letters, and
performing such other duties as the Board of Directors may from time to time
prescribe. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS--Certain Accounting Policies and Procedures."
COMPENSATION OF DIRECTORS
The Company intends to pay each Independent Director compensation of $10,000
per annum in cash, $10,000 of Common Stock per annum (see "--Stock Incentive
Plan") and a fee of $500 for each meeting of the Board of Directors that such
Director attends. In addition, each Independent Director may be granted awards
from time to time under the Stock Incentive Plan. The Company will also
reimburse each Independent Director for ordinary and necessary expenses related
to such Independent Director's attendance at meetings of the Board of Directors
or any committee thereof.
EXECUTIVE COMPENSATION
The Company has not paid, and does not intend to pay, any annual
compensation to the Company's executive officers for their services as executive
officers. However, the executive officers and directors may be granted awards
from time to time pursuant to the Stock Incentive Plan. See "--Stock Incentive
Plan."
STOCK INCENTIVE PLAN
The Company adopted the 1998 Stock Incentive Plan (the "Stock Incentive
Plan") in March 1998 which will be administered by the Compensation Committee.
All employees, officers and Independent Directors of, and consultants to, the
Company and employees and officers of the Manager, CLARION and their affiliates
are eligible to receive awards under the Stock Incentive Plan (each, a "SIP
Participant").
Awards under the Stock Incentive Plan may include: (i) options to purchase
shares of Common Stock, including incentive stock options, non-qualified stock
options or both, which options may contain automatic reload features; (ii) stock
appreciation rights, whether in connection with the grant of stock options or
independent of such grant, or stock appreciation rights that are only
exercisable in the event of a Change of Control of the Company (as defined in
the Stock Incentive Plan) or upon other events; (iii) restricted stock, in which
Common Stock is granted to or purchased by SIP Participants for a purchase
49
<PAGE>
price determined by the Compensation Committee, subject to restrictions on
transferability and other restrictions, which lapse over time; (iv) deferred
stock, in which delivery of Common Stock occurs upon expiration of a deferral
period; (v) bonus stock, consisting of a right to receive Common Stock in an
amount determined with reference to a fixed bonus amount; or (vi) other awards
not otherwise provided for, the value of which are based in whole or in part
upon the value of the Common Stock.
The Compenstion Committee has discretion to select the persons to whom
awards will be granted (from among those eligible), to determine the type, size
and terms of the conditions applicable to each award and to interpret, construe
and implement the Stock Incentive Plan. The total number of shares of Common
Stock which may be the subject of awards under the Stock Incentive Plan shall be
1,300,000 (1,495,000 if the Underwriters' over-allotment option is exercised in
full). Not more than 300,000 shares of Common Stock may be the subject of
options (incentive stock options and nonqualified stock options) and stock
appreciation rights (including stock appreciation rights that are exercisable
only for cash) granted to any individual during any calendar year. Prior to the
Offering, the Board of Directors will grant awards with respect to the issuance
of an aggregate of 770,000 shares (885,500 shares if the Underwriters' over-
allotment option is exercised in full) of its Common Stock. See "--Grants of
Awards."
Based upon certain performance standards to be established by the
Compensation Committee, under the Stock Incentive Plan, the Company may also
grant up to 200,000 shares of deferred stock to certain employees, officers and
consultants of the Company and the Manager and its affiliates.
At the time a stock option is granted, the Compensation Committee, in its
sole discretion, may designate whether the stock option is to be considered an
incentive stock option or non-qualified stock option.
The exercise price of an incentive stock option or a non-qualified stock
option is fixed by the Board of Directors at the date of grant; however, the
exercise price under an incentive stock option must be at least equal to the
fair market value of the Common Stock at the date of grant. The base value of a
stock appreciation right granted in connection with a stock option is equal to
the exercise price of the related option. The base value of a stock appreciation
right granted independently of an option is equal to the fair market value of a
share of Common Stock on the date of grant. Upon any exercise of a stock
appreciation right, the holder is entitled to receive an amount equal to the
spread (or a portion of such spread, as determined by the Board of Directors)
between the fair market value of the Common Stock on the date of exercise and
the base value of the stock appreciation right. Such amount is payable by the
Company in the form of cash or shares of Common Stock, as determined by the
Compensation Committee.
Stock options and stock appreciation rights are exercisable for a duration
determined by the Compensation Committee, but in no event more than ten years
after the date of grant. Options and rights shall be exercisable at such rate
and times as may be fixed by the Compensation Committee on the date of grant. In
accordance with Section 422 of the Code pertaining to incentive stock options,
the aggregate fair market value (determined at the time the option is granted)
of the Common Stock with respect to which incentive stock options are
exercisable for the first time by a SIP Participant during any calendar year
(under all stock incentive plans of the Company) shall not exceed $100,000; to
the extent this limitation is exceeded, such excess options shall be treated as
non-qualified stock options for purposes of the Stock Incentive Plan and the
Code.
The Company shall obtain such consideration for granting awards under the
Stock Incentive Plan as the Compensation Committee in its discretion may
request. Each award may be subject to provisions to assure that the grant, or
any exercise or disposition of Common Stock, will not violate federal and state
securities laws.
No award may be granted under the Stock Incentive Plan after the day
preceding the tenth anniversary of the adoption of the Stock Incentive Plan.
Subject to waiver by the Board of Directors, no awards may be granted under the
Stock Incentive Plan to any person who, assuming exercise or settlement
50
<PAGE>
of all options and rights held by such person, would own or be deemed to own
more than 9.9%, in number of shares or value, of the Common Stock or any class
of preferred stock of the Company.
Payment of the purchase price for shares acquired upon the exercise of
options may be made by any one or more of the following methods: in cash, by
check, by delivery to the Company of shares of Common Stock already owned by the
option holder, or by such other method as the Compensation Committee may permit
from time to time. However, a holder may not use previously owned shares of
Common Stock to pay the purchase price under an option, unless the holder has
beneficially owned such shares for at least six months. Payment of the purchase
price to purchase restricted shares pursuant to a restricted stock award shall
be made in cash or by check payable to the order of the Company.
Stock options and stock appreciation rights terminate 90 days following the
SIP Participant's termination of employment or service. This period is extended
to one year in the case of the disability or death of the SIP Participant and,
in the case of death, the stock option is exercisable by the SIP Participant's
estate. The post-termination exercise period for any individual may be extended
by the Board of Directors, but not beyond the expiration of the original term of
the option.
The awards granted under the Stock Incentive Plan generally become
immediately vested and exercisable in full in the following circumstances (each
an "Acceleration Event"): (i) upon the occurrence of special circumstances
determined in the opinion of the Board of Directors of the Company to merit
special consideration, (ii) upon a termination by the Company of the holder's
employment or service without cause (as defined in the Stock Incentive Plan),
(iii) in the case of an employee or director of the Manager or CLARION, if the
Management Agreement terminates without the occurrence of a Termination Event
(as defined in the Stock Incentive Plan), or (iv) upon a Change of Control (as
defined in the Stock Incentive Plan) of the Company, except that vesting and
exercisability in the event of such a Change of Control shall be limited to the
extent necessary, and shall occur as soon as permissible under GAAP, to permit
pooling of interests accounting treatment if such treatment is desired.
The awards granted under the Stock Incentive Plan are not transferable,
except that the Compensation Committee may authorize a transfer of an award
(other than an incentive stock option) by the holder to certain family members
or trusts or other entities specified in the Plan or permitted by the
Compensation Committee, subject to such terms and conditions as the Compensation
Committee approves.
The awards granted under the Stock Incentive Plan contain anti-dilution
provisions which will automatically adjust the number of shares subject to the
awards in the event of a stock dividend, stock split, conversion, exchange,
reclassification or substitution. In the event of any other change in the
corporate structure or outstanding shares of Common Stock, the Compensation
Committee may make such equitable adjustments to the number of shares and the
class of shares available under the Stock Incentive Plan or any outstanding
awards as it shall deem appropriate to prevent dilution or enlargement of
rights.
The Board of Directors or the Compensation Committee may at any time
withdraw or amend the Stock Incentive Plan and may, with the consent of the
affected holder of an outstanding award at any time withdraw or amend the terms
and conditions of outstanding awards. Any amendment which would increase the
number of shares issuable pursuant to the Stock Incentive Plan or to the
individuals to whom awards may be granted shall be subject to the approval of
the stockholders of the Company.
51
<PAGE>
GRANTS OF AWARDS
In connection with the Offering, options to acquire 770,000 shares of Common
Stock at the initial offering price will be awarded under the Stock Incentive
Plan, to certain individuals and groups of individuals as follows:
<TABLE>
<CAPTION>
STOCK
OPTIONS(1)
---------------
<S> <C>
DIRECTORS AND OFFICERS OF THE COMPANY AND DIRECTORS, OFFICERS AND EMPLOYEES
OF THE MANAGER
Daniel Heflin.................................................................................... 227,000
Frank L. Sullivan, Jr............................................................................ 62,650
William Powell................................................................................... 40,000
Joanne Vitale.................................................................................... 40,000
Independent Directors............................................................................ 22,500
All other employees of the Company, the Manager and their affiliates............................. 100,000
-------
Subtotal..................................................................................... 492,150
DIRECTORS, OFFICERS AND EMPLOYEES OF CLARION
Stephen J. Furnary............................................................................... 73,550
John A. Weisz.................................................................................... 73,550
Charles Grossman................................................................................. 62,650
All other employees of Clarion Partners and its affiliates....................................... 68,100
-------
Subtotal..................................................................................... 277,850
-------
Total............................................................................................ 770,000
-------
-------
</TABLE>
- ------------------------
(1) The options will be non-qualified options with a per share exercise price
equal to the initial public offering price and shall have a ten-year term.
The options become exercisable at the rate of one-third on each of June 30,
1998, June 30, 1999 and June 30, 2000, subject to the holder's continued
employment or service and are exercisable in full upon the earlier
occurrence of an Acceleration Event.
COMPENSATION COMMITTEE INTERLOCKS
The Compensation Committee determines certain aspects of the compensation of
the executive officers of the Company. The members of the Compensation Committee
will be Frank L. Sullivan, Jr., Executive Vice President and Chairman of the
Board of the Company, and two Independent Directors.
The Compensation Committee administers the Stock Incentive Plan. The
Compensation Committee selects the individuals to whom stock awards and stock
options will be granted, subject to approval of the award by the Board of
Directors.
DIVIDEND REINVESTMENT PLAN
The Company may implement a dividend reinvestment plan whereby stockholders
may automatically reinvest their distributions from the Common Stock. Details
about any such plan will be sent to the Company's stockholders following
adoption thereof by the Board of Directors.
EMPLOYEES
The Company will have no employees and will not be responsible for the
salaries or benefits of any of the employees of the Manager.
FACILITIES
The Company's executive offices are located at 335 Madison Avenue, New York,
New York 10017 and its telephone number is (212) 883-2500. The Company uses the
offices and administrative resources (including proprietary systems, computer
hardware and software and databases) of the Manager without payment of any
additional fee or charge.
LEGAL PROCEEDINGS
There are no pending legal proceedings to which the Company is a party or to
which any assets of the Company is subject.
52
<PAGE>
THE MANAGER
The Manager was formed in December 1997 and has registered with the SEC as
an investment adviser. The Manager, comprised of ten investment professionals,
directs all of the real estate debt investment activity of Clarion Partners.
The President and CEO of the Manager is Daniel Heflin who has over ten years
of fixed income, securitization and real estate investment experience. He has
supervised the acquisition and/or structuring of more than $2 billion in
mortgages, debt securities and Mezzanine Investments and has participated in the
securitization of more than $20 billion of assets.
Frank L. Sullivan, Jr. is one of the founders of Clarion Partners and is
Chairman of the Board of the Manager. Mr. Sullivan has over 25 years of real
estate investment experience and has supervised the acquisition and/or
structuring of more than $7 billion in mortgages, Mezzanine Investments and
direct equity. He is also a Professor of Finance at the New York University
Graduate School of Business and a member of the board of directors of
GGP/Homart, Inc., a private REIT controlled by General Growth Properties, Inc.
and New York State Common Retirement Fund. Mr. Sullivan has agreed to serve as
Clarion Partners' investment officer for the Company and, while serving in such
capacity, not to provide his services to any other entity with investment
objectives similar to those of the Company.
CLARION PARTNERS
Clarion Partners was organized in 1982 as a fiduciary for institutional real
estate investors, specializing in sourcing, underwriting and managing Real
Estate Investments, and is registered with the SEC as an investment adviser.
Headquartered in New York, Clarion Partners and its affiliates have offices in
20 cities, and currently have over 350 employees, including 19 principals who
average over 20 years of real estate investment experience.
CLARION is one of the country's largest institutional real estate investment
advisors, managing over $6 billion in Real Estate Investments, including over
$4.5 billion in real property, $1.5 billion in REIT stocks and $600 million in
debt securities, commercial mortgage loans and Mezzanine Investments. Since
inception, CLARION has completed acquisitions and dispositions of over $10
billion in Real Estate Investments, acquired, and negotiated the resolution of,
over $2 billion in non-performing and sub-performing real estate investments and
structured over $2.5 billion in Mezzanine Investments.
CLARION acts as fiduciary for more than 75 institutional investors,
including:
<TABLE>
<S> <C>
- - Ameritech Pension Trust - State of Hawaii Employees Retirement
- - Florida State Board of Administration Systems
- - IBM Retirement Fund - State of Wisconsin Investment Board
- - New York State Teachers' Retirement - United Mine Workers of America 1974
System Pension Trust
- - New York State Common Retirement Fund - US West, Inc.
- - Oregon Public Employees Retirement Fund
</TABLE>
The funds advised by CLARION for its institutional investors, including
those named above, have investment strategies different from the intended
strategies of the Company.
Clarion Partners has been approved as a special servicer by S&P, Moody's and
Fitch IBCA. As an approved special servicer, Clarion Partners should be able to
assist the Company in attempting to control credit losses by managing the
"work-out" of sub-performing loans underlying CMBS which the Company originates
or in which it invests.
Clarion Partners has licensed the name "Clarion" to the Company on a
non-exclusive basis, revocable on 180 days' prior notice.
53
<PAGE>
AGREEMENT BETWEEN THE MANAGER AND CLARION
Under the terms of an agreement between the Manager and CLARION, CLARION
will provide mortgage origination and servicing and acquisition, asset and
property management services to the Manager. The Manager has been granted a
right of first refusal to acquire all commercial debt securities, commercial
mortgages and Mezzanine Investments originated by CLARION until the earlier of
(i) such time as the Company owns assets having a market value in excess of the
Purchasing Priority Amount, anticipated to be $511.3 million, or (ii) May ,
2001, the expiration of the initial term of the Management Agreement.
Thereafter, CLARION has agreed to allocate such investments to the Manager and
CLARION's other clients on a fair and equitable basis. The Manager has agreed
with the Company that this right of first refusal will inure solely to the
benefit of the Company and not to any Affiliated Fund until the Company owns
assets in excess of the Purchasing Priority Amount. Thereafter, the Manager has
agreed to allocate such investments among the Affiliated Funds and the Company
on a fair and equitable basis.
CLARION has agreed to provide such services to the Manager according to the
fee schedule below. Such fees shall be reimbursable by the Company.
<TABLE>
<CAPTION>
ASSET FEE SCHEDULE
- --------------------------------- -------------------------------------------------------------------------------
<S> <C>
Commercial Mortgages - Origination fee of 0.50% of loan amount
- Servicing fee of 0.08% of unpaid principal amount per annum
- Special servicing fee of 0.30% of unpaid principal amount per annum
Fixed Rate Second Mortgages - Origination fee of 1.0% of loan amount (minimum fee of $50,000 per loan)
- Servicing/special servicing fee of 0.35% (minimum fee of $25,000 per annum)
and liquidation fee of 1% of investment
Mezzanine Investments - Acquisition fee of 3.0% on the first $5 million of an investment, 2.0% on the
second $5 million and 1.0% thereafter (minimum fee of $100,000 per
investment)
- Servicing/special servicing fee of 1.0% on the first $5 million of an
investment, 0.75% on the second $5 million and 0.50% thereafter (minimum fee
of $50,000 per investment) and liquidation fee of 1% of investment
</TABLE>
In the event that the Company invests in real property, the Manager may
elect to have CLARION provide services according to the following fees:
acquisition services (at 0.50% of investment), asset management services (at
0.50% of investment per annum), property management and leasing supervision
services (at 4.0% of the property's annual gross revenues per annum) and
liquidation services (at 1.0% of investment).
During the term of such agreement, CLARION has agreed not to provide any of
the services covered by such agreement to any other public REIT with investment
objectives similar to those of the Company.
54
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Manager are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE MANAGER
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Daniel Heflin*....................................... 34 Chief Executive Officer, President and Director
Frank L. Sullivan, Jr.*.............................. 52 Chairman of the Board
Stephen J. Furnary................................... 47 Director
Charles Grossman..................................... 54 Director
John A. Weisz........................................ 53 Director
William Powell*...................................... 38 Senior Vice President
Joanne Vitale*....................................... 41 Senior Vice President
</TABLE>
- ------------------------
*See "THE COMPANY" for biographical information.
Stephen J. Furnary is a Managing Director of Clarion Partners and Chairman
of its Acquisition and Investment Committees. Mr. Furnary joined Clarion
Partners in 1984 and has over 24 years of real estate experience. Prior to
joining Clarion Partners, he was an Executive Vice President and Partner with
Lazard Realty, Inc. and Vice President, Real Estate Investment and Management
Department at Citibank, N.A. Mr. Furnary is a former Chairman of the National
Association of Real Estate Investment Managers and a current member of the Urban
Land Institute and the International Counsel of Shopping Centers.
Charles Grossman is a Managing Director of Clarion Partners and Chairman of
its Asset Management Committee. Mr. Grossman joined Clarion Partners in 1988 and
has over 28 years of real estate experience. Prior to joining Clarion Partners,
Mr. Grossman was a real estate investment manager with James D. Wolfensohn, Inc.
and the Chief Executive Officer of Schroder Real Estate Associates. Mr. Grossman
is a board member of the Pension Real Estate Association.
John A. Weisz is a Managing Director of Clarion Partners and Chairman of its
Management Committee. Mr. Weisz joined Clarion Partners in 1982 and has over 25
years of real estate experience. Prior to joining Clarion Partners, he was Vice
President of Real Estate Investment and Management Department at Citibank, N.A.
and Assistant Vice President of the Real Estate Department of Chase Investors
Management Corporation.
The Manager's executive offices are located at 335 Madison Avenue, New York,
New York 10019 and its telephone number is (212) 883-2500.
MANAGEMENT AGREEMENT
At or prior to the consummation of the Offering, the Company will enter into
the Management Agreement which will have an initial term expiring on the third
anniversary of the Closing Date. Thereafter, successive extensions, each for a
period not to exceed one year, may be made by agreement between the Company and
the Manager. Unless mutually agreed upon by the Company and the Manager, the
base management fee and the incentive fee will be calculated during any such
extension in the same manner as they are calculated during the initial term. The
Company or the holders of a majority of the outstanding shares of Common Stock
may terminate, or decline to extend the term of, the Management Agreement
without cause at any time upon 60 days' written notice from the Company;
PROVIDED, that upon any such termination without cause or failure to extend, the
Manager shall be entitled to receive from the Company a termination fee in an
amount equal to the fair market value of the Management Agreement (without
giving effect to any termination and assuming it is extended in accordance with
its terms) plus any amounts payable by the Manager to third parties, including
CLARION, as a result of the termination of such parties' services to the
Company. In addition, the Company has the right to terminate, without the
payment of any termination fee, the Management Agreement upon the occurrence of
certain specified
55
<PAGE>
events, including a determination that the Manager has been grossly negligent or
has willfully disregarded its duties thereunder.
The Manager at all times will be subject to supervision by the Company's
Board of Directors and will have only such functions and authority as specified
in the Management Agreement or as the Company may delegate to it. The Manager
will be responsible for the investments and day-to-day operations of the Company
and will perform (or cause to be performed) such services and activities
relating to the assets and operations of the Company as may be appropriate,
including:
(i) serving as the Company's consultant with respect to formulation of
investment criteria and preparation of policy guidelines by the Board of
Directors;
(ii) representing the Company in connection with the purchase of, and
commitment to purchase, assets, the sale of, and commitment to sell,
assets, and the maintenance and administration of its portfolio of
assets. See "--Portfolio Management;"
(iii) furnishing reports and statistical and economic research to the Company
regarding the Company's activities and the services performed for the
Company by the Manager;
(iv) monitoring and providing to the Board of Directors on an ongoing basis
price information and other data obtained from certain nationally
recognized dealers that maintain markets in assets identified by the
Board of Directors from time to time, and providing data and advice to
the Board of Directors in connection with the identification of such
dealers;
(v) providing executive and administrative personnel, office space and
office services required in rendering services to the Company;
(vi) administering the day-to-day operations of the Company and performing
and supervising the performance of such other administrative functions
necessary in the management of the Company as may be agreed upon by the
Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's debts and obligations, the
submission of any required public filings by the Company and
maintenance of appropriate computer services to perform such
administrative functions;
(vii) communicating on behalf of the Company with the holders of any equity
or debt securities of the Company as required to satisfy the reporting
and other requirements of any governmental bodies or agencies or
trading markets and to maintain effective relations with such holders;
(viii) designating originators, servicers, property managers, developers,
asset managers and other servicers with respect to the Real Estate
Investments made by the Company and arranging for the monitoring and
administering of such service providers;
(ix) counseling the Company in connection with policy decisions to be made
by the Board of Directors;
(x) engaging in hedging and financing activities on behalf of the Company,
consistent with the Company's status as a REIT; and
(xi) counseling the Company regarding the maintenance of its status as a
REIT and monitoring compliance with the various REIT qualification
tests and other rules set out in the Code and Treasury Regulations
thereunder.
During the term of the Management Agreement, the Manager has agreed not to
provide any of the foregoing services to any public REIT with investment
objectives similar to those of the Company.
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<PAGE>
PORTFOLIO MANAGEMENT
The Manager will perform portfolio management services on behalf of the
Company pursuant to the Management Agreement with respect to the Company's
investments. Such services will include, but not be limited to, consulting the
Company on purchase and sale opportunities; providing (or causing to be provided
to) the Company acquisition, property management and asset management services
and other services related to Real Estate Investments; collection of information
and submission of reports pertaining to the Company's assets, interest rates,
and general economic conditions; periodic review and evaluation of the
performance of the Company's portfolio of assets; acting as liaison between the
Company and banking, mortgage banking, investment banking and other parties with
respect to the purchase, financing and disposition of assets; and other
customary functions related to portfolio management. The Manager may enter into
subcontracts with other parties, including its affiliates, to provide any such
services, and other administrative services, to the Company. See "--Agreement
Between the Manager and CLARION."
MANAGEMENT FEES
For performing its services under the Management Agreement, the Manager will
receive an annual base management fee, payable monthly, and an annual incentive
fee, payable quarterly, in the amounts set forth in the table below. The
incentive fee for the first four quarters of the Company's operating history
shall be paid at the end of the fourth such quarter.
<TABLE>
<CAPTION>
MANAGEMENT FEE INCENTIVE FEE
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
1% of the average stockholders' equity in the Company, The product of (A) 25% of the dollar amount by which (1)
determined in accordance with GAAP, excluding any Adjusted Net Income of the Company per share of common
mark-to-market adjustments to the Company's assets. stock (based on the weighted average number of shares
outstanding) exceeds (2) an amount equal to (a) the
weighted average of the price per share of the Common
Stock at the initial offering and the prices per share
at any secondary offerings of common stock by the
Company multiplied by (b) the Ten-Year U.S. Treasury
Rate plus 2.5% per annum multiplied by (B) the weighted
average number of shares of common stock outstanding,
calculated as a quarterly average over the prior four
quarters.
</TABLE>
For example, based on the net proceeds of the Offering and the Private
Placement, the Manager would receive an annual base management fee of
approximately $2 million.
The management fees are payable in arrears. The Manager's base management
fees and expenses will be calculated by the Manager as promptly as practicable
after each month-end. The Manager's incentive fee will be calculated by the
Manager within 45 days after the end of each quarter (commencing with the end of
the fourth quarter of the Company's operating history). Such calculations shall
be promptly delivered to the Company. The Company shall be obligated to pay such
fees and expenses within 15 days after delivery of such calculation.
The Manager is expected to use its base management fee and incentive fee in
part to pay compensation to its officers and employees who, notwithstanding that
certain of them are officers of the Company, will receive no cash compensation
directly from the Company.
THIRD PARTY FEES AND EXPENSES
The Company does not expect to maintain an office or to employ full-time
personnel. Instead it expects to rely on the facilities and resources of the
Manager to conduct its operations. The Company will
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<PAGE>
reimburse the Manager for all of its reasonable and customary out-of-pocket
expenses (including those incurred in the formation of the Company) and fees
payable to third party service providers (including due diligence agents),
including CLARION. There will be no cap applicable to such out-of-pocket costs.
The Manager will not charge the Company for its corporate overhead or for any
portion of the Manager's employees' salaries or benefits.
In the event the Manager's or CLARION's employees perform certain due
diligence tasks that purchasers of Real Estate Investments (including managers
of REITs) typically hire outside consultants to perform, the Manager will be
reimbursed for (or charge the Company directly for) its or CLARION's out-
of-pocket costs in performing such due diligence on assets purchased or
considered for purchase by the Company.
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Company's Board of Directors in
following or declining to follow its advice or recommendations. The Manager, its
directors and its officers will not be liable to the Company, any subsidiary of
the Company, its directors, its stockholders or any subsidiary's stockholders
for acts performed in accordance with and pursuant to the Management Agreement,
except by reason of acts constituting bad faith, willful misconduct, gross
negligence or reckless disregard of its duties under the Management Agreement.
The Company has agreed to indemnify the Manager, its directors and its officers
with respect to all expenses, losses, damages, liabilities, demands, charges and
claims arising from acts of the Manager not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of duties, performed in good
faith in accordance with and pursuant to the Management Agreement. Under New
York law, the Manager will owe fiduciary duties to the Company with respect to
its obligations under the Management Agreement.
The Management Agreement does not limit or restrict the Manager or any of
its officers, directors, employees or Affiliates from engaging in any business
or rendering services of any kind to any other person, including the purchase
of, or rendering advice to others purchasing, assets that meet the Company's
policies and criteria.
10% OWNERSHIP OF THE MANAGER;
OPTION TO PURCHASE REMAINING INTEREST IN THE MANAGER
In exchange for a 10% interest in the Manager and the option to acquire the
remaining 90% interest in (or all of the assets of) the Manager, the Company has
issued 200,000 shares of Class B Stock to the owners of the Manager. Before the
Class B Subordination Termination Date, any amounts available for distribution
will be distributed quarterly (i) first, to the holders of the Common Stock,
until such holders have received the Yield Threshold with respect to their
shares of Common Stock, (ii) second, to the holders of the Class B Stock, until
such holders have received the Yield Threshold with respect to their shares of
Class B Stock plus the cumulative amount, if any, by which distributions with
respect to the Class B Stock were less than the Yield Threshold in the prior
three quarters and (iii) third, to the holders of the Common Stock and the
holders of the Class B Stock, PRO RATA in accordance with their respective share
ownership. From and after the Class B Termination Date, quarterly distributions
will be made PRO RATA to the holders of the Common Stock and the holders of the
Class B Stock, in accordance with their respective share ownership. See
"DESCRIPTION OF CAPITAL STOCK--Class B Stock."
The Company has been granted the option to acquire either the remaining 90%
membership interest in the Manager or, under certain circumstances, to acquire,
partly in redemption of its interest in the Manager and partly for other
consideration, all of the assets of the Manager, in each case for 90% of the
fair market value of such interest or assets, as the case may be. The option may
be exercised by the Company or one or more affiliates designated by it between
January 2, 2000 and March 31, 2001, in a
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<PAGE>
single transaction for all of such remaining interest (and not in part). Such
fair market value shall be determined by agreement between the Company and the
Manager. In the event the Company and the Manager cannot agree on such fair
market value, two qualified appraisers (one selected by each party) will each
determine such fair market value. In the event such determinations are within
10% of each other, the fair market value shall be the average of such
determinations. In the event such determinations are not within 10% of each
other, such qualified appraisers will select a third qualified appraiser. In the
event the three appraisers, working in concert, cannot agree upon such fair
market value, the fair market value will be the average of the two closest
determinations of such appraisers. Each determination shall take into account
the portion of the Manager's income that, upon acquisition of such interests or
assets by the Company, would not subject the Company to federal income tax and
the portion, if any, of such income, that would, in order for the Company to
preserve its status as a REIT, be earned through a taxable subsidiary of the
Company.
The Company may exercise the option only upon the approval of a majority of
the Independent Directors. The Company may pay the option price in cash or in
limited partnership interests in the Operating Partnership or another subsidiary
partnership and may exercise the option either to acquire the remaining interest
in the Manager or to acquire the Manager's assets, taking into account (after
consultation with the other owners of the Manager) the financial and tax
planning objectives of the other owners of the Manager.
The income the Company derives from its membership interests in the Manager
is, in part, not qualifying REIT income, and, in the event that the Company
exercises the option to purchase the remaining membership interests in, or
assets of, the Manager, it will derive additional income that is not qualifying
REIT income. The Company intends, in general, that the activities generating the
nonqualifying portion of such income will be conducted by noncontrolled
subsidiaries of the Company. Such income therefore will be subject to corporate
income tax. See "FEDERAL INCOME TAX CONSIDERATIONS-- Noncontrolled Taxable
Subsidiaries."
In the event the Company does not exercise its option to purchase the
remaining membership interests in, or assets of, the Manager, the other owners
of the Manager may reacquire the membership interest in the Manager owned by the
Company for 90% of the fair market value of such interest, determined in the
manner described above, at any time between April 1, 2001 and September 30,
2001.
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<PAGE>
CONFLICTS OF INTEREST AND BENEFITS TO RELATED PARTIES
THE MANAGER, CLARION AND THE MANAGEMENT AGREEMENT
The Company is subject to conflicts of interest involving the Manager
because, among other reasons, (i) the Manager shall be advising Affiliated Funds
and many investments appropriate for the Company may also be appropriate for one
or more Affiliated Funds, (ii) all of the officers of the Company, and two of
its directors, will also be officers, employees and/or directors of the Manager
or one or more of its affiliates and (iii) the incentive fee may create an
incentive for the Manager to recommend investments with higher yield potential,
which investments generally are riskier or more speculative than would be the
case if such fee did not include a performance-based component. Nevertheless,
the Manager intends to conduct its operations in a manner that will attempt to
minimize the negative effect of any conflicts of interest. Moreover, a majority
of the Company's Board of Directors must be Independent Directors, individuals
unaffiliated with the Company, the Manager or CLARION (either by ownership or
through business), selected initially by the Manager.
The Management Agreement does not limit or restrict the Manager or any of
its officers, directors, employees or affiliates from engaging in any business
or rendering services of any kind to any other person. The ability of the
Manager and its officers and employees to engage in other business activities
could reduce the time and effort the Manager spends managing the Company.
The Manager may also receive incentive fees from the Affiliated Funds in
connection with the performance of any investments in the Common Stock by the
Affiliated Funds.
In addition, situations may arise in which the investment activities of the
Affiliated Funds may disadvantage the Company, such as the inability of the
market to fully absorb orders for the purchase or sale of particular CMBS placed
by the Manager for the Company and the Affiliated Funds at prices and in
quantities which would be obtained if the orders were being placed only for the
Company. The Manager, however, will not permit the Affiliated Funds to sell
securities or other assets to or purchase securities or other assets from the
Company unless such sale or purchase is made at the current market price of such
security or asset and is approved by the Board of Directors. Furthermore, the
incentive fee payable to the Manager by the Affiliated Funds or other clients
may be higher than the fee paid by the Company, which may increase the potential
of this conflict of interest.
MATERIAL INTERESTS OF AFFILIATES
The Manager and certain of its affiliates will have a material interest in
connection with the Offering. The following table summarizes the nature of their
respective interests:
<TABLE>
<CAPTION>
PROSPECTUS SECTION PROVIDING
ENTITY NATURE OF INTEREST AND CONFLICT, IF ANY MORE DETAILED INFORMATION
- ------------------ ---------------------------------------------------------- ---------------------------------
<S> <C> <C>
The Manager The Manager will manage the Company's Real Estate "THE MANAGER-- Management
Investments for a base management fee and an incentive Agreement"
fee. Such incentive fee may encourage speculative
investment decisions by the Manager.
The Manager The owners of the Manager have received from the Company "10% OWNERSHIP OF THE MANAGER;
200,000 shares of Class B Stock in exchange for a 10% OPTION TO PURCHASE REMAINING
interest in the Manager and an option to purchase the INTEREST IN THE MANAGER;"
remaining 90% interest in the Manager (or all of its "DISTRIBUTION POLICY" and
assets) for 90% of fair market value. The option may be "DESCRIPTION OF CAPITAL
exercised between January 2, 2000 and March 31, 2001 only STOCK--Class B Stock."
with the approval of the Independent Directors.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
PROSPECTUS SECTION PROVIDING
ENTITY NATURE OF INTEREST AND CONFLICT, IF ANY MORE DETAILED INFORMATION
- ------------------ ---------------------------------------------------------- ---------------------------------
<S> <C> <C>
CLARION CLARION will provide the Manager with mortgage origination "THE MANAGER-- Agreement Between
and servicing and acquisition, asset and property the Manager and CLARION"
management services. CLARION will receive compensation for
providing such services.
CLARION The Manager has also been granted a right of first refusal "THE MANAGER-- Agreement Between
to acquire all commercial debt investments originated by the Manager and CLARION"
CLARION until the earlier to occur of (i) such time as the
Company owns assets having a market value in excess of the
Purchasing Priority Amount or (ii) the expiration of the
initial term of the Management Agreement. Thereafter,
CLARION has agreed to allocate such investments to the
Manager and CLARION's other clients on a fair and
equitable basis. The Manager has agreed with the Company
that these benefits will inure solely to the benefit of
the Company and not to any Affiliated Fund until the
Company owns assets in excess of the Purchasing Priority
Amount.
Affiliated Funds Subject to the approval of the Independent Directors, "INVESTMENT OBJECTIVES AND
certain Affiliated Funds will sell the Initial Investments POLICIES--Initial Investments"
to the Company and, subject to the approval of the Board and "CONFLICTS OF INTEREST AND
of Directors, may sell to, or purchase from, the Company BENEFITS TO RELATED PARTIES"
additional Real Estate Investments. The Manager may
receive incentive fees from the Affiliated Funds in
connection with such transaction.
Directors, The Company will grant options to purchase an aggregate of "THE COMPANY--Stock Incentive
Officers and 770,000 shares (885,500 shares if the Underwriters' Plan"
Employees of the over-allotment option is exercised in full) of Common
Company, the Stock to such individuals.
Manager and
CLARION
Mr. Heflin, Such parties have committed to purchase, in the aggregate "PRIVATE PLACEMENT"
Clarion Partners 1,000,000 shares of Common Stock at the initial public
(which includes offering price in a private placement to occur
Mr. Sullivan) and concurrently with the consummation of the Offering.
an Affiliated Fund
</TABLE>
DISTRIBUTION POLICY
In order to avoid corporate income taxation on the earnings that it
distributes, the Company intends to distribute to its stockholders an amount at
least equal to (i) 95% of its REIT taxable income (determined before the
deduction for dividends paid and excluding any net capital gain) plus (ii) 95%
of the excess of its net income from foreclosure property over the tax imposed
on such income by the Code less (iii) any excess noncash income (as determined
under the Code). The actual amount and timing of distributions, however, will be
at the discretion of the Board of Directors and will depend upon the
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<PAGE>
financial condition of the Company in addition to the requirements of the Code.
It is anticipated that the first distribution will be made after the first full
calendar quarter following the completion of the Offering.
Subject to the REIT distribution requirements referred to in the immediately
preceding paragraph, the Company intends, to the extent practicable, to reinvest
substantially all of the principal from repayments, sales and refinancings of
the Company's Real Estate Investments. The Company may, however, under certain
circumstances make a distribution of such principal, including when the
Company's REIT distribution requirements cannot be satisfied from other sources.
Such distributions, if any, will be made at the discretion of the Company's
Board of Directors. In general, however, the Company does not intend to make
significant distributions that would represent a return of capital to its
stockholders.
It is anticipated that distributions generally will be taxable as ordinary
income to non-exempt stockholders of the Company, although a portion of such
distributions may be designated by the Company as long-term capital gain or may
constitute a return of capital. The Company will furnish annually to each of its
stockholders a statement setting forth distributions paid during the preceding
year and their federal income tax status. For a discussion of the federal income
tax treatment of distributions by the Company and certain adverse tax
consequences for stockholders associated with REMIC Residual Interests held by
the Company, see "FEDERAL INCOME TAX CONSIDERATIONS--Taxation of the Company"
and "--Taxation of Taxable U.S. Stockholders."
Prior to the Class B Subordination Termination Date, any amounts available
for distribution, after a quarterly distribution to the holders of the Common
Stock equal to the Yield Threshold, shall be distributed (i) first, to the
holders of the Class B Stock, until such holders received an amount equal to the
Yield Threshold plus the cumulative amount, if any, by which distributions with
respect to the Class B Stock were less than the Yield Threshold in the prior
three quarters and (ii) second, to the holders of the Common Stock and the
holders of the Class B Stock, PRO RATA in accordance with their respective share
ownership. From and after the Class B Subordination Termination Date,
distributions will be made PRO RATA to the holders of the Common Stock and the
holders of the Class B Stock, in accordance with their respective share
ownership.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company was organized in February 1998 and has no operating history and
will commence operations only upon the closing of the Offering and the Private
Placement. The Company's day-to-day operations will be managed by the Manager,
subject to the supervision of the Board of Directors.
The Company intends to generate net income for distribution to stockholders
from the spread between the interest income earned on its investment portfolio
and the costs of borrowing to finance the portfolio. The Company's results of
operations will be affected by various factors, many of which are beyond the
control of the Company, including the availability of opportunities for the
acquisition of assets, the level and volatility of interest rates, conditions in
the financial markets and other economic conditions.
The Company will elect to qualify as a REIT under the Code and, as such,
anticipates distributing at least 95% of its taxable income annually, subject to
certain adjustments. Cash for such distributions is expected to be generated
from the Company's operations, although the Company also may borrow funds to
make distributions.
The Company may experience high volatility in net interest income from
quarter to quarter and year to year, primarily as a result of fluctuations in
interest rates, borrowing costs, reinvestment opportunities, credit losses and
prepayment rates. Because changes in interest rates and credit loses may
significantly affect the Company's activities, the operating results of the
Company will depend, in large part, upon the ability of the Company to manage
its interest rate, prepayment and credit risks while effectively maintaining its
status as a REIT. See "INVESTMENT OBJECTIVES AND POLICIES."
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<PAGE>
INITIAL INVESTMENTS
The Company, through the Operating Partnership, has contracted (subject to
the approval of the Independent Directors) with certain Affiliated Funds, upon
or soon after the closing of the Offering with the net proceeds of the Offering
and the Private Placement and additional financing to be obtained prior to the
Closing Date, to purchase the Initial Investments. The Company will be
purchasing the Initial Investments at fair market value, determined at the
closing of the purchase and sale of such assets. On March 31, 1998, the fair
market value of the Initial Investments was estimated to be $212.2 million
(approximately 100 % of the expected net proceeds of the Offering and the
Private Placement). Such purchase price will be adjusted to reflect any change
in fair market value between March 31, 1998 and the date of the closing of such
purchase.
LEVERAGING
The Company intends to employ a leveraging strategy of borrowing against
existing assets to make additional Real Estate Investments, primarily through
the use of securitizations, reverse repurchase agreements and bank borrowings.
The Company also may issue debt in the public market to the extent the Manager
deems appropriate. Leverage can reduce the net income available for
distributions to stockholders. To the extent that changes in market conditions
cause the cost of such financing to increase relative to the income that can be
derived from the assets acquired, the Company may reduce the amount of leverage
it utilizes. The Company also intends to securitize a portion of the mortgage
loans it originates or acquires primarily by issuing structured debt, such as
CMBS, and retaining the subordinate classes thereof. See "INVESTMENT OBJECTIVES
AND POLICIES--Investment Management--Leveraging."
HEDGING
To the extent consistent with REIT qualification, the Company intends to
enter into hedging transactions to protect its Real Estate Investments and
related debt from interest rate fluctuations. These transactions may include
interest rate swaps, the purchase or sale of caps or floors, options and other
hedging instruments. See "INVESTMENT OBJECTIVES AND POLICIES--Investment
Management--Hedging."
LIQUIDITY AND CAPITAL RESOURCES
Since the Company is newly-formed and will commence operations only upon the
closing of the Offering and the Private Placement, it has not yet established
any lines of credit or collateralized financing facilities. The Company has
conducted preliminary discussions with potential lenders and believes, on the
basis of these discussions, that it will be able to obtain financing in amounts
and at interest rates consistent with the Company's financing objectives. The
Company intends to conduct its operations so that the net proceeds of the
Offering and the Private Placement, combined with the cash flow from operations
and borrowings, will be sufficient to enable the Company to close its purchase
of the Initial Investments and to meet its anticipated liquidity and capital
requirements through such time as the net proceeds of the Offering and the
Private Placement have been fully invested in Real Estate Investments. See
"INVESTMENT OBJECTIVES AND POLICIES--Operating Policies and Strategies."
INFLATION
The Company's debt assets and liabilities will be financial in nature. As a
result, interest rates are expected to influence the Company's performance more
directly than inflation. While changes in interest rates do not necessarily
correlate with inflation rates or changes in inflation rates, interest rates
ordinarily increase during periods of high or increasing inflation and decrease
during periods of low or declining inflation. Accordingly, the Company's
financial condition or results of operations is expected to be influenced by
inflation to the extent interest rates are affected by inflation.
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<PAGE>
CERTAIN ACCOUNTING POLICIES AND PROCEDURES
CMBS ACCOUNTING TREATMENT. Because a portion of the Company's CMBS will be
classified for accounting purposes as "available for sale," and, accordingly,
carried at their market values, unrealized fluctuations in market values of such
CMBS will affect the balance sheet, but not the income statement, of the
Company. As a result of this treatment, the book value and book value per share
of the Company are likely to fluctuate more than if the Company used amortized
cost accounting. As a result, comparisons with companies using historical cost
accounting may be misleading.
Positive mark-to-market changes will increase the Company's equity base and
allow the Company to increase its spread lending activities while negative
changes will limit spread lending growth under the Company's leveraging
strategy. A large negative change in the net market value of Mortgage Assets and
interest rate agreements might impair the Company's liquidity position,
requiring the Company to dispose of Real Estate Investments.
MORTGAGE LOAN ACCOUNTING TREATMENT. Substantially all of the Company's
mortgage loans will be classified for accounting purposes as "held for long-term
investment," and accordingly, the Company will carry said mortgage loans at
amortized cost. Holding the mortgage loans as investments will result in the
Company recording income as interest is earned.
MEZZANINE INVESTMENTS ACCOUNTING TREATMENT. Generally, the Company will use
amortized cost to record the carried value of its Mezzanine Investments.
However, equity participations may warrant recording the Company's pro rata
share of revenue and expenses of the underlying property.
TAXABLE INCOME AND GAAP INCOME. Taxable income differs from GAAP income for
several reasons. Interest income differs due to different methods of calculating
the rate of amortization of the premium or discount when CMBS are acquired at a
price above or below the stated principal amount of the underlying mortgage
loans. Treatment of credit losses differs between tax and GAAP methods because
the Company takes credit provisions in order to make reserves for credit losses,
whereas only actual credit losses are deducted in calculating taxable income.
General and administrative expenses differ due to differing treatment of
leasehold amortization and other items. The Company's largest expense will
likely be the cost of borrowed funds. Interest expense generally will be
calculated in the same manner for GAAP and tax purposes.
These distinctions are relevant to the Company's stockholders because
distributions are based on taxable income as is the incentive fee paid to the
Manager. The Company generally will not pay federal taxes so long as it meets
the requirements of the REIT Provisions of the Code and makes distributions to
stockholders in an amount equal to its taxable income. See "FEDERAL INCOME TAX
CONSIDERATIONS-- Requirements for Qualification."
THE OPERATING PARTNERSHIP
The Company has incorporated two qualified REIT subsidiaries, the General
Partner and the Initial Limited Partner, each a Delaware corporation. The
Initial Limited Partner and General Partner have organized the Operating
Partnership, a Delaware limited partnership, which will undertake the business
of the Company, including the acquisition of Real Estate Investments. The
General Partner will hold a 1% general partnership interest in the Operating
Partnership, and the Initial Limited Partner will hold a 99% limited partnership
interest in the Operating Partnership. At Closing, the Company will purchase
( if the Underwriters' overallotment option is exercised in full) Units
with the net proceeds of the Offering and the Private Placement. Of these Units,
1% will be contributed to the General Partner and the remaining 99% will be
contributed to the Initial Limited Partner by the Company.
Because the Company indirectly owns 100% of the partnership interests in the
Operating Partnership, the Operating Partnership will be disregarded as a
separate entity from the Company for federal income tax purposes until a third
party is admitted as a partner of the Operating Partnership. The Company
organized the Operating Partnership in order to provide future sellers of assets
with the opportunity to
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<PAGE>
transfer those assets to the Company in a tax-deferred exchange. The following
summary of the partnership agreement for the Operating Partnership (the
"Operating Partnership Agreement"), describes certain provisions that currently
appear in the Operating Partnership Agreement. However, upon the admittance to
the Operating Partnership of third-party sellers of assets who wish to achieve
tax deferral, certain of such provisions will be the subject of business
negotiation.
GENERAL
Pursuant to the Operating Partnership Agreement, the General Partner, as the
sole general partner of the Operating Partnership, will have full, exclusive and
complete responsibility and discretion in the management and control of the
Operating Partnership. The limited partners of the Operating Partnership (the
"Limited Partners") will have no authority in their capacity as Limited Partners
to transact business for, or participate in the management activities or
decisions of, the Operating Partnership, except as required by applicable law.
Consequently, the Company, by virtue of its ownership of the General Partner,
will control the assets and business of the Operating Partnership. However, any
amendment to the Operating Partnership Agreement that would (i) affect the
Redemption Rights (as defined below), (ii) adversely affect the Limited
Partners' rights to receive cash distributions, (iii) alter the Operating
Partnership's allocations of income or loss, or (iv) impose on the Limited
Partners any obligations to make additional contributions to the capital of the
Operating Partnership, will require the consent of Limited Partners (other than
the Initial Limited Partner) holding more than two-thirds of the Units held by
such partners.
GENERAL PARTNER NOT TO WITHDRAW
It is anticipated that the General Partner will not be able to voluntarily
withdraw from the Operating Partnership or transfer or assign its interest in
the Operating Partnership unless the transaction in which such withdrawal or
transfer occurs results in the Limited Partners receiving property in an amount
equal to the amount they would have received had they exercised the Redemption
Rights immediately prior to such transaction.
CAPITAL CONTRIBUTION
The Company will contribute, through the General Partner and the Initial
Limited Partner, all of the net proceeds of the Offering to the Operating
Partnership in exchange for all of its outstanding Units. Although the Operating
Partnership will receive the net proceeds of the Offering and the Private
Placement, the Initial Limited Partner and the General Partner will be deemed to
have made a capital contribution to the Operating Partnership in the aggregate
amount of the gross proceeds of the Offering and the Private Placement and the
Operating Partnership will be deemed simultaneously to have paid the
Underwriters' discount in connection with the Offering and other expenses paid
or incurred in connection with the Offering and the Private Placement.
The Operating Partnership Agreement provides that if the Operating
Partnership requires additional funds at any time or from time to time in excess
of funds available to the Operating Partnership from borrowing or capital
contributions, the General Partner may borrow such funds from a financial
institution or other lender and lend such funds to the Operating Partnership on
the same terms and conditions as are applicable to the General Partner's
borrowing of such funds. Under the Operating Partnership Agreement, each of the
General Partner and the Initial Limited Partner is obligated to contribute the
net proceeds of any future share offering by the Company as additional capital
to the Operating Partnership in exchange for an additional partnership interest.
Upon such contribution, the General Partner's and the Initial Limited Partner's
percentage interests in the Operating Partnership would be increased in
proportion to the amount of such additional capital contributions. The
percentage interests of the Limited Partners (other than the Initial Limited
Partner) would be decreased on a proportionate basis in the event of additional
capital contributions by the General Partner and the Initial Limited Partner. In
addition, if the General Partner and the Initial Limited Partner were to
contribute additional capital to the Operating
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<PAGE>
Partnership, the General Partner would revalue the property of the Operating
Partnership to its fair market value (as determined by the General Partner) and
the capital accounts of the partners would be adjusted to reflect the manner in
which the unrealized gain or loss inherent in such property (that has not been
reflected in the capital accounts previously) would be allocated among the
partners under the terms of the Operating Partnership Agreement as if there were
a taxable disposition of such property for such fair market value on the date of
the revaluation.
REDEMPTION RIGHTS
Pursuant to the Operating Partnership Agreement, the Limited Partners (other
than the Initial Limited Partner) will have the right (the "Redemption Rights")
to cause the Operating Partnership to redeem their Units for cash or, at the
election of the General Partner, shares of Common Stock on a one-for-one basis.
The redemption price will be paid in cash in the discretion of the Company or in
the event that the issuance of shares of Common Stock to the redeeming Limited
Partner would (i) result in any person owning, directly or indirectly, shares of
Common Stock in excess of the Ownership Limitation, (ii) result in shares of
capital stock of the Company being owned by fewer than 100 persons (determined
without reference to any rules of attribution), (iii) result in the Company
being "closely held" within the meaning of Section 856(h) of the Code, (iv)
cause the Company to own, actually or constructively, 10% or more of the
ownership interests in a tenant of the Company's or the Operating Partnership's
real property, within the meaning of Section 856(d)(2)(B) of the Code, or (v)
cause the acquisition of shares of Common Stock by such redeeming Limited
Partner to be "integrated" with any other distribution of shares of Common Stock
for purposes of complying with the Securities Act.
OPERATIONS
The Operating Partnership Agreement requires that the Operating Partnership
be operated in a manner that will enable the Company to satisfy the requirements
for being classified as a REIT for federal tax purposes, to avoid any federal
income or excise tax liability imposed by the Code, and to ensure that the
Operating Partnership will not be classified as a "publicly traded partnership"
taxed as a corporation for purposes of Section 7704 of the Code.
In addition to the administrative and operating costs and expenses incurred
by the Operating Partnership, it is anticipated that the Operating Partnership
will pay all administrative costs and expenses of the Company and the General
Partner (collectively, the "Company Expenses") and the Company Expenses will be
treated as expenses of the Operating Partnership. The Company Expenses generally
will include (i) all expenses relating to the formation and continuity of
existence of the Company and the General Partner, (ii) all expenses relating to
the public offering and registration of securities by the Company, (iii) all
expenses associated with the preparation and filing of any periodic reports by
the Company under federal, state or local laws or regulations, (iv) all expenses
associated with compliance by the Company and the General Partner with laws,
rules and regulations promulgated by any regulatory body and (v) all other
operating or administrative costs of the General Partner incurred in the
ordinary course of its business on behalf of the Operating Partnership.
DISTRIBUTIONS
It is anticipated that the Operating Partnership Agreement will provide that
the Operating Partnership shall distribute cash from operations (including net
sale or refinancing proceeds, but excluding net proceeds from the sale of the
Operating Partnership's property in connection with the liquidation of the
Operating Partnership) on a quarterly (or, at the election of the General
Partner, more frequent) basis, in amounts determined by the General Partner, to
the partners in accordance with their respective interests in the Operating
Partnership. Upon liquidation of the Operating Partnership, after payment of, or
adequate provision for, debts and obligations of the Operating Partnership,
including any partner loans, it is anticipated that any remaining assets of the
Operating Partnership will be distributed to all partners with positive capital
accounts in accordance with their respective positive capital account balances.
If the
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General Partner has a negative balance in its capital account following a
liquidation of the Operating Partnership, it will be obligated to contribute
cash to the Operating Partnership equal to the negative balance in its capital
account.
ALLOCATIONS
It is anticipated that income, gain and loss of the Operating Partnership
for each fiscal year generally will be allocated among the partners in
accordance with their respective interests in the Operating Partnership, subject
to compliance with the provisions of Code Sections 704(b) and 704(c) and
Treasury regulations ("Treasury Regulations") promulgated thereunder.
TERM
The Operating Partnership shall continue until December 31, 2063, or until
sooner terminated as provided in the Operating Partnership Agreement or by
operation of law.
TAX MATTERS
Pursuant to the Operating Partnership Agreement, the General Partner is the
tax matters partner of the Operating Partnership and, as such, has authority to
handle tax audits and to make tax elections under the Code on behalf of the
Operating Partnership.
FEDERAL INCOME TAX CONSIDERATIONS
THE FOLLOWING IS A GENERAL SUMMARY OF MATERIAL FEDERAL INCOME TAX
CONSIDERATIONS THAT MAY BE RELEVANT TO A PROSPECTIVE HOLDER OF COMMON STOCK.
SHEARMAN & STERLING HAS ACTED AS COUNSEL TO THE COMPANY AND HAS REVIEWED THIS
SUMMARY AND HAS RENDERED AN OPINION THAT THE DESCRIPTIONS OF THE LAW AND THE
LEGAL CONCLUSIONS CONTAINED HEREIN ARE CORRECT IN ALL MATERIAL RESPECTS, AND THE
DISCUSSIONS HEREUNDER FAIRLY SUMMARIZE THE FEDERAL INCOME TAX CONSIDERATIONS
THAT ARE LIKELY TO BE MATERIAL TO THE COMPANY AND A HOLDER OF THE COMMON STOCK.
THE DISCUSSION CONTAINED HEREIN DOES NOT ADDRESS ALL ASPECTS OF TAXATION THAT
MAY BE RELEVANT TO PARTICULAR STOCKHOLDERS IN LIGHT OF THEIR PERSONAL INVESTMENT
OR TAX CIRCUMSTANCES, OR TO CERTAIN TYPES OF STOCKHOLDERS (INCLUDING INSURANCE
COMPANIES, TAX-EXEMPT ORGANIZATIONS, FINANCIAL INSTITUTIONS OR BROKER-DEALERS,
FOREIGN CORPORATIONS, AND PERSONS WHO ARE NOT CITIZENS OR RESIDENTS OF THE
UNITED STATES) SUBJECT TO SPECIAL TREATMENT UNDER THE FEDERAL INCOME TAX LAWS.
THE STATEMENTS IN THIS DISCUSSION AND THE OPINION OF SHEARMAN & STERLING ARE
BASED ON CURRENT PROVISIONS OF THE CODE, EXISTING, TEMPORARY, AND CURRENTLY
PROPOSED TREASURY REGULATIONS PROMULGATED UNDER THE CODE, THE LEGISLATIVE
HISTORY OF THE CODE, EXISTING ADMINISTRATIVE RULINGS AND PRACTICES OF THE
SERVICE, AND JUDICIAL DECISIONS. NO ASSURANCE CAN BE GIVEN THAT FUTURE
LEGISLATIVE, JUDICIAL, OR ADMINISTRATIVE ACTIONS OR DECISIONS, WHICH MAY BE
RETROACTIVE IN EFFECT, WILL NOT AFFECT THE ACCURACY OF ANY STATEMENTS IN THIS
PROSPECTUS WITH RESPECT TO THE TRANSACTIONS ENTERED INTO OR CONTEMPLATED PRIOR
TO THE EFFECTIVE DATE OF SUCH CHANGES.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP, AND
SALE OF THE COMMON STOCK AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT,
INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX CONSEQUENCES OF SUCH
PURCHASE, OWNERSHIP, SALE, AND ELECTION, AND OF POTENTIAL CHANGES IN APPLICABLE
TAX LAWS.
TAXATION OF THE COMPANY
The Company plans to make an election to be taxed as a REIT under the REIT
Provisions of the Code commencing with its first taxable year.
The sections of the Code relating to qualification and operation as a REIT
are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its stockholders. The discussion is qualified in its
entirety by
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the applicable Code provisions, Treasury Regulations promulgated thereunder, and
administrative and judicial interpretations thereof, all of which are subject to
change prospectively or retroactively.
Shearman & Sterling has acted as counsel to the Company in connection with
the Offering and the Company's election to be taxed as a REIT. In the opinion of
Shearman & Sterling, assuming that the elections and other procedural steps
described in this discussion of "FEDERAL INCOME TAX CONSIDERATIONS" are
completed by the Company in a timely fashion, commencing with the Company's
first taxable year, the Company will qualify to be taxed as a REIT pursuant to
the REIT Provisions of the Code, and the Company's organization and proposed
method of operation, as disclosed in this Prospectus, will enable it to continue
to meet the requirements for qualification and taxation as a REIT under the
Code. Investors should be aware, however, that opinions of counsel are not
binding upon the Service or any court. It must be emphasized that Shearman &
Sterling's opinion is based on various assumptions and is conditioned upon
certain representations made by the Company as to factual matters, including
representations regarding the nature of the Company's properties and the future
conduct of its business. Such factual assumptions and representations are
described below in this discussion of "FEDERAL INCOME TAX CONSIDERATIONS" and
are set out in the federal income tax opinion of Shearman & Sterling. Moreover,
such qualification and taxation as a REIT depends upon the Company's ability to
meet on a continuing basis, through actual annual operating results,
distribution levels, and stock ownership, the various qualification tests
imposed under the Code discussed below. Shearman & Sterling will not review the
Company's compliance with those tests on a continuing basis. Accordingly, no
assurance can be given that the actual results of the Company's operations for
any particular taxable year will satisfy such requirements. For a discussion of
the tax consequences of failure to qualify as a REIT, see "--Failure to
Qualify."
If the Company qualifies for taxation as a REIT, it generally will not be
subject to federal corporate income tax on its net income that is distributed
currently to its stockholders. That treatment substantially eliminates the
"double taxation" (i.e., taxation at both the corporate and stockholder levels)
that generally results from an investment in a corporation. However, the Company
will be subject to federal income tax in the following circumstances. First, the
Company will be taxed at regular corporate rates on any undistributed REIT
taxable income, including undistributed net capital gains. Second, under certain
circumstances, the Company may be subject to the "alternative minimum tax" on
its undistributed items of tax preference, if any. Third, if the Company has (i)
net income from the sale or other disposition of "foreclosure property" that is
held primarily for sale to customers in the ordinary course of business or (ii)
other nonqualifying income from foreclosure property, it will be subject to tax
at the highest corporate rate on such income. Fourth, if the Company has net
income from prohibited transactions (which are, in general, certain sales or
other dispositions of property (other than foreclosure property) held primarily
for sale to customers in the ordinary course of business), such income will be
subject to a 100% tax as discussed below. Fifth, if the Company should fail to
satisfy the 75% gross income test or the 95% gross income test (as discussed
below), and nonetheless has maintained its qualification as a REIT because
certain other requirements have been met, it will be subject to a 100% tax on
the net income attributable to the greater of the amount by which the Company
fails the 75% or 95% gross income test. Sixth, if the Company should fail to
distribute during each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain net income for
such year, and (iii) any undistributed taxable income from prior periods, the
Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. Seventh, if the Company
acquires any asset from a "C" corporation" (i.e., a corporation generally
subject to full corporate-level tax) in a merger or other transaction in which
the basis of the asset in the Company's hands is determined by reference to the
basis of the asset (or any other asset) in the hands of the "C" corporation and
the Company recognizes gain on the disposition of such asset during the 10-year
period beginning on the date on which it acquired such asset, then to the extent
of such asset's "built-in-gain" (i.e., the excess of the fair market value of
such asset at the time of acquisition by the Company over the adjusted basis in
such asset at such time), the Company will be subject to tax at the highest
regular corporate rate applicable (as
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provided in Treasury Regulations that have not yet been promulgated). The
results described above with respect to the tax on "built-in-gain" assume that
the Company will elect pursuant to IRS Notice 88-19 to be subject to the rules
described in the preceding sentence if it were to make any such acquisition.
Finally, the Company will be subject to tax at the highest marginal corporate
rate on the portion of any excess inclusion derived by the Company from REMIC
residual interests equal to the percentage of the stock of the Company held by
the United States, any state or political subdivision thereof, any foreign
government, any international organization, any agency or instrumentality of any
of the foregoing, any other tax-exempt organization (other than a farmer's
cooperative described in Section 521 of the Code) that is exempt from taxation
under the unrelated business taxable income provisions of the Code, or any rural
electrical or telephone cooperative (each, a "Disqualified Organization"). Any
such tax on the portion of any excess inclusion allocable to stock of the
Company held by a Disqualified Organization will reduce the cash available for
distribution from the Company to all stockholders.
Pursuant to proposed Treasury Regulations, a "dealer" (as specially defined
in Section 475 of the Code) generally is required to mark-to-market for tax
purposes, i.e. treat as sold in a taxable transaction, securities that are
transferred to an entity in a securitization transaction unless the transferor
expects to hold for investment each of the interests received. The Company
intends to structure its activities in a manner that avoids (or substantially
reduces or eliminates any potential negative impact of) application to it of the
mark-to-market rule. The final Treasury Regulations may require a different
treatment of mortgage loans or securities acquired in securitizations than
provided in the proposed Treasury Regulations, possibly with retroactive effect.
REQUIREMENTS FOR QUALIFICATION
The Code defines a REIT as a corporation, trust, or association (i) that is
managed by one or more trustees or directors; (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for the REIT Provisions of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in order
to elect and maintain REIT status; (viii) that uses a calendar year for federal
income tax purposes and complies with the recordkeeping requirements of the Code
and Treasury Regulations promulgated thereunder; and (ix) that meets certain
other tests, described below, regarding the nature of its income and assets. The
Code provides that conditions (i) to (iv), inclusive, must be met during the
entire taxable year and that condition (v) must be met during at least 335 days
of a taxable year of 12 months, or during a proportionate part of a taxable year
of less than 12 months. Conditions (v) and (vi) do not apply until after the
first taxable year for which an election is made by the Company to be taxed as a
REIT.
For purposes of determining stock ownership under the 5/50 Rule, a
supplemental unemployment compensation benefits plan, a private foundation, or a
portion of a trust permanently set aside or used exclusively for charitable
purposes generally is considered an individual. A trust that is a qualified
trust under Code Section 401(a), however, generally is not considered an
individual and beneficiaries of such trust are treated as holding shares of a
REIT in proportion to their actuarial interests in such trust for purposes of
the 5/50 Rule.
The Company will not satisfy condition (v) during 1998. Pursuant to the
Offering, however, the Company anticipates issuing sufficient Common Stock with
sufficient diversity of ownership to allow it to satisfy requirement (v) and
continue to satisfy requirement (vi). In addition, the Company's Charter
provides for restrictions regarding the transfer of the Common Stock that are
intended to assist the
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Company in continuing to satisfy the share ownership requirements described in
clauses (v) and (vi) above. Such transfer restrictions are described in
"DESCRIPTION OF CAPITAL STOCK--Transfer Restrictions."
INCOME TESTS. In order to qualify and to maintain its qualification as a
REIT, the Company must satisfy annually two requirements relating to its gross
income. First, at least 75% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must consist of any
combination of defined types of income derived directly or indirectly from
investments relating to real property or mortgages on real property (including
"rents from real property" and interest on obligations secured by mortgages on
real property or on interests in real property) or qualified temporary
investment income. Second, at least 95% of the Company's gross income (excluding
gross income from prohibited transactions) for each taxable year must be derived
from such real property, mortgages on real property, or temporary investments,
and from dividends, other types of interest, and gain from the sale or
disposition of stock or securities, or from any combination of the foregoing.
The specific application of these tests to the Company is discussed below.
The term "interest," as defined for purposes of the 75% and 95% gross income
tests, generally does not include any amount received or accrued (directly or
indirectly) if the determination of such amount depends in whole or in part on
the income or profits of any person. However, an amount received or accrued
generally will not be excluded from the term "interest" solely by reason of
being based on a fixed percentage or percentages of receipts or sales. In
addition, an amount received or accrued generally will not be excluded from the
term "interest" solely by reason of being based on the income or profits of a
debtor if the debtor derives substantially all of its gross income from the
related property through the leasing of substantially all of its interests in
the property, to the extent the amounts received by the debtor would be
characterized as rents from real property if received by a REIT. Subject to this
exception, the Company generally will not be able to derive qualifying income
from a loan, the interest on which is based in whole or in part on the net
income of the obligor or any other person.
Interest on obligations secured by mortgages on real property or on
interests in real property is qualifying income for purposes of the 75% gross
income test. Any amount includible in gross income with respect to a regular or
residual interest in a REMIC or regular interest in a FASIT generally is treated
as interest on an obligation secured by a mortgage on real property. If,
however, less than 95% of the assets of the REMIC or FASIT consists of real
estate assets (determined as if the Company held such assets), the Company will
be treated as receiving directly its proportionate share of the income of the
REMIC or FASIT. In addition, if the Company receives interest income with
respect to a mortgage loan that is secured by both real property and other
property and the highest principal amount of the loan outstanding during a
taxable year exceeds the fair market value of the real property on the date the
Company purchased the mortgage loan, the interest income will be apportioned
between the real property and the other property, which apportionment may cause
the Company to recognize income that is not qualifying income for purposes of
the 75% gross income test.
The Company expects to structure its investments so that the interest,
original issue discount, and market discount income that the Company derives
from CMBS and mezzanine debt investments generally will be qualifying interest
income for purposes of both the 75% and the 95% gross income tests, except to
the extent that less than 95% of the assets of a REMIC in which the Company
holds an interest consists of real estate assets (determined as if the Company
held such assets), and the Company's proportionate share of the income of the
REMIC includes income that is not qualifying income for purposes of the 75% and
95% gross income tests. In some cases, however, the loan amount of a mortgage
loan may exceed the value of the real property securing the loan, which will
result in a portion of the income from the loan being classified as qualifying
income for purposes of the 95% gross income test, but not for purposes of the
75% gross income test. Further, in the event that the interest income from a
mortgage loan would be based in part on the borrower's profits or net income,
the income from the loan generally would be disqualified for purposes of both
the 75% and the 95% gross income tests.
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The Company may originate or acquire Mezzanine Investments that provide for
interest based in part on shared appreciation. To the extent that interest from
a loan that is based on the cash proceeds from the sale of the property securing
the loan constitutes a "shared appreciation provision" (as defined in the Code),
income attributable to such participation feature will be treated as gain from
the sale of the secured property, which generally is qualifying income for
purposes of the 75% and 95% gross income tests but which also must be tested
under the "prohibited transaction" rules. In addition, the Company may be
required to recognize income from a shared appreciation provision over the term
of the related loan using the constant yield method pursuant to certain Treasury
Regulations.
The rent received by the Company from the tenants of its real property
("Rent") will qualify as "rents from real property" in satisfying the gross
income tests for a REIT described above only if several conditions are met.
First, the amount of Rent must not be based, in whole or in part, on the income
or profits of any person. However, an amount received or accrued generally will
not be excluded from the term "rents from real property" solely by reason of
being based on a fixed percentage or percentages of receipts or sales. Second,
the Code provides that the Rent received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if the Company,
or a direct or indirect owner of 10% or more of the Company, owns 10% or more of
such tenant, taking into account both direct and constructive ownership (a
"Related Party Tenant"). For this purpose, a partnership is deemed to
constructively own stock owned by its partner if such partner owns 25% or more
of the capital or profits interest in the partnership. Third, if Rent
attributable to personal property, leased in connection with a lease of real
property, is greater than 15% of the total Rent received under the lease, then
the portion of Rent attributable to such personal property will not qualify as
"rents from real property." Finally, for the Rent to qualify as "rents from real
property", the Company generally must not operate or manage the real property or
furnish or render services to the tenants of such real property, other than
through an "independent contractor" who is adequately compensated and from whom
the Company derives no revenue. The "independent contractor" requirement,
however, does not apply to the extent the services provided by the Company are
"usually or customarily rendered" in connection with the rental of space for
occupancy only and are not otherwise considered "rendered to the occupant".
However, all of the rental income derived by the Company with respect to a
property will not cease to qualify as "rents from real property" if any
impermissible tenant services income from such property (which is deemed to be
an amount that is no less than 150% of the Company's direct costs of furnishing
or rendering the service or providing the management or operation) does not
exceed 1% of all amounts received or accrued during the taxable year directly or
indirectly by the Company with respect to such property.
The Company has represented that it will not charge Rent for any portion of
any real property that is based, in whole or in part, on the income or profits
of any person (except by reason of being based on a fixed percentage or
percentages of receipts of sales, as described above) to the extent that the
receipt of such rent would jeopardize the Company's status as a REIT. In
addition, the Company has represented that, to the extent that it receives Rent
from a Related Party Tenant, such Rent will not cause the Company to fail to
satisfy either the 75% or 95% gross income test.
The Company also has represented that it will not allow the Rent
attributable to personal property leased in connection with any lease of real
property to exceed 15% of the total Rent received under the lease, if the
receipt of such Rent would cause the Company to fall to satisfy either the 75%
or 95% gross income test.
Finally, the Company has represented that it will not operate or manage its
real property or furnish or render noncustomary services to the tenants of its
real property other than through an "independent contractor," to the extent that
such operation or the provision of such services would jeopardize the Company's
status as a REIT.
REITs generally are subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualifying
income for purposes of the 75% gross income test), less expenses directly
connected with the production of such income. "Foreclosure property" is defined
as
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any real property (including interests in real property) and any personal
property incident to such real property (i) that is acquired by a REIT as the
result of such REIT having bid in such property at foreclosure, or having
otherwise reduced such property to ownership or possession by agreement or
process of law, after there was a default (or default was imminent) on a lease
of such property or on an indebtedness owed to the REIT that such property
secured, (ii) for which the related loan was acquired by the REIT at a time when
default was not imminent or anticipated, and (iii) for which such REIT makes a
proper election to treat such property as foreclosure property. The Company does
not anticipate that it will receive significant income from foreclosure property
that is not qualifying income for purposes of the 75% gross income test, but, if
the Company does receive any such income, the Company expects to make an
election to treat the related property as foreclosure property.
If property is not eligible for the election to be treated as foreclosure
property ("Ineligible Property") because the related loan was acquired by the
REIT at a time when default was imminent or anticipated, income received with
respect to such Ineligible Property may not be qualifying income for purposes of
the 75% or 95% gross income test. The Company anticipates that any income it
receives with respect to Ineligible Property will be qualifying income for
purposes of the 75% and 95% gross income tests.
It is possible that, from time to time, the Company will enter into hedging
transactions with respect to one or more of its assets or liabilities. Any such
hedging transactions could take a variety of forms, including short sales of
U.S. Treasuries, interest rate swap contracts, interest rate cap or floor
contracts, futures or forward contracts, and options. To the extent that the
Company enters into an interest rate swap or cap contract, option, futures
contract, forward rate agreement, or any similar financial instrument to reduce
interest rate risk with respect to indebtedness incurred to acquire or carry
real estate assets, any periodic income and any gain from the disposition of
such contract would be qualifying income for purposes of the 95% gross income
test, but generally not the 75% gross income test. To the extent that the
Company hedges with other types of financial instruments or in other situations,
it may not be entirely clear how the income from those transactions will be
treated for purposes of the various income tests that apply to REITs under the
Code. The Company intends to structure any hedging transactions in a manner that
does not jeopardize its status as a REIT. Accordingly, the Company may conduct
some or all of its hedging activities through a corporation that is fully
subject to federal corporate income tax and in which it owns solely nonvoting
stock.
During the one-year period beginning on the date the Company receives, in
exchange for stock (other than pursuant to a dividend reinvestment plan) or in a
public offering of debt obligations having maturities of at least five years,
new capital, income received or accrued from the temporary investment of such
new capital in stock or debt instruments is treated as "qualified temporary
investment income" that counts favorably towards the 75% income test.
The Company may originate or acquire mortgage loans and securitize such
loans through the issuance of senior debt securities secured by such mortgage
loans. As a result of such transactions, the Company will retain an equity
ownership interest in the mortgage loans that has economic characteristics
similar to those of a CMBS. In addition, the Company may resecuritize CMBS
through the issuance of senior debt securities secured by such CMBS, retaining
an equity interest in the CMBS used as collateral for the resecuritization. Such
transactions, which effectively are borrowings, will not cause the Company to
fail to satisfy the gross income tests or the asset tests described below and,
as presently intended to be structured by the Company, should not result in
application of the taxable mortgage pool rules described above.
The Company may receive income not described above that is not qualifying
income for purposes of the 75% and 95% gross income tests. For example, certain
fees for services will not be qualifying income for purposes of the gross income
tests, nor will foreign currency gains from non-dollar denominated loans or from
hedges of non-dollar denominated assets. Further, dividends or interest received
from an entity taxable as a regular "C" corporation would be qualifying income
for purposes of the 95% test but not the 75% test. The Company will monitor the
amount of nonqualifying income produced by its assets and has represented that
it will manage its portfolio in order to comply at all times with the gross
income tests.
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If the Company fails to satisfy one or both of the 75% and 95% gross income
tests for any taxable year, it nevertheless may qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. Those relief
provisions generally will be available if the Company's failure to meet such
tests is due to reasonable cause and not due to willful neglect, the Company
attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of those relief provisions. As
discussed in "--Taxation of the Company," even if those relief provisions apply,
a 100% tax would be imposed on the net income attributable to the greater of the
amount by which the Company fails the 75% or 95% gross income test.
Although not an income test for REIT qualification, the "prohibited
transaction" penalty tax is imposed on certain types of REIT income. As
discussed below, any gain realized by the Company on the sale of any property
held as inventory or other property held primarily for sale to customers in the
ordinary course of its trade or business will be treated as income from a
prohibited transaction that is subject to a 100% penalty tax. See "--Sales of
the Company's Assets."
ASSETS TESTS. In order to qualify and maintain its qualification as a REIT,
the Company, at the close of each quarter of each taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through stock (other
than pursuant to a dividend reinvestment plan) or long-term (at least five-year)
public debt offerings, temporary investments in stock or debt instruments during
the one-year period following the Company's receipt of such capital. The term
"real estate assets" includes interests in real property, interests in mortgages
on real property to the extent the principal balance of a mortgage does not
exceed the fair market value of the associated real property, regular or
residual interests in a REMIC or regular interests in a FASIT (except that, if
less than 95% of the assets of the REMIC or FASIT consists of "real estate
assets" (determined as if the Company held such assets), the Company will be
treated as holding directly its proportionate share of the assets of such REMIC
or FASIT), and shares of other REITs.
For purposes of the 75% asset test, the term "interest in real property"
includes an interest in mortgage loans or land and improvements thereon, such as
buildings or other inherently permanent structures (including items that are
structural components of such buildings or structures), a leasehold of real
property, and an option to acquire real property (or a leasehold of real
property). An "interest in real property" also generally includes an interest in
mortgage loans secured by controlling equity interests in entities treated as
partnerships for federal income tax purposes that own real property, to the
extent that the principal balance of the mortgage does not exceed the fair
market value of the real property that is allocable to the equity interest.
The second asset test requires that, of the investments not included in the
75% asset class, the value of any one issuer's securities owned by the Company
may not exceed 5% of the value of the Company's total assets, and the Company
may not own more than 10% of any one issuer's outstanding voting securities
(except for its interests in the Operating Partnership, the General Partner, the
Initial Limited Partner, any other interests in any qualified REIT subsidiary
and any entity that is disregarded as a separate entity under Treasury
Regulations dealing with entity classification). The 1998 Budget Proposal would
prohibit REITs from holding stock possessing more than 10% of the vote or value
of all classes of stock of a corporation. This proposal would be effective with
respect to stock acquired on or after the date of first committee action. In
addition, to the extent that a REIT's stock ownership is grandfathered by virtue
of this effective date, that grandfathered status will terminate if the
subsidiary corporation engages in a trade or business that is not engaged in on
the date of first committee action or acquires substantial new assets on or
after such date.
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In general, the Company intends to structure any real property, CMBS, and,
in general, Mezzanine Investments that it acquires so as to be qualifying assets
for purposes of the 75% asset test, except to the extent that less than 95% of
the assets of a REMIC or FASIT in which the Company owns an interest consists of
"real estate assets" and the Company's proportionate share of those assets
includes assets that are nonqualifying assets for purposes of the 75% asset
test. CMBS and Mezzanine Investments that are debt obligations will be
qualifying assets for purposes of the 75% asset test to the extent that the
principal balance of each such loan does not exceed the value of the associated
real property. The Company will monitor the status of the assets that it
acquires for purposes of the various asset tests and has represented that it
will manage its portfolio in order to comply at all times with such tests.
If the Company should fail to satisfy the asset tests at the end of a
calendar quarter, such a failure would not cause it to lose its REIT status if
(i) it satisfied the asset tests at the close of the preceding calendar quarter
and (ii) the discrepancy between the value of the Company's assets and the asset
test requirements arose from changes in the market values of its assets and was
not wholly or partly caused by the acquisition of one or more non-qualifying
assets. If the condition described in clause (ii) of the preceding sentence were
not satisfied, the Company still could avoid disqualification by eliminating any
discrepancy within 30 days after the close of the calendar quarter in which it
arose.
QUALIFIED REIT SUBSIDIARIES
The General Partner and the Initial Limited Partner are subsidiaries of the
Company, and the Company may have additional subsidiaries in the future. Code
Section 856(i) provides that a corporation that is a "qualified REIT subsidiary"
shall not be treated as a separate corporation, and all assets, liabilities, and
items of income, deduction, and credit of a "qualified REIT subsidiary" shall be
treated as assets, liabilities, and items of income, deduction, and credit of
the REIT. A "qualified REIT subsidiary" is a corporation, all of the capital
stock of which is held by the REIT. If the Company acquires a corporation
already in existence at the time of the acquisition, such corporation would be
treated as liquidating on the date of acquisition and the Company would be
required to distribute any "C" corporation earnings and profits of the
Corporation before the end of the Company's taxable year. Thus, in applying the
requirements described herein, any "qualified REIT subsidiaries" of the Company
will be ignored, and all assets, liabilities, and items of income, deduction,
and credit of such subsidiaries will be treated as assets, liabilities, and
items of income, deduction, and credit of the Company.
OPERATING PARTNERSHIP AND DISREGARDED ENTITIES
Initially, the Company will own 100% of the partnership interests in the
Operating Partnership. Pursuant to Treasury Regulations relating to entity
classification, an unincorporated entity that has a single owner and that does
not elect to be classified as a corporation is disregarded as an entity separate
from its owner for federal income tax purposes. Because the Company will be
deemed to own 100% of the partnership interests in the Operating Partnership for
federal income tax purposes unless and until interests in the Operating
Partnership are issued to other persons, the Operating Partnership will be
disregarded as an entity separate from the Company under such Treasury
Regulations.
The Company also may decide to organize one or more unincorporated entities
to be wholly owned by it. Such entities will be disregarded as entities separate
from the Company under such Treasury Regulations.
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT for purposes of Section 856 of the Code, including satisfying the
gross income and asset tests described below.
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Thus, in the event the Operating Partnership admits a partner other than the
Company or a qualified REIT subsidiary of the Company, the Company's
proportionate share of the assets and gross income of the Operating Partnership
will be treated as assets and gross income of the Company for purposes of
applying the requirements described herein.
NONCONTROLLED TAXABLE SUBSIDIARIES
Certain hedging and other activities (which include certain activities
likely to be conducted by the Company and might include, in certain
circumstances, the creation of mortgage securities through securitization) may
be done through a noncontrolled taxable subsidiary of the Company. To this end,
the Company and one or more other persons may form and capitalize one or more
corporations taxable as "C" corporations (i.e., the income of which would be
subject to corporate level tax). In order to ensure that the Company would not
violate the more than 10% voting stock of a single issuer limitation described
below, the Company would own only nonvoting preferred and/or nonvoting common
stock and the other persons would own all of the voting stock. The value of the
Company's investment in each such corporation must also be limited to 5% or less
of the value of the Company's total assets at the end of each calendar quarter
so that the Company can also comply with the 5% of value, single issuer asset
limitation described under "--Asset Tests." The taxable corporation would not
elect REIT status and would distribute only net after-tax profits to its
stockholders, including the Company. The ability of the Company to employ such
investment techniques may be curtailed in the event that certain proposals
contained in the 1998 Budget Proposal are introduced into legislation and
enacted into the law. There is no way to predict the likelihood that such
proposals ultimately will be enacted.
DISTRIBUTION REQUIREMENTS
The Company, in order to avoid corporate income taxation of the earnings
that it distributes, is required to distribute with respect to each taxable year
dividends (other than capital gain dividends) to its stockholders in an
aggregate amount at least equal to (i) the sum of (A) 95% of its "REIT taxable
income" (computed without regard to the dividends paid deduction and its net
capital gain) and (B) 95% of the net income (after tax), if any, from
foreclosure property, minus (ii) the sum of certain items of noncash income.
Such distributions must be paid in the taxable year to which they relate, or in
the following taxable year if declared before the Company timely files its
federal income tax return for such year and if paid on or before the first
regular dividend payment date after such declaration.
To the extent that the Company does not distribute all of its "REIT taxable
income," as adjusted, it will be subject to tax thereon at regular corporate tax
rates. To the extent that the Company does not distribute all of its net capital
gain, it will be subject to tax on the undistributed amount of such gain. The
Company may elect, however, to pay the tax on its undistributed long-term
capital gains on behalf of its stockholders, in which case the stockholders
would include in income their proportionate share of the undistributed long-term
capital gains and receive a credit or refund for their share of the tax paid by
the Company.
Furthermore, if the Company should fail to distribute during each calendar
year (or, in the case of distributions with declaration and record dates falling
in the last three months of the calendar year, by the end of the January
immediately following such year) at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain income for such
year, and (iii) any undistributed taxable income from prior periods, the Company
would be subject to a 4% nondeductible excise tax on the excess of such required
distribution over the amounts actually distributed (apparently regardless of
whether the Company elects (as described above) to pay the capital gains tax on
undistributed capital gains). The Company intends to make timely distributions
sufficient to satisfy the annual distribution requirements.
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It is possible that, from time to time, the Company may experience timing
differences between (i) the actual receipt of income and actual payment of
deductible expenses and (ii) the inclusion of that income and deduction of such
expenses in arriving at its REIT taxable income. For example, the Company will
recognize taxable income in excess of its cash receipts when, as generally
happens, OID accrues with respect to its CMBS. Furthermore, some mortgage loans
may be deemed to have OID, in which case the Company will be required to
recognize taxable income in advance of the related cash flow. OID generally will
be accrued using a methodology that does not allow credit losses to be reflected
until they are actually incurred. The Company will attempt to structure its
investments so as not to recognize excess inclusion or other "phantom" taxable
income from REMIC residual interests; however, there can be no assurance that
such income can be avoided. While neither the amount (if any) by which OID on a
debt instrument exceeds cash receipts from such instrument nor the amount (if
any) of excess inclusion is generally subject to the 95% distribution
requirement relating to maintenance of REIT status, such amounts would have to
be distributed to avoid corporate income taxation thereof at the REIT level.
In addition, the Company may recognize taxable market discount income upon
the receipt of proceeds from the disposition of, or principal payments on, CMBS
and mortgage loans that are "market discount bonds" (i.e., obligations with a
stated redemption price at maturity that is greater than the Company's tax basis
in such obligations), although such proceeds often will be used to make non-
deductible principal payments on related borrowings. Market discount income is
treated as ordinary income that is subject to the 95% distribution requirement.
It also is possible that, from time to time, the Company may recognize net
capital gain attributable to the sale of depreciated property that exceeds its
cash receipts from the sale. In addition, pursuant to certain Treasury
Regulations, the Company may be required to recognize the amount of any payment
to be made pursuant to a shared appreciation provision over the term of the
related loan using the constant yield method. Finally, the Company may recognize
taxable income without receiving a corresponding cash distribution if it
forecloses on or makes a "significant modification" (as defined in Treasury
Regulations Section 1.1001-3(e)) to a loan, to the extent that the fair market
value of the underlying property or the principal amount of the modified loan,
as applicable, exceeds the Company's basis in the original loan. Therefore, the
Company may have less cash than is necessary to meet its annual 95% distribution
requirement or to avoid corporate income tax or the excise tax imposed on
certain undistributed income. In such a situation, the Company may find it
necessary to arrange for short-term (or possibly long-term) borrowings or to
raise funds through the issuance of preferred stock or additional Common Stock.
Under certain circumstances, the Company may be able to rectify a failure to
meet the distribution requirements for a year by paying "deficiency dividends"
to its stockholders in a later year, which may be included in the Company's
deduction for dividends paid for the earlier year. Although the Company may be
able to avoid being taxed on amounts distributed as deficiency dividends, it
will be required to pay to the Service interest based upon the amount of any
deduction taken for deficiency dividends.
RECORDKEEPING REQUIREMENTS
Pursuant to applicable Treasury Regulations, in order to be able to elect to
be taxed as a REIT, the Company must maintain certain records and request on an
annual basis certain information from its stockholders designed to disclose the
actual ownership of its outstanding stock. The Company intends to comply with
such requirements. A REIT's failure to comply with such requirements would
result in a monetary fine imposed on such REIT. However, no penalty would be
imposed if such failure is due to reasonable cause and not to willful neglect.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the Company's stockholders in any year
in
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which the Company fails to qualify will not be deductible by the Company nor
will they be required to be made. In such event, to the extent of the Company's
current and accumulated earnings and profits, all distributions to stockholders
will be taxable as ordinary income and, subject to certain limitations of the
Code, corporate distributees may be eligible for the dividends received
deduction. Unless entitled to relief under specific statutory provisions, the
Company also will be disqualified from taxation as a REIT for the four taxable
years following the year during which the Company ceased to qualify as a REIT.
It is not possible to state whether in all circumstances the Company would be
entitled to such statutory relief.
SALES OF THE COMPANY'S ASSETS
As noted above, a REIT is subject to a 100% tax on its net income derived
from prohibited transactions. The term "prohibited transaction" generally
includes a sale or other disposition of property (other than foreclosure
property) that is held primarily for sale to customers in the ordinary course of
a trade or business. The Company intends that no material amount of assets owned
by the Company or, if applicable, the Operating Partnership will be held for
sale to customers and that a sale of any such asset will not be in the ordinary
course of the Company's or, if applicable, the Operating Partnership's business.
Whether property is held "primarily for sale to customers in the ordinary course
of a trade or business" depends, however, on the facts and circumstances in
effect from time to time, including those related to a particular property. With
respect to real property, the Company presently intends to attempt to comply
with the terms of safe-harbor provisions in the Code prescribing when asset
sales will not be characterized as prohibited transactions, although such
compliance ultimately may not be possible or feasible.
TAXATION OF TAXABLE U.S. STOCKHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable U.S. Stockholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such U.S. Stockholders as ordinary income and will not be eligible
for the dividends received deduction generally available to corporations. As
used herein, the term "U.S. Stockholder" means a holder of Common Stock that for
U.S. federal income tax purposes is (i) a citizen or resident of the United
States, (ii) a corporation, partnership, or other entity taxable as such created
or organized in or under the laws of the United States or of any State
(including the District of Columbia), (iii) an estate whose income from sources
without the United States is includible in gross income for U.S. federal income
tax purposes, regardless of its connection with the conduct of a trade or
business within the United States, or (iv) any trust with respect to which (A) a
U.S. court is able to exercise primary supervision over the administration of
such trust and (B) one or more U.S. fiduciaries have the authority to control
all substantial decisions of the trust.
Distributions that are properly designated by the Company as capital gain
dividends are subject to special treatment. According to a notice published by
the Service, until further guidance is issued, if the Company designates a
dividend as a capital gain dividend, it may also designate the dividend as (i) a
20% rate gain distribution, (ii) an unrecaptured Section 1250 gain distribution
(25% rate) or (iii) a 28% rate gain distribution. The maximum amount which may
be designated in each class of capital gain dividends is determined by treating
the Company as an individual with capital gains that may be subject to the
maximum 20% rate, the maximum 25% rate, and the maximum 28% rate. If the Company
does not designate all or part of a capital gain dividend as within such
classes, the undesignated portion will be considered as a 28% rate gain
distribution. Such designations are binding on each stockholder, without regard
to the period for which the stockholder has held its Common Stock. However,
corporate stockholders may be required to treat up to 20% of certain capital
gain dividends as ordinary income. Capital gain dividends are not eligible for
the dividends received deduction for corporations.
Distributions in excess of current and accumulated earnings and profits will
not be taxable to a stockholder to the extent that they do not exceed the
adjusted basis of the stockholder's Common Stock, but rather will reduce the
adjusted basis of such stock. To the extent that such distributions in excess of
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current and accumulated earnings and profits exceed the adjusted basis of a
stockholder's Common Stock, such distributions will be included in income as
long-term capital gain (or short-term capital gain if the Common Stock had been
held for one year or less), assuming the Common Stock is a capital asset in the
hands of the stockholder. In addition, any distribution declared by the Company
in October, November, or December of any year and payable to a stockholder of
record on a specified date in any such month shall be treated as both paid by
the Company and received by the stockholder on December 31 of such year,
provided that the distribution is actually paid by the Company during January of
the following calendar year.
Stockholders may not include in their individual income tax returns any net
operating losses or capital losses of the Company. Instead, such losses would be
carried over by the Company for potential offset against its future income
(subject to certain limitations). Taxable distributions from the Company and
gain from the disposition of the Common Stock will not be treated as passive
activity income and, therefore, stockholders generally will not be able to apply
any passive activity losses (such as losses from certain types of limited
partnerships in which a stockholder is a limited partner) against such income.
In addition, taxable distributions from the Company generally will be treated as
investment income for purposes of the investment interest limitations. Capital
gains from the disposition of Common Stock (or distributions treated as such),
however, will be treated as investment income only if the stockholder so elects,
in which case such capital gains will be taxed at ordinary income rates. The
Company will notify stockholders after the close of the Company's taxable year
as to the portions of the distributions attributable to that year that
constitute ordinary income or capital gain dividends.
The Company's investment in certain types of CMBS, certain Mezzanine
Investments and certain securitizations performed by the Company, may cause it
under certain circumstances to recognize taxable income in excess of its
economic income and to experience an offsetting excess of economic income over
its taxable income in later years. As a result, stockholders may from time to
time be required to pay federal income tax on distributions that economically
represent a return of capital, rather than a dividend. Such distributions would
be offset in later years by distributions representing economic income that
would be treated as returns of capital for federal income tax purposes.
Accordingly, if the Company receives such phantom income, its stockholders may
be required to pay federal income tax with respect to such income on an
accelerated basis, i.e., before such income is realized by the stockholders in
an economic sense. Taking into account the time value of money, such an
acceleration of federal income tax liabilities would cause stockholders to
receive an after-tax rate of return on an investment in the Company that would
be less than the after-tax rate of return on an investment with an identical
before-tax rate of return that did not generate phantom income. For example, if
an investor subject to an effective income tax rate of 30% purchased a bond
(other than a tax-exempt bond) with an annual interest rate of 10% for its face
value, his before-tax return on his investment would be 10%, and his after-tax
return would be 7%. However, if the same investor purchased stock of the Company
at a time when the before-tax rate of return was 10%, his after-tax rate of
return on his stock might be somewhat less than 7% as a result of the Company's
phantom income.
In general, as the ratio of the Company's phantom income to its total income
increases, the after-tax rate of return received by a taxable stockholder of the
Company will decrease. The Company will consider the potential effects of
phantom income on its taxable stockholders in managing its investments.
Because the Company may own residual interests in REMICs ("REMIC Residual
Interests"), stockholders (other than certain thrift institutions) may not be
permitted to offset certain portions of the dividend income they derive from the
Company with their current deductions or net operating loss carryovers or
carrybacks. The portion of a stockholder's dividends that will be subject to
this limitation will equal its allocable share of any excess inclusion income
derived by the Company with respect to the REMIC Residual Interests. The
Company's excess inclusion income for any calendar quarter will equal the excess
of its income from REMIC Residual Interests over its "daily accruals" with
respect to such REMIC Residual Interests for the calendar quarter. Daily
accruals for a calendar quarter are computed by
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allocating to each day on which a REMIC Residual Interest is owned a ratable
portion of the product of (i) the "adjusted issue price" of the REMIC Residual
Interest at the beginning of the quarter and (ii) 120% of the long term federal
interest rate (adjusted for quarterly compounding) on the date of issuance of
the REMIC Residual Interest. The adjusted issue price of a REMIC Residual
Interest at the beginning of a calendar quarter equals the original issue price
of the REMIC Residual Interest, increased by the amount of daily accruals for
prior quarters and decreased by all prior distributions to the Company with
respect to the REMIC Residual Interest. To the extent provided in future
Treasury Regulations, the excess inclusion income with respect to any REMIC
Residual Interests owned by the Company that do not have significant value will
equal the entire amount of the income derived from such REMIC Residual
Interests.
Furthermore, to the extent that the Company (or a qualified REIT subsidiary)
acquires or originates mortgage loans and uses those loans to collateralize an
offering of debt obligations having two or more maturities for which no REMIC
election is made, it is possible that, to the extent provided in future Treasury
Regulations dealing with "taxable mortgage pools," stockholders (other than
certain thrift institutions) will not be permitted to offset certain portions of
the dividend income that they derive from the Company that are attributable to
such transaction with current deductions or net operating loss carryovers or
carrybacks. Although no applicable Treasury Regulations have yet been issued, no
assurance can be provided that such regulations will not be issued in the future
or that, if issued, such regulations will not prevent the Company's stockholders
from offsetting some portion of their dividend income with deductions or losses
from other sources.
CAPITAL GAINS AND LOSSES. A capital asset generally must be held for more
than one year in order for gain or loss derived from its sale or exchange to be
treated as long-term capital gain or loss. The highest marginal individual
income tax rate is 39.6% and the tax rate on long-term capital gains applicable
to non-corporate taxpayers is 28% for sales and exchanges of assets held for
more than one year but not more than eighteen months, and 20% for sales and
exchanges of assets held for more than eighteen months. Thus, the tax rate
differential between capital gain and ordinary income for non-corporate
taxpayers may be significant. In addition, the characterization of income as
capital gain or ordinary income may affect the deductibility of capital losses.
All or a portion of any loss realized upon a taxable disposition of the Common
Stock may be disallowed if other shares of Common Stock are purchased within 30
days before or after the disposition. Capital losses not offset by capital gains
may be deducted against a non-corporate taxpayer's ordinary income only up to a
maximum annual amount of $3,000. Unused capital losses may be carried forward
indefinitely by non-corporate taxpayers. All net capital gain of a corporate
taxpayer is subject to tax at ordinary corporate rates. A corporate taxpayer can
deduct capital losses only to the extent of capital gains, with unused losses
being carried back three years and forward five years.
Recently enacted legislation reduces the maximum rate on long-term capital
gains of non-corporate taxpayers from 28% to 20% (10% for taxpayers in the 15%
tax bracket). However, the reduced long-term capital gains rates are only
available for sales or exchanges of capital assets held for more than 18 months.
Any long-term capital gains from the sale or exchange of depreciable real
property that would be subject to ordinary income taxation (i.e., "depreciation
recapture") if it were treated as personal property will be subject to a maximum
tax rate of 25% instead of the 20% maximum rate for gains taken into account
after July 28, 1997. Also, under the legislation, for taxable years beginning
after December 31, 2000 the maximum capital gains rates for assets which are
held more than five years are 18% and 8% (rather than 20% and 10%). These rates
will generally only apply to assets for which the holding period begins after
December 31, 2000.
The capital gains provisions in the legislation authorize the Service to
issue regulations (including regulations requiring reporting) applying the
provisions to any "pass-through entity" including a REIT and interests in such
an entity. No assurance can be given concerning the content of any such
regulations. Generally, the determination of when gain is properly taken into
account will be made at the entity level.
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INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING. The Company will
report to its U.S. stockholders and to the Service the amount of distributions
paid during each calendar year, and the amount of tax withheld, if any. Under
the backup withholding rules, a stockholder may be subject to backup withholding
at the rate of 31% with respect to distributions paid unless such holder (i) is
a corporation or comes within certain other exempt categories and, when
required, demonstrates this fact or (ii) provides a taxpayer identification
number, certifies as to no loss of exemption from backup withholding, and
otherwise complies with the applicable requirements of the backup withholding
rules. A stockholder that does not provide the Company with its correct taxpayer
identification number also may be subject to penalties imposed by the Service.
Any amount paid as backup withholding will be creditable against the
stockholder's income tax liability. In addition, the Company may be required to
withhold a portion of capital gain distributions to any stockholders who fail to
certify their nonforeign status to the Company.
TAXATION OF TAX-EXEMPT STOCKHOLDERS
Tax-exempt entities, including qualified employee pension and profit sharing
trusts and individual retirement accounts ("Exempt Organizations"), generally
are exempt from federal income taxation. However, they are subject to taxation
on their unrelated business taxable income ("UBTI"). While many investments in
real estate generate UBTI, the Service has issued a published ruling that
dividend distributions from a REIT to an exempt employee pension trust do not
constitute UBTI, provided that the shares of the REIT are not otherwise used in
an unrelated trade or business of the exempt employee pension trust. Based on
that ruling, amounts distributed by the Company to Exempt Organizations
generally should not constitute UBTI. However, if an Exempt Organization
finances its acquisition of the Common Stock with debt, a portion of its income
from the Company will constitute UBTI pursuant to the "debt-financed property"
rules. Furthermore, social clubs, voluntary employee benefit associations,
supplemental unemployment benefit trusts, and qualified group legal services
plans that are exempt from taxation under paragraphs (7), (9), (17), and (20),
respectively, of Section 501(c) of the Code are subject to different UBTI rules,
which generally will require them to characterize distributions from the Company
as UBTI. See "ERISA CONSIDERATIONS."
Any dividends received by an Exempt Organization that are allocable to
excess inclusion will be treated as UBTI. In addition, the Company will be
subject to tax at the highest marginal corporate rate on the portion of any
excess inclusion income derived by the Company from REMIC Residual Interests
that is allocable to stock of the Company held by Disqualified Organizations.
Any such tax would be deductible by the Company against its income that is not
excess inclusion income.
If the Company derives excess inclusion income from REMIC Residual
Interests, a tax similar to the tax on the Company described in the preceding
paragraph may be imposed on stockholders who are (i) pass-through entities
(i.e., partnerships, estates, trusts, regulated investment companies, REITs,
common trust funds, and certain types of cooperatives (including farmers'
cooperatives described in Section 521 of the Code)) in which a Disqualified
Organization is a record holder of shares or interests and (ii) nominees who
hold Common Stock on behalf of Disqualified Organizations. Consequently, a
brokerage firm that holds shares of Common Stock in a "street name" account for
a Disqualified Organization may be subject to federal income tax on the excess
inclusion income derived from those shares.
The Treasury Department has been authorized to issue regulations regarding a
REIT or qualified REIT subsidiary that is considered a "taxable mortgage pool"
by reason of issuances of mortgage-backed securities having two or more
maturities for which no REMIC election is made. If such Treasury Regulations are
issued in the future, it is possible that some percentage of the Company's
dividends might be treated as UBTI for stockholders that are Exempt
Organizations.
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TAXATION OF NON-U.S. STOCKHOLDERS
The discussion below summarizes certain U.S. federal income tax consequences
relating to the ownership and disposition of Common Stock by a holder who is not
a United States Person (a "Non-U.S. Stockholder"). A "United States Person"
means a citizen or resident of the United States, a corporation or partnership
organized in or under the laws of the United States or any state thereof
(including the District of Columbia), an estate the income of which is subject
to U.S. federal income taxation regardless of source, or a trust that meets the
following two tests: (i) a U.S. court is able to exercise primary supervision
over the administration of the trust and (ii) one or more U.S. persons have the
authority to control all substantial decisions of the trust.
The rules governing the U.S. federal income taxation of Non-U.S.
Stockholders are complex and no attempt is made herein to provide more than a
summary of such rules. Non-U.S. Stockholders are urged to consult their tax
advisors to determine the U.S. federal, state, local and foreign tax
consequences associated with an investment in the Common Stock.
Distributions to Non-U.S. Stockholders that are not attributable to gain
from sales or exchanges by the Company of "U.S. real property interests" and are
not designated by the Company as capital gains dividends will be treated as
dividends of ordinary income to the extent that they are made out of current or
accumulated earnings and profits of the Company. Such distributions ordinarily
will be subject to a withholding tax equal to 30% of the gross amount of the
distribution unless an applicable tax treaty reduces or eliminates that tax.
However, if income from the investment in the Common Stock is treated as
effectively connected with the Non-U.S. Stockholder's conduct of a U.S. trade or
business, the Non-U.S. Stockholder generally will be subject to federal income
tax at graduated rates, in the same manner as U.S. Stockholders are taxed with
respect to such distributions (and also may be subject to the 30% branch profits
tax in the case of a Non-U.S. Stockholder that is a non-U.S. corporation). The
Company expects to withhold U.S. income tax at the rate of 30% on the gross
amount of any such distributions made to a Non-U.S. Stockholder (31% if
appropriate documentation evidencing such Non-U.S. Stockholders' foreign status
has not been provided) unless (i) a lower treaty rate applies and any required
form evidencing eligibility for that reduced rate is filed with the Company or
(ii) the Non-U.S. Stockholder files an IRS Form 4224 with the Company for the
taxable year involved claiming that the distribution is effectively connected
income. The Treasury Department issued final regulations in October 1997 that
modify the manner in which the Company complies with the withholding
requirements, generally effective for distributions after December 31, 1998.
If the Company derives excess inclusion income from REMIC Residual
Interests, the portion of the dividends paid to Non-U.S. Stockholders that is
treated as excess inclusion income will not be eligible for exemption from the
30% withholding tax or a reduced treaty rate. In addition, Treasury Regulations
may be issued in the future regarding a REIT or qualified REIT subsidiary, or
any portion thereof, that is considered a "taxable mortgage pool" by reason of
issuing mortgage-backed securities having two or more maturities for which no
REMIC election is made. If such Treasury Regulations are issued in the future,
it is possible that some percentage of the Company's dividends would not be
eligible for a reduced withholding tax rate under an otherwise applicable tax
treaty.
Distributions in excess of current and accumulated earnings and profits of
the Company will not be taxable to a stockholder to the extent that such
distributions do not exceed the adjusted basis of the stockholder's Common
Stock, but rather will reduce the adjusted basis of such shares. To the extent
that distributions in excess of current and accumulated earnings and profits
exceed the adjusted basis of a Non-U.S. Stockholder's Common Stock, such
distributions will give rise to tax liability if the Non-U.S. Stockholder would
otherwise be subject to tax on any gain from the sale or disposition of his
Common Stock, as described below. Because it generally cannot be determined at
the time a distribution is made whether or not such distribution will be in
excess of current and accumulated earnings and profits, amounts in excess
thereof may be withheld by the Company. However, any such excess amount withheld
would be refundable to the extent it is determined subsequently that such
distribution was, in fact, in excess of
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current and accumulated earnings and profits of the Company. Under a separate
provision, the Company is required to withhold 10% of any distribution in excess
of the Company's current and accumulated earnings and profits. Consequently,
although the Company intends to withhold at a rate of 30% (or 31%, if
applicable) on the entire amount of any distribution, to the extent that the
Company does not do so, any portion of a distribution not subject to withholding
at a rate of 30% (or 31%, if applicable) will be subject to withholding at a
rate of 10%.
For any year in which the Company qualifies as a REIT, distributions that
are attributable to gain from sales or exchanges by the Company of U.S. real
property interests will be taxed to a Non-U.S. Stockholder under the provisions
of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under
FIRPTA, distributions attributable to gain from sales of U.S. real property
interests are taxed to a Non-U.S. Stockholder as if such gain were effectively
connected with a U.S. business. Non-U.S. Stockholders thus would be taxed at the
normal capital gain rates applicable to U.S. Stockholders (subject to applicable
alternative minimum tax and a special alternative minimum tax in the case of
nonresident alien individuals). Distributions subject to FIRPTA also may be
subject to the 30% branch profits tax in the hands of a non-U.S. corporate
stockholder not entitled to treaty relief or exemption. The Company is required
to withhold 35% of any distribution that is designated by the Company as a
capital gains dividend. The amount withheld is creditable against the Non-U.S.
Stockholder's FIRPTA tax liability.
Gain recognized by a Non-U.S. Stockholder upon a sale of his Common Stock
generally will not be taxed under FIRPTA if the Company is a "domestically
controlled REIT," defined generally as a REIT in which at all times during a
specified testing period less than 50% in value of the stock was held directly
or indirectly by non-U.S. persons. It is currently anticipated that the Company
will be a "domestically controlled REIT" and, therefore, the sale of the Common
Stock will not be subject to taxation under FIRPTA. No assurance can be given
that the Company will be a "domestically controlled REIT." If the gain on the
sale of the Common Stock were to be subject to taxation under FIRPTA, the
Non-U.S. Stockholder would be subject to the same treatment as U.S. Stockholders
with respect to such gain (subject to applicable alternative minimum tax, a
special alternative minimum tax in the case of nonresident alien individuals,
and the possible application of the 30% branch profits tax in the case of
non-U.S. corporations). Furthermore, gain not subject to FIRPTA would be taxable
to a Non-U.S. Stockholder if (i) investment in the Common Stock is effectively
connected with the Non-U.S. Stockholder's U.S. trade or business, in which case
the Non-U.S. Stockholder will be subject to the same treatment as U.S.
Stockholders with respect to such gain, or (ii) the Non-U.S. Stockholder is a
nonresident alien individual who was present in the U.S. for 183 days or more
during the taxable year and certain other conditions apply, in which case the
nonresident alien individual will be subject to a 30% tax on the individual's
capital gains.
BACKUP WITHHOLDING AND INFORMATION REPORTING. United States backup
withholding tax (as opposed to the 30% withholding tax referred to above)
generally will not apply to dividends paid on Common Stock to a Non-U.S.
Stockholder at an address outside the United States. The Company, however, must
report annually to the IRS and to each Non-U.S. Stockholder the amount of
dividends paid to such stockholder and the amount, if any, of tax withheld with
respect to such dividends. This information may also be made available to the
tax authorities in the Non-U.S. Stockholder's country of residence.
Upon the sale or other taxable disposition of Common Stock by a Non-U.S.
Stockholder to or through a United States office of a broker, the broker must
backup withhold at a rate of 31 percent and report the sale to the IRS, unless
such stockholder certifies (generally, on IRS Form W-8) its non-U.S. status
under penalties of perjury or otherwise establishes an exemption. Upon the sale
or other taxable disposition of Common Stock by a Non-U.S. Stockholder to or
through the foreign office of a United States broker, or a foreign broker with
certain types of relationships to the United States, the broker must report the
sale to the IRS (but is not required to backup withhold) unless the broker has
documentary evidence in its files that the seller is a Non-U.S. Stockholder and
certain other conditions are met, or such stockholder otherwise establishes an
exemption.
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The United States Treasury Department has recently issued regulations
generally effective for payments made after December 31, 1998 that unify the
forms, clarify the reliance standards and unify and tighten the procedures to be
followed by a Non-U.S. Stockholder in establishing such stockholder's status as
a Non-U.S. Stockholder for purposes of the withholding, backup withholding and
information reporting rules discussed herein. Among other things, a Non-U.S.
Stockholder that previously was not required to provide certifications regarding
its tax status (such as in the case of a foreign addressee receiving a dividend)
may be required to furnish certifications to comply with the new regulations,
and other non-U.S. Stockholders may be required to furnish new tax
certifications to comply with the new regulations.
Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules are generally allowable as a refund or credit against
such Non-U.S. Stockholder's United States federal income tax liability, if any,
provided that the required information is furnished to the IRS.
FEDERAL ESTATE TAXES
Common Stock owned or treated as owned by an individual who is not a citizen
or resident (as specially defined for United States federal estate tax purposes)
of the United States at the time of death will be included in such individual's
gross estate for United States federal estate tax purposes, unless an applicable
estate tax treaty provides otherwise.
STATE AND LOCAL TAXES
The Company or the holders of the Common Stock may be subject to state and
local tax in various states and localities, including those states and
localities in which it or they transact business, own property, or reside. The
state and local tax treatment of the Company and its stockholders in such
jurisdictions may differ from the federal income tax treatment described above.
Consequently, prospective stockholders should consult their own tax advisors
regarding the effect of state and local tax laws upon an investment in the
Common Stock.
ERISA CONSIDERATIONS
The following is a summary of material considerations arising under ERISA,
and the prohibited transaction provisions of Section 4975 of the Code that may
be relevant to a prospective purchaser subject to ERISA. The discussion does not
purport to deal with all aspects of ERISA or Section 4975 of the Code that may
be relevant to particular stockholders in light of their particular
circumstances.
The discussion is based on current provisions of ERISA and the Code,
existing and currently proposed regulations under ERISA and the Code, the
legislative history of ERISA and the Code, existing administrative rulings of
the Department of Labor ("DOL") and reported judicial decisions. No assurance
can be given that legislative, judicial, or administrative changes will not
affect the accuracy of any statements herein with respect to transactions
entered into or contemplated prior to the effective date of such changes.
EMPLOYEE BENEFIT PLANS, TAX-QUALIFIED RETIREMENT PLANS AND IRAS
ERISA imposes certain requirements on Plans and on those persons who are
fiduciaries with respect to such Plans. Investments by Plans are subject to
ERISA's general fiduciary requirements, including the requirement of investment
prudence and diversification and the requirement that such Plans' investments be
made in accordance with the documents governing the Plans.
Governmental plans and certain church plans, while not subject to the
fiduciary responsibility provisions of ERISA or the provisions of Section 4975
of the Code, may nevertheless be subject to state or other federal laws that are
substantially similar to the foregoing provisions of ERISA and the Code.
Fiduciaries of any such plans should consult with their counsel before
investing.
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STATUS OF THE COMPANY UNDER ERISA
The following section discusses certain principles that apply in determining
whether the fiduciary requirements of ERISA and the prohibited transaction
provisions of ERISA and the Code apply to an entity because one or more
investors in the equity interests in the entity is a Plan. A Plan fiduciary also
should consider the relevance of those principles to ERISA's prohibition on
improper delegation of control over or responsibility for "plan assets."
If the assets of the Company are deemed to be "plan assets" under ERISA, (i)
the prudence standards and other provisions of Part 4 of Title I of ERISA would
be applicable to any transactions involving the Company's assets, (ii) persons
who exercise any authority over the Company's assets, or who provide investment
advice to the Company, would (for purposes of the fiduciary responsibility
provisions of ERISA) be fiduciaries of each Plan that acquires Common Stock, and
transactions involving the Company's assets undertaken at their direction or
pursuant to their advice might violate their fiduciary responsibilities under
ERISA, especially with regard to conflicts of interest, (iii) a fiduciary
exercising his investment discretion over the assets of a Plan to cause it to
acquire or hold the Common Stock could be liable under Part 4 of Title I of
ERISA for transactions entered into by the Company that do not conform to ERISA
standards of prudence and fiduciary responsibility, and (iv) certain
transactions that the Company might enter into in the ordinary course of its
business and operations might constitute "prohibited transactions" under ERISA
and the Code.
The "Plan Asset Regulations" generally provide that when a Plan acquires a
security that is an equity interest in an entity and the security is neither a
"publicly-offered security" nor a security issued by an investment company
registered under the Investment Company Act, the Plan's assets include both the
equity interest and an undivided interest in each of the underlying assets of
the issuer of such equity interest, unless one or more exceptions specified in
the Plan Asset Regulations are satisfied.
The Plan Asset Regulations define a publicly-offered security as a security
that is "widely-held," "freely transferable," and either part of a class of
securities registered under the Exchange Act, or sold pursuant to an effective
registration statement under the Securities Act (provided the securities are
registered under the Exchange Act within 120 days after the end of the fiscal
year of the issuer during which the Offering occurred). The Common Stock is
being sold in an offering registered under the Securities Act and will be
registered under the Exchange Act. The Plan Asset Regulations provide that a
security is "widely held" only if it is part of a class of securities that is
owned by 100 or more investors independent of the issuer and of one another. A
security will not fail to be widely held because the number of independent
investors falls below 100 subsequent to the initial public offering as a result
of events beyond the issuer's control. The Company anticipates that upon
completion of the Offering, the Common Stock will be "widely held."
The Plan Asset Regulations provide that whether a security is "freely
transferable" is a factual question to be determined on the basis of all
relevant facts and circumstances. The Plan Asset Regulations further provide
that where a security is part of an offering in which the minimum investment is
$10,000 or less (as is the case with the Offering), certain restrictions
ordinarily will not, alone or in combination, affect a finding that such
securities are freely transferable. The restrictions on transfer enumerated in
the Plan Asset Regulations as not affecting that finding include: (i) any
restriction on or prohibition against any transfer or assignment that would
result in the termination or reclassification of an entity for federal or state
tax purposes, or that otherwise would violate any federal or state law or court
order, (ii) any requirement that advance notice of a transfer or assignment be
given to the issuer, (iii) any administrative procedure that establishes an
effective date, or an event (such as completion of an offering), prior to which
a transfer or assignment will not be effective, and (iv) any limitation or
restriction on transfer or assignment that is not imposed by the issuer or a
person acting on behalf of the issuer. The Company believes that the
restrictions imposed under the Charter on the transfer of the Company's stock
will not result in the failure of the Common Stock to be "freely transferable."
The Company also is not aware of
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any other facts or circumstances limiting the transferability of the Common
Stock that are not enumerated in the Plan Asset Regulations as those not
affecting free transferability, but no assurance can be given that the DOL or
the Treasury Department will not reach a contrary conclusion.
Assuming that the Common Stock will be "widely held" and that no other facts
and circumstances other than those referred to in the preceding paragraph exist
that restrict transferability of the Common Stock, the shares of Common Stock
should be publicly offered securities and the assets of the Company should not
be deemed to be "plan assets" of any Plan, IRA or non-ERISA Plan that invests in
the Common Stock.
Without regard to whether the assets of the Company are considered plan
assets, fiduciaries of Plans should consider the application of the prohibited
transaction provisions of ERISA and the Code in making their decision to
purchase the Common Stock, as such acquisition may be a sale or exchange of
property between a Plan and a party in interest or disqualified person.
A FIDUCIARY MAKING THE DECISION TO INVEST IN THE COMMON STOCK ON BEHALF OF A
PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A TAX-QUALIFIED
RETIREMENT PLAN, OR AN IRA SHOULD CONSULT ITS OWN LEGAL ADVISOR REGARDING THE
SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975 OF THE CODE, AND STATE
LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP, OR SALE OF THE COMMON STOCK BY SUCH
PLAN OR IRA.
CERTAIN PROVISIONS OF MARYLAND LAW
AND THE COMPANY'S CHARTER AND BYLAWS
The following summary of certain provisions of the MGCL and of the Charter
and the Bylaws of the Company does not purport to be complete and is subject to
and qualified in its entirety by reference to Maryland law and to the Charter
and the Bylaws of the Company, copies of which are filed as exhibits to the
Registration Statement of which this Prospectus is a part.
CERTAIN ANTI-TAKEOVER PROVISIONS
The Charter and the Bylaws of the Company contain certain provisions that
could discourage, impede or impair acquisition of control of the Company by
means of a tender offer, a proxy contest or otherwise. These provisions are
expected to discourage certain types of coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
the Company to negotiate first with the Board of Directors. The Company believes
that these provisions increase the likelihood that proposals initially will be
on more attractive terms than would be the case in their absence and increases
the likelihood of negotiations, which might outweigh the potential disadvantages
of discouraging such proposals because, among other things, negotiation of such
proposals might result in improvement of terms. The description set forth below
is a summary only, and is qualified in its entirety by reference to the Charter
and the Bylaws which have been incorporated by reference as exhibits to the
Registration Statement of which this Prospectus is a part. See "DESCRIPTION OF
CAPITAL STOCK--Restrictions on Transfer."
STAGGERED BOARD OF DIRECTORS
The Charter and the Bylaws divide the Board of Directors into three classes
of directors, each class constituting approximately one-third of the total
number of directors, with the classes serving staggered three-year terms. The
classification of the Board of Directors will make it more difficult for
stockholders to change the composition of the Board of Directors because only a
minority of the directors can be elected at once. The Company believes, however,
that the staggered Board of Directors will help to ensure continuity and
stability of the Company's management and policies. The classification
provisions could also discourage a third party from accumulating the Company's
stock or attempting to obtain control of the
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Company, even though this attempt might be beneficial to the Company and some,
or a majority, of its stockholders. Accordingly, under certain circumstances
stockholders could be deprived of opportunities to sell their shares of Common
Stock at a higher price than might otherwise be available.
NUMBER OF DIRECTORS, FILLING VACANCIES, REMOVAL
The Charter and Bylaws provide that the number of directors will be five, a
majority of whom will at all times be Independent Directors. The number of
directors may be changed by a vote of 80% of the entire Board of Directors. In
addition, the Charter provides that, unless the Board of Directors otherwise
determines, any vacancies may be filled by a vote of the stockholders or a
majority of the remaining directors, though less than a quorum, except vacancies
created by the increase in the number of directors, which only may be filled by
a majority of the entire Board of Directors; provided, however, that vacancies
among the Independent Directors may be filled only by nominees of the remaining
Independent Directors. Accordingly, the Board of Directors could temporarily
prevent any stockholder from enlarging the Board of Directors and filling the
new directorship with such stockholder's own nominees. The Charter and the
Bylaws provide that, subject to the rights of any class or series to elect
directors, directors may be removed only for cause upon the affirmative vote of
a majority of stockholders of all the then outstanding shares of stock entitled
to vote generally in the election of directors, voting together as a single
class.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER PROPOSALS
The Bylaws establish an advance notice procedure for stockholders to make
nominations of candidates for director or bring other business before an annual
meeting of stockholders of the Company. The Bylaws provide that (i) only persons
who are nominated by, or at the direction of, the Board of Directors, or by a
stockholder who has given timely written notice containing specified information
to the Secretary of the Company prior to the meeting, at which directors are to
be elected, will be eligible for election as directors of the Company, and (ii)
at an annual meeting, only such business may be conducted as has been brought
before the meeting by or at the direction of, the Chairman or the Board of
Directors or by a stockholder who has given timely written notice to the
Secretary of the Company of such stockholder's intention to bring such business
before such meeting. In general, for notice of stockholder nominations or
proposed business (other than business to be included in the Company's Proxy
Statement under the SEC's Rule 14a-8) to be conducted at an annual meeting to be
timely, such notice must be received by the Company not less than 60 days nor
more than 90 days prior to the first anniversary of the previous year's annual
meeting. The timing of such notice will be changed in the event the annual
meeting is delayed or advanced from the anniversary date. The purpose of
requiring stockholders to give the Company advance notice of nominations and
other business is to afford the Board of Directors a meaningful opportunity to
consider the qualifications of the proposed nominees or the advisability of the
other proposed business and, to the extent deemed necessary or desirable by the
Board of Directors, to inform stockholders and make recommendations about such
nominees or business, as well as to ensure an orderly procedure for conducting
meetings of stockholders. Although the Charter and the Bylaws do not give the
Board of Directors power to block stockholder nominations for the election of
directors or proposals for action, they may have the effect of discouraging
stockholders from proposing nominees or business, precluding a contest for the
election of directors or the consideration of stockholder proposals if
procedural requirements are not met and deterring third parties from soliciting
proxies for a non-management slate of directors or proposals, without regard to
the merits of such slate or proposals.
RIGHTS TO PURCHASE SECURITIES AND OTHER PROPERTY
The Charter provides that the Board of Directors may create and authorize
the Company to issue rights entitling the holders thereof to purchase from the
Company shares of capital stock or other securities or property. The times at
which and terms upon which such rights are to be issued are within the
discretion of the Board of Directors. The provision is intended to confirm the
Board of Directors'
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authority to issue share purchase rights which could have terms that would
impede a merger, tender offer or other takeover attempt, or other rights to
purchase securities of the Company or any other entity.
INDEMNIFICATION
The Company's Charter obligates the Company to indemnify its directors and
officers and to pay or reimburse expenses for such individuals in advance of the
final disposition of a proceeding to the maximum extent permitted from time to
time by Maryland law. The MGCL permits a corporation to indemnify its present
and former directors and officers, among others, against judgments, penalties,
fines, settlements and reasonable expenses actually incurred by them in
connection with any proceeding to which they may be made a party by reason of
their service in those or other capacities, unless it is established that (a)
the act or omission of the director or officer was material to the matter giving
rise to the proceeding and (i) was committed in bad faith, or (ii) was a result
of active and deliberate dishonesty, (b) the director or officer actually
received an improper personal benefit in money, property or services, or (c) in
the case of any criminal proceeding, the director or officer had reasonable
cause to believe that the act or omission was unlawful. As permitted by the
MGCL, the Company's Charter obligates the Company to indemnify its present and
former directors and officers and to pay or reimburse reasonable expenses for
such individuals in advance of the final disposition of a proceeding to the
maximum extent permitted from time to time by Maryland law.
LIMITATION OF LIABILITY
The MGCL permits the Charter of a Maryland corporation to include a
provision limiting the liability of its directors and officers to the
corporation and to its stockholders for money damages, except to the extent that
(i) it is proved that the person actually received an improper benefit or profit
in money, property or services for the amount of the benefit or profit in money,
property or services actually received, or (ii) a judgment or other final
adjudication adverse to the person is entered in a proceeding based on a finding
that the person's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Charter contains a provision providing for limitation
of the liability of its directors and officers to the Company or its
stockholders for money damages to the maximum extent permitted by Maryland law
as amended or interpreted.
BUSINESS COMBINATIONS
Under Section 3-602(a) of the MGCL and unless exempted under Section
3-603(c), (d) or (e), certain "business combinations" (including a merger,
consolidation, share exchange, or, in certain circumstances, an asset transfer
or issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns 10% or more of the voting power
of the corporation's shares after the date on which the corporation had 100 or
more beneficial owners of its shares or an affiliate or associate of the
corporation which, at any time within the two-year period prior to the date in
question, beneficially owned 10% or more of the voting power of the
corporation's shares after the date on which the corporation had 100 or more
beneficial owners of its shares (an "Interested Stockholder") or an affiliate
thereof, are prohibited for five years after the most recent date on which the
Interested Stockholder became an Interested Stockholder. Thereafter, any such
business combination must be recommended by the board of directors of such
corporation and approved by the affirmative vote of at least (a) 80% of the
votes entitled to be cast by holders of outstanding voting shares of the
corporation and (b) two-thirds of the votes entitled to be cast by holders of
outstanding voting shares of the corporation other than shares held by the
Interested Stockholder with whom (or with whose affiliate) the business
combination is to be effected, or by an affiliate or associate of the Interested
Stockholder, voting together as a single voting group unless, among other
things, the corporation's stockholders receive a minimum price (as defined in
the MGCL) for their shares and the consideration is received in cash or in the
same form as previously paid by the Interested Stockholder for its shares. These
provisions of Maryland law do not apply, however, to business combinations that
are approved or exempted by the board of directors of the corporation prior to
the time that the Interested Stockholder becomes an Interested Stockholder.
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CONTROL SHARE ACQUISITIONS
Section 3-702(a) of the MGCL provides that "control shares" of a Maryland
corporation acquired in a "control share acquisition" have no voting rights
except to the extent approved by a vote of two-thirds of the votes entitled to
be cast on the matter, excluding shares of stock owned by the acquirer or by
officers or directors who are employees of the corporation. "Control shares" are
voting shares of stock which, if aggregated with all other shares of stock owned
by such a person, would entitle the acquirer to exercise or direct the voting
power in electing directors within one of the following ranges of voting power:
(i) one-fifth or more but less than one-third, (ii) one-third or more but less
than a majority, or (iii) a majority or more of all voting power. "Control
shares" do not include shares of stock the acquiring person is then entitled to
vote as a result of having previously obtained stockholder approval. A "control
share acquisition" means, subject to certain exceptions, the acquisition of,
ownership of, or the power to direct the exercise of voting power with respect
to "control shares."
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares" (except those for which voting rights have previously been
approved) for fair value determined, without regard to absence of voting rights
for the control shares, as of the date of the last "control share acquisition"
or of any meeting of stockholders at which the voting rights of such shares are
considered and not approved. If voting rights for "control shares" are approved
at a stockholders' meeting and the acquirer becomes entitled to vote a majority
of the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock, as determined for purposes of such
appraisal rights may not be less than the highest price per share paid in the
"control share acquisition," and certain limitations and restrictions otherwise
applicable to the exercise of appraisal rights do not apply in the context of
"control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
charter or bylaws of the corporation adopted prior to the acquisition of the
shares. The Company has adopted a provision in its Charter and its Bylaws that
exempts the Company's shares of Common Stock from application of the "control
share acquisition" statute. No assurance can be given, however, that such
provision may not removed at any time by amendment of the Bylaws.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Charter provides that the Company may issue up to 100,000,000 shares of
capital stock, consisting of 74,000,000 shares of Common Stock, $.001 par value
per share, 1,000,000 shares of Class B Stock, $.001 par value per share, and
25,000,000 shares of preferred stock, $0.01 par value per share ("Preferred
Stock"). Upon completion of this Offering and the Private Placement, 11,000,750
shares (12,500,750 shares if the Underwriters' over-allotment option is
exercised in full) of Common Stock and 200,000 shares of Class B Stock will be
issued and outstanding, 1,300,000 shares (1,495,000 if the Underwriters' over-
allotment option is exercised in full) of Common Stock will be reserved for
issuance upon grants of deferred stock awards and the exercise of options, and
no Preferred Stock will be issued and outstanding.
COMMON STOCK
All outstanding shares of Common Stock will be duly authorized, fully paid
and nonassessable upon the Closing. Subject to the preferential rights of any
other shares or series of shares of capital stock, holders of Common Stock will
be entitled to receive dividends if and when authorized and declared by the
Board of Directors of the Company out of assets legally available therefor and
to share ratably in the assets
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of the Company legally available for distribution to its stockholders in the
event of its liquidation, dissolution or winding-up after payment of, or
adequate provision for, all known debts and liabilities of the Company. The
Company intends to pay quarterly dividends.
Each outstanding share of Common Stock entitles the holder to one vote on
all matters submitted to a vote of stockholders, including the election of
directors, and, except as otherwise required by law or except as provided with
respect to any other class or series of shares of capital stock, the holders of
the Common Stock will possess the exclusive voting power. There is no cumulative
voting in the election of directors, which means in all elections of directors,
each holder of Common Stock has the right to cast one vote for each share of
stock for each position.
CLASS B STOCK
All outstanding shares of Class B Stock will be duly authorized, fully paid
and nonassessable upon the Closing Date. Subject to the preferential rights of
any other shares or series of shares of capital stock, holders of Class B Stock
will be entitled to receive distributions if and when authorized and declared by
the Board of Directors of the Company out of assets legally available therefor;
PROVIDED, HOWEVER, that before the Class B Subordination Termination Date, any
amounts available for distribution will be distributed quarterly (i) first, to
the holders of the Common Stock, until such holders have received the Yield
Threshold with respect to their shares of Common Stock, (ii) second, to the
holders of the Class B Stock, until such holders have received the Yield
Threshold with respect to their shares of Class B Stock plus the cumulative
amount, if any, by which distributions with respect to the Class B Stock were
less than the Yield Threshold in the prior three quarters and (iii) third, to
the holders of the Common Stock and the holders of the Class B Stock, PRO RATA
in accordance with their respective share ownership. From and after the Class B
Subordination Termination Date, quarterly distributions will be made PRO RATA to
the holders of the Common Stock and the holders of the Class B Stock, in
accordance with their respective share ownership. The holders of Class B Stock
will be entitled to receive and to share ratably in the assets of the Company
legally available for distribution to its Stockholders in the event of its
liquidation, dissolution or winding-up after payment of, or adequate provision
for, all known debts and liabilities of the Company.
After the Class B Subordination Termination Date, shares of Class B Stock
are convertible into shares of the Common Stock. The Company has agreed that,
upon a valid conversion of shares of Class B Stock to shares of Common Stock, it
will file and use its best efforts to have declared effective a resale
registration statement covering the sale of such shares of Common Stock.
Except as provided by applicable Maryland law, the shares of Class B Stock
shall have no voting rights.
PREFERRED STOCK
Preferred Stock of the Company may be issued from time to time in one or
more series, as authorized by the Board of Directors. Because the Board of
Directors has the power to establish the preferences and rights of each class or
series of Preferred Stock, the Board of Directors may afford the holders of any
series or class of Preferred Stock preferences, powers and rights, voting or
otherwise, senior to the rights of the holders of Common Stock. This could
affect the ability of the Company to make dividend distributions to the holders
of Common Stock. The Board could authorize the issuance of Preferred Stock with
terms and conditions which could have the effect of discouraging a takeover or
other transaction which holders of some, or a majority, of the shares of Common
Stock might believe to be in their best interests or in which holders of some,
or a majority, of the shares of Common Stock might receive a premium for their
shares of Common Stock over the then market price of such shares of Common
Stock. As of the date hereof, no shares of Preferred Stock are outstanding.
REGISTRATION RIGHTS
The Company has agreed that it will file with the SEC, and use its best
efforts to have declared effective, a resale registration statement covering the
sale of the shares sold in the Private Placement. The Company has agreed with
Mr. Heflin, Clarion Partners and an Affiliated Fund that it will keep such
resale
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registration statement effective until such time as sales may be made in
reliance on Rule 144(k) under the Securities Act. See "PRIVATE PLACEMENT."
RESTRICTIONS ON TRANSFER
For the Company to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, not more than 50% in value of the Company's outstanding
capital stock may be owned, directly or indirectly, by five or fewer individuals
(as defined in the Code to include certain entities) during the last half of a
taxable year, and the Company must be beneficially owned by 100 or more persons
during at least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year. See "FEDERAL INCOME TAX
CONSIDERATIONS-- Requirements for Qualification."
Because the Board of Directors believes it is essential for the Company to
continue to qualify as a REIT, the Charter, subject to certain exceptions and
waivers described below, provide that no person may own, or be deemed to own by
virtue of the attribution provisions of the Code, more than (i) 9.9% of the
number of outstanding shares of Common Stock, or (ii) 9.9% of the number of
outstanding shares of any series of Preferred Stock (the "Ownership Limit").
Subject to certain exceptions described below, any purported transfer of
shares of Common Stock or Preferred Stock that would (i) result in any person
owning, directly or indirectly, shares of Common Stock or Preferred Stock in
excess of the Ownership Limitation, (ii) result in the shares of Common Stock
and Preferred Stock, collectively, being owned by fewer than 100 persons
(determined without reference to any rules of attribution), (iii) result in the
Company being "closely held" within the meaning of Section 856(h) of the Code,
or (iv) cause the Company to own, actually or constructively, 10% or more of the
ownership interests in a tenant of the Company's real property, within the
meaning of Section 856(d)(2)(B) of the Code, will be designated as
"Shares-in-Trust" and transferred automatically to a trust (the "Trust")
effective on the day before the purported transfer of such shares of Common
Stock or Preferred Stock. The record holder of the shares of Common Stock or
Preferred Stock that are designated as Shares-in-Trust (the "Prohibited Owner")
will be required to submit such number of shares of Common Stock or Preferred
Stock to the Company for registration in the name of the Trust. The trustee of
the Trust (the "Trustee") will be designated by the Company, but will not be
affiliated with the Company. The beneficiary of the Trust (the "Beneficiary")
will be one or more charitable organizations that are named by the Company.
Shares-in-Trust will remain issued and outstanding shares of Common Stock or
Preferred Stock and will be entitled to the same rights and privileges as all
other shares of the same class or series. The Trustee will receive all dividends
and distributions on the Shares-in-Trust and will hold such dividends or
distributions in trust for the benefit of the Beneficiary. The Trustee will vote
all Shares-in-Trust. The Trustee will designate a permitted transferee of the
Shares-in-Trust, provided that the permitted transferee (i) purchases such
Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Trustee the amount of any dividends or distributions received by
the Prohibited Owner (i) that are attributable to any Shares-in-Trust and (ii)
the record date of which was on or after the date that such shares became
Shares-in-Trust. The Prohibited Owner generally will receive from the Trustee
the lesser of (i) the price per share such Prohibited Owner paid for the shares
of Common Stock or Preferred Stock that were designated as Shares-in-Trust (or,
in the case of a gift or devise, the Market Price (as defined below) per share
on the date of such transfer) or (ii) the price per share received by the
Trustee from the sale of such Shares-in-Trust. Any amounts received by the
Trustee in excess of the amounts to be paid to the Prohibited Owner will be
distributed to the Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the Market Price per share on the date of such
transfer)
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or (ii) the Market Price per share on the date that the Company, or its
designee, accepts such offer. The Company will have the right to accept such
offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust or (ii) the date the
Company determines in good faith that a transfer resulting in such
Shares-in-Trust occurred.
"Market Price" on any date shall mean the average of the Closing Price (as
defined below) for the five consecutive Trading Days (as defined below) ending
on such date. The "Closing Price" on any date shall mean (i) the last reported
sales price regular way or, in case no such reported sale takes place on such
day, the average of the reported closing bid and asked prices regular way, in
either case on the NYSE, or (ii) if the shares of Common Stock are not listed as
admitted to trading on the NYSE, the last reported sales price regular way, or
in case no such reported sale takes place on such day, the average of the
reported closing bid and asked prices regular way, on the principal national
securities exchange on which the shares of Common Stock are listed or admitted
to. "Trading Day" shall mean any day other than a Saturday, a Sunday or a day on
which banking institutions in the State of New York are authorized or obligated
by law or executive order to close.
Any person who acquires or attempts to acquire shares of Common Stock or
Preferred Stock in violation of the foregoing restrictions, or any person who
owned shares of Common Stock or Preferred Stock that were transferred to a
Trust, will be required (i) to give immediately written notice to the Company of
such event and (ii) to provide to the Company such other information as it may
request in order to determine the effect, if any, of such transfer on the
Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must, within 30 days
after January 1 of each year, provide to the Company a written statement or
affidavit stating the name and address of such direct or indirect owner, the
number of shares of Common Stock and Preferred Stock owned directly or
indirectly, and a description of how such shares are held. In addition, each
direct or indirect stockholder shall provide to the Company such additional
information as the Company may request in order to determine the effect, if any,
of such ownership on the Company's status as a REIT and to ensure compliance
with the Ownership Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates in
a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the Service or an opinion of counsel and upon such
other conditions as the Board of Directors may direct, may exempt a person from
the Ownership Limitation under certain circumstances. The foregoing restrictions
will not be removed until (A)(i) such restrictions are no longer required in
order to qualify as a REIT and (ii) the Board of Directors determines that it is
no longer in the best interest of the Company to retain such restrictions; or
(B) the Board of Directors determines that it is no longer in the best interests
of the Company to attempt to qualify, or to continue to qualify, as a REIT.
All certificates representing shares of Common Stock or Preferred Stock will
bear a legend referring to the restrictions described above.
The Ownership Limitation could have the effect of discouraging a takeover or
other transaction in which holders of some, or a majority, of shares of Common
Stock might receive a premium for their shares of Common Stock over the then
prevailing market price or which such holders might believe to be otherwise in
their best interest.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is State Street Bank
and Trust Company.
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\
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this Offering, there has been no public market for the Common Stock
of the Company. Application will be made to list the shares of Common Stock on
the NYSE. Sales of a substantial number of shares of Common Stock in the public
market following the Offering, or the perception that such sales could occur,
could adversely affect the market price of the Common Stock prevailing from time
to time and could impair the Company's future ability to raise capital through
an offering of equity securities.
The Company has reserved for issuance 1,300,000 shares (1,495,000 shares if
the Underwriters' over-allotment option is exercised in full) under the Stock
Incentive Plan. The 10,000,000 shares (11,500,000 if the Underwriters'
over-allotment option is exercised in full) of Common Stock issued in the
Offering will be freely tradable by persons other than affiliates, (as such term
is defined under the Securities Act, "Affiliates") of the Company without
restriction under the Securities Act, subject to certain limitations on
ownership set forth in the Charter. See "DESCRIPTION OF CAPITAL
STOCK--Restrictions on Transfer."
At the Closing Date, options to purchase 770,000 shares (885,500 shares if
the Underwriters' over-allotment option is exercised in full) of Common Stock
will be outstanding. Shortly after the Offering, the Company intends to file a
Registration Statement on Form S-8 under the Securities Act covering shares of
Common Stock reserved for issuance under the Company's Stock Incentive Plan.
Shares of Common Stock issued upon exercise of options under the Registration
Statement on Form S-8 will be available for sale in the public market, subject
to Rule 144 manner of sale and volume limitations in the case of Affiliates (as
discussed in the next paragraph and subject to any lock-up restrictions
discussed in "UNDERWRITING").
Based upon certain performance standards to be established by the
Compensation Committee, under the Stock Incentive Plan, the Company may also
grant up to 200,000 shares of deferred stock to certain employees, officers and
consultants of the Company and the Manager and its affiliates.
In general, pursuant to Rule 144 under the Securities Act as currently in
effect, if one year has elapsed since the later of the date of acquisition of
restricted shares from the Company or any Affiliate of the Company, the acquirer
or subsequent holder thereof is entitled to sell within any three-month period a
number of shares that does not exceed the greater of 1% of the then outstanding
Common Stock or the average weekly trading volume of the Common Stock during the
four calendar weeks preceding the date on which notice of the sale is filed with
the Commission. Sales pursuant to Rule 144 under the Securities Act also are
subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. If two years have
elapsed since the date of acquisition of restricted shares from the Company or
from any Affiliate of the Company at any time during the three months preceding
a sale, such person would be entitled to sell such shares in the public market
pursuant to Rule 144(k) under the Securities Act without regard to the volume
limitations, manner of sale provisions, public information requirements or
notice requirements.
The 1,000,000 shares of Common Stock sold in the Private Placement are
"restricted securities" for purposes of Rule 144 under the Securities Act.
However, the Company will file and seek to have declared effective a resale
registration statement covering the sale of such shares in the public market.
See "DESCRIPTION OF CAPITAL STOCK--Registration Rights." Following expiration of
the applicable lock-up restrictions discussed in "UNDERWRITING," these shares
will be available for sale in the public market, subject to Rule 144 manner of
sale and volume limitations in the case of Affiliates. See "PRIVATE PLACEMENT."
The Company has agreed that, upon a valid conversion of shares of Class B
Stock to shares of Common Stock, it will file and use its best efforts to have
declared effective a resale registration statement covering the sale of such
shares of Common Stock. See "CONFLICTS OF INTEREST AND BENEFITS TO RELATED
PARTIES" and "DESCRIPTION OF CAPITAL STOCK--Class B Stock."
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UNDERWRITING
The underwriters of the Offering of the Common Stock (the "Underwriters"),
for whom Bear, Stearns & Co. Inc. ("Bear Stearns") and Lehman Brothers Inc. are
acting as representatives (the "Representatives"), have severally agreed,
subject to the terms and conditions of the Underwriting Agreement (the
"Underwriting Agreement") (a form of which is filed as an exhibit to the
Registration Statement of which this Prospectus is a part), to purchase from the
Company the aggregate number of shares of Common Stock set forth opposite their
name below:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Bear, Stearns & Co. Inc. ..................................................
Lehman Brothers Inc. ......................................................
--------
Total..................................................................
--------
--------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that, if any of the foregoing
shares of Common Stock are purchased by the Underwriters pursuant to the
Underwriting Agreement, all such shares must be so purchased. The Company has
agreed to indemnify the Underwriters against certain liabilities, including
liabilities under the Securities Act, or to contribute to payments that the
Underwriters may be required to make in respect thereof.
The Company has been advised that the Underwriters propose to offer the
shares of Common Stock to the public initially at the public offering price set
forth on the cover of this Prospectus and to certain selected dealers (who may
include the Underwriters) at such public offering price less a concession not to
exceed $ per share. The selected dealers may reallow a concession to certain
other dealers not to exceed $ per share. After the initial offering to the
public, the public offering price, the concession to selected dealers and the
reallowance to other dealers may be changed by the Representatives.
In order to facilitate the Offering, certain persons participating in the
Offering may engage in transactions that stabilize, maintain or otherwise affect
the price of the Common Stock during and after the Offering. Specifically, the
Underwriters may over-allot or otherwise create a short position in the Common
Stock for their own account by selling more shares of Common Stock than have
been sold to them by the Company. The Underwriters may elect to cover any such
short position by purchasing shares of Common Stock in the open market or by
exercising the over-allotment option granted to the Underwriters. In addition,
such persons may stabilize or maintain the price of the Common Stock by bidding
for or purchasing shares of Common Stock in the open market and may impose
penalty bids, under which selling concessions allowed to syndicate members or
other broker-dealers participating in the Offering are reclaimed if shares of
Common Stock previously distributed in the Offering are repurchased in
connection with stabilization transactions or otherwise. The effect of these
transactions may be to stabilize or maintain the market price of the Common
Stock at a level above that which might otherwise prevail in the open market.
The imposition of a penalty bid may also affect the price of the Common Stock to
the extent that it discourages resales thereof. No representation is made as to
the magnitude or effect of any such stabilization or other transactions. Such
transactions may be effected on the NYSE or otherwise and, if commenced, may be
discontinued at any time.
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The Company has agreed to indemnify the several Underwriters or to
contribute to losses arising out of certain liabilities, including certain
liabilities under the Securities Act.
The Company has granted the Underwriters an option to purchase up to
1,500,000 additional shares of Common Stock at the public offering price less
underwriting discounts and commissions set forth on the cover page of this
Prospectus, solely to cover over-allotments, if any. Such option may be
exercised at any time until 30 days after the date of this Prospectus. To the
extent the Underwriters exercise such option, each of the Underwriters will be
committed, subject to certain conditions, to purchase a number of additional
shares of Common Stock proportionate to such Underwriter's initial commitment as
indicated in the preceding table.
The Company has applied for listing on the NYSE. The Underwriters have
agreed that the Common Stock will be sold in compliance with NYSE distribution
standards, including such standards relating to round lots and aggregate market
value.
Prior to the Offering, there has been no public market for the Common Stock.
Consequently, the public offering price was determined by negotiation between
the Company and the Underwriters. Among the factors considered in such
negotiations were the nature of the Company's business, its prospects and
management, and the general conditions of the securities markets at the time of
the Offering. There can be no assurance, however, that the prices at which the
shares will sell in the public market after the Offering will not be lower than
the price at which they are sold by the Underwriters.
The Representatives have informed the Company that the Underwriters do not
intend to confirm sales to any accounts over which they exercise discretionary
authority.
In connection with the Offering, Mr. Heflin, Clarion Partners (which
includes Mr. Sullivan) and an Affiliated Fund, which have purchased 1,000,000
shares, in the aggregate, of Common Stock in the Private Placement have agreed
that they will not, directly or indirectly, offer, pledge, sell, offer to sell,
contract to sell or grant any option to purchase or otherwise sell or dispose
(or announce any offer, pledge, sale, offer of sale, contract of sale, grant of
any option to purchase or other sale or disposition) of any shares of Common
Stock or other capital stock or securities exchangeable or exercisable for, or
convertible into, shares of Common Stock or other capital stock for a period of
180 days (or such shorter period as expressly agreed to by Bear Stearns) after
the date of this Prospectus, except (i) with the prior written consent of the
Bear Stearns, on behalf of the Underwriters, and (ii) in the case of the
Company, for issuances under the terms of the Stock Incentive Plan or any
dividend reinvestment plan adopted by the Company.
The Underwriters have from time to time performed investment banking
services in the ordinary course of business for the Company, the Manager and
their affiliates, for which it has received customary compensation and may
continue to do so in the future.
PRIVATE PLACEMENT
The Company received commitments from Mr. Heflin, Clarion Partners (which
includes Mr. Sullivan) and Monroe Investment Corp., an Affiliated Fund, on March
11, 1998 for the purchase, in a private placement, of 1,000,000 shares of Common
Stock, in the aggregate, at the initial public offering price.
Consummation of such purchase is contingent only upon, and will occur
simultaneous with, the closing of the Offering. The shares sold in the Private
Placement will be sold without registration under the Securities Act, in
reliance on the exemption provided by Section 4(2) thereof.
The Company has agreed that it will file and use its best efforts to have
declared effective a resale registration statement covering the sale of the
shares purchased in the Private Placement. These shares will be subject to
certain lock-up restrictions as described in "UNDERWRITING" but will be
available for public sale following expiration of such restrictions.
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LEGAL MATTERS
Certain legal matters will be passed upon for the Company by Shearman &
Sterling, New York, New York, and for the Underwriters by Stroock & Stroock &
Lavan LLP, New York, New York. Shearman & Sterling may rely as to matters of
Maryland law on the advice of Shulman, Rogers, Gandal, Pordy & Ecker, P.A.,
Rockville, Maryland. Certain tax matters have been passed upon by Shearman &
Sterling, special tax counsel to the Company.
EXPERTS
The statement of financial condition of the Company as of February 18, 1998
included in this Prospectus has been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report appearing herein, and is so
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the SEC a Registration Statement (of which this
Prospectus forms a part) under the Securities Act, with respect to the Common
Stock offered pursuant to the Prospectus. This Prospectus contains summaries of
the material terms of the documents referred to herein and therein, but does not
contain all of the information set forth in the Registration Statement pursuant
to the rules and regulations of the SEC. For further information, reference is
made to such Registration Statement and the exhibits thereto. Such Registration
Statement and exhibits as well as reports and other information filed by the
Company can be inspected without charge and copied at prescribed rates at the
public reference facilities maintained by the SEC at the Public Reference
Section of the SEC, 450 Fifth Street, N. W., Washington, D.C. 20549, and at its
Regional Offices located as follows: Chicago Regional Office, Citicorp Center,
Suite 1400, 500 West Madison Street, Chicago, Illinois 60661-2511; and New York
Regional Office, Seven World Trade Center, Suite 1300, New York, New York 10048.
The SEC maintains a Web site that contains reports, proxy, and information
statements and other information regarding registrants that file electronically
with the Commission. The Web site is located at http://www.sec.gov.
Application has been made to list the Common Stock on the NYSE. Reports and
other information concerning the Company can also be inspected at the office of
the NYSE, 20 Broad Street, New York, New York 10005.
Statements contained in this Prospectus as to the contents of any contract
or other document that is filed as an exhibit to the Registration Statement are
not necessarily complete, and each such statement is qualified in its entirety
by reference to the full text of such contract or document.
The Company will be required to file reports and other information with the
Commission pursuant to the Exchange Act. In addition to applicable legal
requirements, if any, holders of Common Stock will receive annual reports
containing audited financial statements with a report thereon by the Company's
independent auditors, and quarterly reports containing unaudited financial
information for each of the first three quarters of each fiscal year.
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GLOSSARY
As used in this Prospectus, the capitalized and other terms listed below
have the meanings indicated.
"1998 Budget Proposal" means President Clinton's February 1998 Budget
Proposal.
"Acceleration Event" means any of the following circumstances in which the
awards granted under the Stock Incentive Plan generally become immediately
vested and exercisable: (i) upon the occurrence of special circumstances
determined in the opinion of the Board of Directors of the Company to merit
special consideration, (ii) upon a termination by the Company of the
stockholder's employment or service without cause (as defined in the Stock
Incentive Plan), (iii) in the case of an employee or director of the Manager, if
the Management Agreement terminates without the occurrence of a Termination
Event (as defined in the Stock Incentive Plan), or (iv) upon a Change of Control
(as defined in the Stock Incentive Plan) of the Company, except that vesting and
exercisability in the event of such a Change of Control shall be limited to the
extent necessary, and shall occur as soon as permissible under GAAP, to permit
pooling of interests accounting treatment if such treatment is desired.
"ADA" means the Americans with Disabilities Act of 1990.
"Adjusted Net Income" means the taxable income of the Company within the
meaning of the Code, less any unrealized capital depreciation with respect to
any assets of the Company for which market quotations are readily available but
before the Manager's incentive fees and before deduction of dividends paid.
"Affiliate" means, when used with reference to a specified person, (i) any
person that directly or indirectly controls or is controlled by or is under
common control with the specified person, (ii) any person that is an officer of,
partner in or trustee of, or serves in a similar capacity with respect to, the
specified person or of which the specified person is an officer, partner or
trustee, or with respect to which the specified person serves in a similar
capacity, and (iii) any person that, directly or indirectly, is the beneficial
owner of 5% or more of any class of equity securities of the specified person or
of which the specified person is directly or indirectly the owner of 5% or more
of any class of equity securities.
"Affiliated Funds" means the private investment funds advised by the
Manager.
"Bear Stearns" means Bear, Stearns & Co. Inc., one of the Representatives.
"Board of Directors" means the Board of Directors of the Company.
"Bylaws" means the Bylaws, as amended, of the Company.
"CERCLA" means the Comprehensive Environmental Response, Compensation and
Liability Act, as amended.
"Charter" means the Articles of Incorporation, as amended, of the Company.
"CLARION" means, collectively, Clarion Partners and its affiliates.
"Clarion Partners" means Clarion Partners, LLC.
"Class B Stock" means the Class B common stock, $.001 par value per share,
of the Company.
"Class B Subordination Termination Date" means the earlier to occur of (i)
January 2, 2000 or (ii) the date on which the Company makes its fourth
consecutive quarterly distribution with respect to the Common Stock in an amount
that equals or exceeds the Yield Threshold.
"Closing Date" means the date of the closing of the Offering.
"CMBS" means commercial mortgage-backed securities.
"CMOs" means collateralized mortgage obligations.
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"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Property" means the property securing commercial mortgage loans,
which includes multi-family, shopping centers, office buildings, hotels,
industrial properties, hospitals and nursing homes.
"Common Stock" means the Class A common stock, $.001 par value per share, of
the Company.
"Company" means Clarion Commercial Holdings, Inc., a Maryland corporation.
"Company Expenses" means all administrative costs and expenses of the
Company and the General Partner.
"DOL" means the U.S. Department of Labor.
"Duff & Phelps" means Duff & Phelps Credit Rating Co.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"excess inclusion" means taxable income that is generated by the Company's
assets constituting a "taxable mortgage pool" under regulations to be issued by
the Treasury Department.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"FASIT" means a Financial Asset Securitization Investment Trust.
"5/50 Rule" means that, for the Company to maintain its qualification as a
REIT, during the last half of each taxable year, not more than 50% in value of
its outstanding shares may be owned directly or indirectly by five or fewer
individuals.
"FIRPTA" means Foreign Investment in Real Property Tax Act of 1980.
"Fitch IBCA" means Fitch IBCA Investors Service, L.P.
"GAAP" means generally accepted accounting principles.
"GAAP income" means income calculated according to GAAP.
"General Partner" means CCHI General, Inc., a Delaware corporation.
"Independent Directors" means those directors that are not affiliated,
directly, or indirectly, with the Company, the Manager or CLARION, whether by
ownership of, ownership interest in, employment by, any material business or
professional relationship with, or serving as an officer or director of the
Company or the Manager or an affiliated business entity of the Company, the
Manager or CLARION.
"Ineligible Property" means a property that is not eligible for the election
to be treated as foreclosure property.
"Initial CMBS" means the portion of the Initial Investments comprised of
CMBS.
"Initial Investments" means the initial investments in Real Estate
Investments to be made by the Company with a portion of the net proceeds of the
Offering.
"Initial Limited Partner" means CCHI Limited, Inc., a Delaware corporation.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"IRA" means an Individual Retirement Account.
"Lehman Brothers" means Lehman Brothers Inc., one of the Representatives.
"LIBOR" means the interest rate per annum at which deposits in U.S. dollars
are offered to prime banks in the London interbank market.
"Limited Partners" means the limited partners of the Operating Partnership.
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"LLC" means a limited liability company.
"Management Agreement" means the agreement by and between the Company and
the Manager whereby the Manager agrees to perform certain services to the
Company in exchange for certain fees.
"Manager" means Clarion Capital, LLC, a New York limited liability company.
"margin call" means additional collateral that the Company would be required
to deposit due to potential reverse repurchase and dollar roll agreements.
"Master Servicer" means an entity that will administer and supervise the
performance by servicers of the duties and responsibilities under Servicing
Agreements in respect of the collateral for a series of Mortgage Securities.
"Mezzanine Investment" means a Real Estate Investment in the form of
preferred or PARI PASSU equity, leveraged joint venture equity or subordinate or
participating mortgage loans.
"MGCL" means the Maryland General Corporation Law.
"Mortgage Collateral" means the commercial mortgage loans underlying a given
issuance of CMBS.
"mortgaged property" means the property pledged as collateral for a mortgage
loan.
"Mortgage Seller" means the seller of the commercial mortgage loans
acquired, from time to time, by the Company.
"Non-U.S. Stockholder" means a holder of Common Stock that for U.S. federal
income tax purposes is not a U.S. Stockholder.
"Moody's" means Moody's Investors Service, Inc.
"NYSE" means the New York Stock Exchange.
"Offering" means the initial public offering of the Company's Common Stock
pursuant to this Prospectus.
"OID" means original issue discount with respect to debt obligations.
"Operating Partnership" means CCHI Limited Partnership, a Delaware limited
partnership.
"Operating Partnership Agreement" means the partnership agreement for the
Operating Partnership.
"Option Exercise Date" means January 2, 2000.
"Ownership Limit" means the limit set forth by the Charter of the Company
which prohibits direct or indirect ownership by any person of more than 9.9% of
the number of outstanding shares of Common Stock.
"phantom income" means that the Company's investment in certain types of
CMBS may cause it under certain circumstances to recognize taxable income in
excess of its economic income.
"Plan" means any pension, profit-sharing or other employee benefit plan
subject to Title I of ERISA.
"Plan Asset Regulations" means regulations of the DOL defining "plan
assets."
"Preferred Stock" means the Company's preferred stock, par value $0.01.
"Private Placement" means the consummation of the transactions described
herein under the caption "PRIVATE PLACEMENT."
"prohibited transaction" means a transaction involving a sale of dealer
property, other than foreclosure property.
99
<PAGE>
"Purchasing Priority Amount" shall mean an amount equal to 2.5 times the net
proceeds of the Offering and the Private Placement.
"purported transfer" means any transfer of shares of capital stock that
would result in disqualification of the Company as a REIT or that would (a)
create a direct or constructive ownership of shares of stock in excess of the
Ownership Limit, (b) result in the shares of stock being beneficially owned by
fewer than 100 persons or (c) result in the Company being "closely held" within
the meaning of Section 856(h) of the Code.
"purported transferee" means any intended transferee of a purported
transfer.
"qualified REIT subsidiaries" means subsidiaries that meet the requirements
under Section 856(i)(2) of the Code.
"Qualifying Interests" means "mortgages and other liens on and interests in
real estate," as defined in Section 3(c)(5)(C) under the Investment Company Act.
"Rating Agencies" means the nationally-recognized rating agencies.
"Real Estate Investments" means the commercial debt and equity real estate
investments to be made by the Company.
"Redemption Rights" means the rights to redeem Units for cash or, at the
election of the General Partner, shares of Common Stock on a one-for-one basis.
"REIT" means real estate investment trust.
"REIT Provisions of the Code" means Sections 856 through 860 of the Code.
"REMIC" means real estate mortgage investment conduit.
"REMIC Residual Interests" means Company owned residual interests in REMICs.
"Rent" means the rent received by the Company from the tenants of its real
property.
"Representatives" mean Bear Stearns and Lehman Brothers, acting as
representatives for the several Underwriters of the Offering.
"S&P" means Standard & Poor's Ratings Group, a division of McGraw Hill, Inc.
"Service" shall mean the Internal Revenue Service.
"SFAS" means Statement of Financial Accounting Standards published by the
Financial Accounting Standards Board.
"Securities Act" means the Securities Act of 1933, as amended.
"Service" means the Internal Revenue Service.
"Shares-in-Trust" shall mean shares designated as such as a result of any
purported transfer.
"SEC" means the Securities and Exchange Commission.
"SIP Participant" means all directors and officers of, and consultants to,
the Company, as well as all employees, officers and members of the Manager and
CLARION, eligible to receive awards under the Stock Incentive Plan.
"Special Servicing Rights" means the right to service (including to
foreclose upon) any underlying Mortgage Collateral that is in default.
"Stock Incentive Plan" means the 1998 Stock Incentive Plan adopted by the
Company.
100
<PAGE>
"taxable mortgage pool" means a REIT that incurs debt obligations with two
or more maturities and which are secured by assets such as the Real Estate
Investments.
"Ten-Year U.S. Treasury Rate" means the arithmetic average of the weekly
average yield to maturity for actively traded current coupon U.S. Treasury fixed
interest rate securities (adjusted to a constant maturity of ten years)
published by the Federal Reserve Board during a quarter, or, if such rate is not
published by the Federal Reserve Board, any Federal Reserve Bank or agency or
department of the federal government selected by the Company.
"Treasury Regulations" means the regulations promulgated under the Code by
the U.S. Treasury Department.
"UBTI" means unrelated taxable income.
"Underwriters" means the underwriters acting as underwriters of the
Offering.
"Underwriting Agreement" means the agreement between the Company and the
Underwriters with respect to the underwriting of the Common Stock.
"Units" means units of partnership interest in the Operating Partnership.
"U.S. Stockholder" means a holder of Common Stock that for U.S. federal
income tax purposes is (i) a citizen or resident of the U.S., (ii) a
corporation, partnership, or other entity taxable as such created or organized
in or under the laws of the U.S. or of any State (including the District of
Columbia), (iii) an estate whose income from sources without the United States
is includible in gross income for U.S. federal income tax purposes regardless of
its connection with the conduct of a trade or business within the United States,
or (iv) any trust with respect to which (A) a U.S. court is able to exercise
primary supervision over the administration of such trust and (B) one or more
U.S. persons have the authority to control all substantial decisions of the
trust.
"Yield Threshold" means a quarterly distribution with respect to the Common
Stock equal to % (on an annualized basis) of the initial public offering price
of the Common Stock (adjusted on account of any stock splits, stock dividends or
reclassifications) during such quarter.
101
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Clarion Commercial Holdings, Inc.:
We have audited the accompanying statement of financial condition of Clarion
Commercial Holdings, Inc. (the "Company") as of February 18, 1998. This
statement of financial condition is the responsibility of the Company's
management. Our responsibility is to express an opinion on this statement of
financial condition based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statement of financial condition is free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the statement of financial condition.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall statement of
financial condition presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the statement of financial condition referred to above
presents fairly, in all material respects, the financial position of Clarion
Commercial Holdings, Inc. as of February 18, 1998 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
New York, New York
April 15, 1998
F-1
<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
STATEMENT OF FINANCIAL CONDITION, FEBRUARY 18, 1998
<TABLE>
<S> <C>
ASSETS
Cash............................................................................... $ 15,000
---------
---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Stockholders' equity:
Preferred Stock, par value $.01 per share, authorized 25,000,000 shares;
no shares issued and outstanding............................................... $ 0
Class A Common Stock, par value $.001 per share, authorized 74,000,000 shares;
750 shares issued and outstanding.............................................. 1
Class B Common Stock, par value $.001 per share, authorized 1,000,000 shares;
no shares issued or outstanding................................................ 0
Additional paid-in capital......................................................... 14,999
---------
Total stockholders' equity......................................................... $ 15,000
---------
---------
</TABLE>
The accompanying notes are an integral part of this Statement of Financial
Condition.
F-2
<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
NOTES TO STATEMENT OF FINANCIAL CONDITION
NOTE 1. BUSINESS AND ORGANIZATION
Clarion Commercial Holdings, Inc. (the "Company") was incorporated in
Maryland on February 9, 1998 and has had no operations to date other than
matters relating to its organization and the issuance of 750 shares of Class A
common stock, par value $.001 per share (the "Common Stock") to its initial
stockholders. Clarion Capital, LLC (the "Manager"), a subsidiary of Clarion
Partners, LLC ("Clarion Partners") will manage the day-to-day operations of the
Company subject to the supervision of the Board of Directors. The Company
intends to incorporate two corporate subsidiaries. These subsidiaries will
jointly organize a subsidiary operating partnership which will undertake the
business of the Company.
The Company is a specialty finance company that will invest primarily in
commercial mortgage-backed securities, commercial mortgage loans, mezzanine
investments (which include subordinate mortgages, participating mortgages,
leveraged joint venture equity and preferred equity), and other commercial real
estate related investments. The commercial mortgage-backed securities will
include multi-class debt or pass-through securities backed by a mortgage loan or
pools of mortgage loans. The Company intends to originate, acquire and
accumulate commercial mortgage loans for investment and securitization.
The Company intends to elect to be taxed as a real estate investment trust
(a "REIT") and to comply with the provisions of the Internal Revenue Code of
1986, as amended, with respect thereto. Accordingly, the Company will not be
subject to Federal income tax to the extent of its distributions to
stockholders. As a REIT, the Company is required to distribute at least 95% of
its taxable income to stockholders each year. The Company intends to make
regular quarterly distributions.
The Company intends to file a registration statement to offer Common Stock
in an initial public offering (the "Offering").
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ESTIMATES
The preparation of the statement of financial condition in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the financial statement.
Actual results may differ from those estimates.
OFFERING EXPENSES
In connection with the Offering, the Company expects to incur offering
expenses. These costs will be deferred until such time as the Offering proceeds
are received, at which time the costs will be reflected as a reduction of
stockholders' equity.
NOTE 3. STOCK INCENTIVE PLAN
The Company intends to adopt the 1998 Stock Incentive Plan (the "Stock
Incentive Plan"). All directors and officers of, and consultants to, the Company
and directors, officers and employees of the Manager and Clarion Partners, LLC
and its affiliates (collectively, "CLARION") are eligible to receive awards
under the Stock Incentive Plan (each a "SIP Participant").
Awards under the Stock Incentive Plan may include (i) options to purchase
shares of Common Stock, including incentive stock options, non-qualified stock
options or both, which may contain automatic reload features; (ii) stock
appreciation rights, whether in connection with the grant of stock options or
independent of such grant, or stock appreciation rights that are only
exercisable in the event of a Change
F-3
<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
NOTES TO STATEMENT OF FINANCIAL CONDITION (CONTINUED)
NOTE 3. STOCK INCENTIVE PLAN (CONTINUED)
of Control of the Company (as defined in the Stock Incentive Plan) or upon other
events; (iii) restricted stock, in which Common Stock is granted to or purchased
by SIP Participants for a purchase price determined by the Board of Directors,
subject to restrictions on transferability and other restrictions, which lapse
over time; (iv) deferred stock, in which delivery of Common Stock occurs upon
expiration of a deferral period; (v) bonus stock, consisting of a right to
receive Common Stock in an amount determined with reference to a fixed bonus
amount; or (vi) other awards not otherwise provided for, the value of which are
based in whole or in part upon the value of the Common Stock. The total number
of shares of Common Stock which may be the subject of awards under the Stock
Incentive Plan shall be 1,300,000 (1,495,000 if the Underwriters' over-allotment
option is exercised in full); provided, however, that such number will be
increased on a pro rata basis to the extent the Underwriters exercise their
over-allotment option.
In connection with the Offering, the Company intends to grant options to
acquire 770,000 shares (885,500 shares if the Underwriters' over-allotment
option is exercised in full) of Common Stock at the initial offering price under
the Stock Incentive Plan, to certain individuals, directors and employees of the
Manager and Clarion Partners.
NOTE 4. RELATED PARTY TRANSACTIONS
The Manager will manage the Company pursuant to a management agreement which
is expected to be entered into between the Company and the Manager. The
management agreement will have an initial term of three years from the closing
of the Offering. Thereafter, successive extensions, each for a period not to
exceed one year, may be made by agreement between the Company and the Manager.
Under the management agreement, the Company will pay the Manager (i) an annual
base management fee equal to 1% of the average shareholders' equity in the
Company, determined in accordance with generally accepted accounting principles,
excluding any mark-to-market adjustments to the Company's assets and (ii) an
annual incentive fee in an amount equal to the product of (A) 25% of the dollar
amount by which (1) Adjusted Net Income of the Company (as defined in the
management agreement) per share of common stock (based on the weighted average
number of shares outstanding) exceeds (2) an amount equal to (a) the weighted
average price of the share of the Common Stock at the initial public offering
and the prices per share at any secondary offerings of common stock by the
Company multiplied by (b) the Ten-Year U.S. Treasury Rate plus 2.5% percent per
annum multiplied by (B) the weighted average number of shares of common stock
outstanding, calculated as a quarterly average over the prior four quarters.
Upon consummation of the Offering, the owners of the Manager will be issued
200,000 shares of the Company's Class B common stock in exchange for a 10%
ownership interest in the Manager and an option to purchase the remaining 90%
interest in the Manager (or all of its assets) for 90% of fair market value. The
option may be exercised between January 2, 2000 and March 31, 2001 only with the
approval of the Company's Independent Directors. If the Company does not
exercise its option, the other owners of the Manager may reaquire the membership
interest in the Manager owned by the Company for 90% of the fair market value of
such interest at any time between April 1, 2001 and September 30, 2001.
The Company received a commitment from its President and Chief Executive
Officer, Clarion Partners and a private fund managed by the Manager for the
purchase, in a private placement, of 1,000,000 shares, in the aggregate, of the
Common Stock for the initial public offering price. The consummation of such
purchases is contingent only upon, and will occur simultaneously with, the
closing of the Offering.
F-4
<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
NOTES TO STATEMENT OF FINANCIAL CONDITION (CONTINUED)
NOTE 4. RELATED PARTY TRANSACTIONS (CONTINUED)
The Company has contracted (subject to the consent of the Independent
Directors) with certain funds managed by the Manager to purchase, using the net
proceeds of the Offering and the Private Placement, together with additional
financing to be obtained prior to the closings thereof, upon or soon after such
closings, the following investments (the "Initial Investments"): (i) 22 classes
of CMBS, (ii) two commercial mortgage loans and (iii) one mezzanine investment.
The Initial Investments will be purchased for their aggregate fair market value,
which was estimated by the Company to be $212.2 million as of March 31, 1998.
F-5
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATED OR AN OFFER TO SELL, OR A
SOLICITATION OR ANY OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH
SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IN CORRECT AS OF
ANY TIME SUBSEQUENT TO THE DATE HEREOF.
------------------
SUMMARY TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................. 5
Organization and Relationships................. 14
Risk Factors................................... 15
Use of Proceeds................................ 30
Capitalization................................. 31
Investment Objectives and Policies............. 32
The Company.................................... 42
The Manager.................................... 47
10% Ownership of the Manager; Option to
Purchase Remaining Interest in the Manager... 52
Certain Transactions with Related Parties...... 53
Distribution Policy............................ 54
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 55
The Operating Partnership...................... 57
Federal Income Tax Considerations.............. 60
ERISA Considerations........................... 76
Certain Provisions of Maryland Law and the
Company's Charter and Bylaws................. 78
Description of Capital Stock................... 82
Shares Eligible for Future Sale................ 86
Underwriting................................... 87
Private Placement.............................. 88
Legal Matters.................................. 95
Experts........................................ 96
Additional Information......................... 96
Glossary....................................... 97
</TABLE>
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
10,000,000 SHARES
CLARION COMMERCIAL
HOLDINGS, INC.
CLASS A COMMON STOCK
----------------
PROSPECTUS
----------------
BEAR, STEARNS & CO. INC.
LEHMAN BROTHERS
, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The expenses estimated to be incurred in connection with the issuance and
distribution of the securities being registered are as set forth below:
<TABLE>
<S> <C>
SEC registration fee............................................... $ 67,850
NASD filing fee.................................................... 23,500
NYSE listing fee................................................... 107,350
Directors' and Officers' insurance................................. *
Legal fees and expenses............................................ 350,000
Accounting fees and expenses....................................... *
Blue Sky qualification fees and expenses (including counsel
fees)............................................................ 5,000
Printing and engraving fees........................................ 100,000
Transfer Agent and Registrar fees.................................. 3,000
Miscellaneous...................................................... *
---------
Total.......................................................... $ *
---------
---------
</TABLE>
- ------------------------
* To be completed by amendment.
ITEM 32. SALES TO SPECIAL PARTIES.
On March 11, 1998, the Company received a commitment for the purchase of
1,000,000 shares of Common Stock, in the aggregate, at the initial public
offering price from Daniel Heflin, Clarion Partners, LLC and Monroe Investment
Corp., a private fund managed by Clarion Capital, LLC. This sale is contingent
only upon, and will be consummated concurrently with, the closing of the
Offering. The foregoing shares were sold without registration under the
Securities Act, in reliance upon the exemption provided by Section 4(2) thereof.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
In addition to the commitments described in Item 32, on March 11, 1998, the
Company received a commitment for the purchase of 200,000 shares of Class B
common stock, in the aggregate, from Daniel Heflin and Clarion Partners, LLC in
exchange for a 10% membership interest in Clarion Capital, LLC and an option to
purchase the remaining 90% interest in such entity. This sale is contingent only
upon, and will be consummated concurrently with, the closing of the Offering.
The foregoing shares were sold without registration under the Securities Act, in
reliance upon the exemption provided by Section 4(2) thereof.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 2-418 of the Maryland General Corporation Law provides that a
Maryland corporation may indemnify any director (and any person who, while a
director of the corporation, is or was serving at the request of the corporation
as director, officer, partner, trustee, employee, or agent of another foreign or
domestic corporation, partnership, joint venture, trust, or other enterprise or
employee benefit plan) who is made a party to any proceeding by reason of
service in that capacity unless it is established that (i) the act or omission
of the director was material to the matter giving rise to the proceeding and was
committed in bad faith or was the result of active and deliberate dishonesty;
(ii) the director actually received an improper personal benefit in money,
property or services; or (iii) in the case of any criminal proceeding, the
director had reasonable cause to believe that the act or omission was unlawful.
Indemnification may be against judgments, penalties, fines, settlements and
reasonable expenses actually incurred by the director
II-1
<PAGE>
in connection with the proceeding. If the proceeding was one by or in the right
of the corporation, indemnification may not be made in respect of any
proceedings in which the director shall have been adjudged to be liable to the
corporation. Such indemnification may not be made unless authorized for a
specific proceeding after a determination has been made, in the manner
prescribed by the law, that indemnification is permissible in the circumstances
because the director has met the applicable standard of conduct. On the other
hand, the director must be indemnified for expenses if he has been successful in
the defense of such proceeding or as otherwise ordered by a court. The law also
permits the circumstances under which the corporation may advance expenses to,
or obtain insurance or similar protection for, directors.
The law also permits for comparable indemnification for corporate officers
and agents.
The Company's Charter provides that its directors and officers shall, and
its agents in the discretion of the Board of Directors may, be indemnified to
the fullest extent required or permitted from time to time by the laws of
Maryland.
The Maryland General Corporation Law permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages except to the
extent that (i) it is proved that the person actually received an improper
benefit or profit in money, property or services for the amount of the benefit
or profit in money, property or services actually received, or (ii) a judgment
or other final adjudication is entered in a proceeding based on a finding that
the person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's Charter contains a provision providing for elimination
of the liability of its directors and officers to the Company or its
stockholders for money damages to the maximum extent permitted by Maryland law
from time to time.
Policies of insurance may be obtained and maintained by the Company under
which its directors and officers, will be insured, within the limits and subject
to the limitations of the policies, against certain expenses in connection with
the defense of, and certain liabilities which might be imposed as a result of,
actions, suits or proceedings to which they are parties by reason of being or
having been such directors or officers.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements:
(b) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement*
3.1 Amended and Restated Charter**
3.2 Bylaws**
4.1 Specimen Common Stock Certificate*
5.1 Opinion of Shulman, Rogers, Gandal, Pordy & Ecker, P.A. (including
consent)+
8.1 Opinion of Shearman & Sterling as to certain tax matters (including
consent)+
10.1 Management Agreement between the Company and Clarion Capital, LLC*
10.2 Agreement between Clarion Capital, LLC and Clarion Partners, LLC*
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBIT
- ------ --------------------------------------------------------------------------
<C> <S>
10.3 Employment Agreement between the Clarion Capital, LLC and Daniel Heflin*
10.4 Form of 1998 Stock Incentive Plan*
21.1 Subsidiaries of the Company+
23.1 Consent of Shulman, Rogers, Gandal, Pordy & Ecker, P.A. (to be included in
Exhibit 5.1)+
23.2 Consent of Shearman & Sterling (to be included in Exhibit 8.1)*
23.3 Consent of Independent Auditors+
24.1 Power of Attorney (included in the signature page)**
</TABLE>
- ------------------------
+ Filed herewith.
* To be filed by amendment.
** Previously filed.
ITEM 37. UNDERTAKINGS.
The Company hereby undertakes to provide to the Underwriters specified in
the Underwriting Agreement at the closing, certificates in such denominations
and registered in such names as required by the Underwriters to permit prompt
delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company,
pursuant to the foregoing provisions, or otherwise, the Company has been advised
that in the opinion of the Commission, such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Company of expenses incurred or paid by a director, officer
or controlling person of the Company in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the Company will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned Company hereby undertakes that: (i) for purposes of
determining any liability under the Securities Act, the information omitted from
the form of Prospectus filed as a part of this Registration Statement in
reliance upon Rule 430A and contained in a form of Prospectus filed by the
Company pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act
shall be deemed to be part of this Registration Statement as of the time it was
declared effective; and (ii) for the purpose of determining liability under the
Securities Act, each post-effective amendment that contains a form of Prospectus
shall be deemed to be a new Registration Statement, relating to the securities
offered therein and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Company
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this Amendment No. 1 to
this Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized in the City of New York, State of New York, on the
21st day of April, 1998.
<TABLE>
<S> <C> <C>
CLARION COMMERCIAL HOLDINGS, INC.,
a Maryland corporation
By: /s/ DANIEL HEFLIN
-----------------------------------------
Daniel Heflin
Chief Executive Officer and President
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons on the 21st day
of April, 1998 in the capacities indicated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ DANIEL HEFLIN
- ------------------------------ Chief Executive Officer, April 21, 1998
Daniel Heflin President and Director
* Executive Vice President
- ------------------------------ and Chairman of the April 21, 1998
Frank L. Sullivan, Jr. Board
* Vice President, Chief
- ------------------------------ Financial Officer and April 21, 1998
William Powell Treasurer
*
- ------------------------------ Vice President and April 21, 1998
Joanne Vitale Secretary
* Daniel Heflin, by signing his name hereto, does sign this document on behalf
of each of the persons indicated above for whom he is attorney-in-fact
pursuant to a power of attorney duly executed by such person and filed with
the Securities and Exchange Commission.
/s/ DANIEL HEFLIN
- ------------------------------
Daniel Heflin
ATTORNEY-IN-FACT
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE
- ----------- ------------------------------------------------------------------------------------------------ ---------
<C> <S> <C>
1.1 Form of Underwriting Agreement*.................................................................
3.1 Amended and Restated Charter**..................................................................
3.2 Bylaws**........................................................................................
4.1 Specimen Common Stock Certificate*..............................................................
5.1 Opinion of Shulman, Rogers, Gandal, Pordy & Ecker, P.A. (including consent)+....................
8.1 Opinion of Shearman & Sterling as to certain tax matters (including consent)+...................
10.1 Management Agreement between the Company and Clarion Capital, LLC*..............................
10.2 Agreement between Clarion Capital, LLC and Clarion Partners, LLC*...............................
10.3 Employment Agreement between the Clarion Capital, LLC and Daniel Heflin*........................
10.4 Form of 1998 Stock Incentive Plan*..............................................................
21.1 Subsidiaries of the Company+....................................................................
23.1 Consent of Shulman, Rogers, Gandal, Pordy & Ecker, P.A. (to be included in Exhibit 5.1)+........
23.2 Consent of Shearman & Sterling (to be included in Exhibit 8.1)*.................................
23.3 Consent of Independent Auditors+................................................................
24.1 Power of Attorney (included in the signature page)**............................................
</TABLE>
- ------------------------
+ Filed herewith.
* To be filed by amendment.
** Previously filed.
<PAGE>
Exhibit 5.1
Opinion of Shulman, Rogers, Gandal, Pordy & Ecker, P.A.
___________, 1998
Clarion Commercial Holdings, Inc.
335 Madison Avenue
New York, New York 10017
Ladies and Gentlemen:
In connection with the registration under the Securities Act of
1933 (the "Act") of 11,500,000 shares of Class A common stock (the "Common
Stock") of Clarion Commercial Holdings, Inc., a Maryland corporation, on its
Registration Statement on Form S-11 (No. 333-47887) (the "Registration
Statement"), we have examined such corporate records, certificates and
documents as we deemed necessary for the purpose of this opinion. Based on
that examination, we advise you that in our opinion the Common Stock has been
duly and validly authorized and, when issued upon the terms and in the manner
set forth in the Registration Statement, will be legally issued, fully paid
and non-assessable.
We hereby consent to the filing of this opinion as an exhibit to
the Registration Statement. In giving our consent, we do not thereby admit that
we are in the category of persons whose consent is required under Section 7 of
the Act or the rules and regulations of the Securities and Exchange Commission
thereunder. The opinion expressed herein is limited to the matters set forth in
this letter and no other opinion should be inferred beyond the matters
expressly stated.
Very truly yours,
Shulman, Rogers, Gandal, Pordy & Ecker,
a Professional Association
By:
-------------------------------------
<PAGE>
EXHIBIT 8.1
[FORM OF TAX OPINION]
SHEARMAN & STERLING
________________ 1998
Clarion Commercial Holdings, Inc.
335 Madison Avenue
New York, New York 10017
Ladies and Gentlemen:
We have acted as counsel to Clarion Commercial Holdings, Inc., a
Maryland corporation (the "Company"), in connection with the preparation of a
Form S-11 registration statement (the "Registration Statement") filed with
the Securities and Exchange Commission on March 13, 1998 (No. 333-47787), as
amended through the date hereof, with respect to the offering and sale (the
"Offering") of up to 11,500,000 shares of Class A common stock, par value
$0.001 per share, of the Company (the "Common Stock"). You have requested
our opinion regarding certain U.S. federal income tax matters in connection
with the Offering.
In giving this opinion letter, we have examined (i) the Company's
Articles of Incorporation, as duly filed with the Secretary of State of the
Commonwealth of Maryland on February 9, 1998; (ii) the Company's Restated and
Amended Articles of Incorporation, a form of which is filed as an exhibit to
the Registration Statement; (iii) the Company's Bylaws; (iv) the Registration
Statement, including the prospectus contained as part of the Registration
Statement (the "Prospectus"); and such other documents as we have deemed
necessary or appropriate for purposes of this opinion.
In connection with the opinions rendered below, we have assumed,
that (i) each of the documents referred to above has been duly authorized,
executed, and delivered; (ii) each of the documents referred to above is
authentic, if an original, or is accurate, if a copy, and has not been
amended; (iii) during its short taxable year ending December 31, 1998 and
future taxable years, the Company will operate in a manner consistent with
the representations contained in the certificate, dated May, 1998 and
executed by a duly appointed officer of the Company (the "Officer's
Certificate"); (iv) the Company will not make any amendments to its
organizational documents after the date of this opinion that would affect its
qualification as a real estate investment trust (a "REIT") for any taxable
year; and (v) no action will be taken by the
<PAGE>
Clarion Commercial Holdings, Inc.
____________, 1998
Page 2
Company, after the date hereof, that would have the effect of altering the facts
upon which we have based the opinions set forth below.
In connection with the opinions rendered below, we also have relied
upon the correctness of the representations contained in the Officer's
Certificate. No facts have come to our attention, however, that would cause us
to question the accuracy and completeness of the facts contained in the
documents and assumptions set forth above, the representations set forth in the
Officer's Certificate, or the Prospectus in a material way.
Based on the documents and assumptions set forth above, the
representations set forth in the Officer's Certificate, and the discussion in
the Prospectus under the caption "Federal Income Tax Considerations" (which is
incorporated herein by reference), we are of the opinion that:
(a) commencing with the Company's short taxable year ending December
31, 1998, the Company will qualify to be taxed as a REIT pursuant to
sections 856 through 860 of the Internal Revenue Code of 1986, as amended
(the "Code"), and the Company's organization and proposed method of
operation will enable it to continue to meet the requirements for
qualification and taxation as a REIT under the Code;
(b) the descriptions of the law and the legal conclusions contained
in the Prospectus under the caption "Federal Income Tax Considerations" are
correct in all material respects, and the discussion thereunder fairly
summarizes the federal income tax considerations that are likely to be
material to a holder of the Common Stock.
We will not review on a continuing basis the Company's compliance with
the documents or assumptions set forth above, or the representations set forth
in the Officer's Certificate. Accordingly, no assurance can be given that the
actual results of the Company's operations for any given taxable year will
satisfy the requirements for qualification and taxation as a REIT.
We note that our opinion expressed herein is based on our examination
of the law, our review of the documents described above, the statements and
representations referred to above, the provisions of the Code, the regulations,
published rulings and announcements thereunder, and the judicial interpretations
thereof currently in effect. This opinion will not be binding on the Internal
Revenue Service (the "Service"), and there can be no assurance that the Service
will not challenge the conclusion stated herein or that, if the issue were
decided in court, such a challenge would not ultimately succeed. Further, there
can be no assurance that future legislative or administrative changes or future
court decisions or the inaccuracy of any statements or representations on which
we have relied may not significantly affect the continuing validity of this
opinion.
We hereby consent to the filing of this opinion as an exhibit to
the Registration Statement. We also consent to the references to Shearman &
Sterling under the caption "Federal Income Tax Considerations" in the
Prospectus. In giving this consent, we do not admit that we are in the
category of persons whose consent is required by Section 7 of the Securities
Act of 1933, as amended, or the rules and regulations promulgated thereunder
by the Securities and Exchange Commission.
The foregoing opinions are limited to the U.S. federal income tax
matters addressed herein, and no other opinions are rendered with respect to
other federal tax matters or to any issues arising under the tax laws of any
other country, or any state or locality. We undertake no obligation to update
the opinions expressed herein after the date of this letter.
Very truly yours,
<PAGE>
Exhibit 21.1
Subsidiaries of the Company
CCHI General, Inc., a Delaware corporation*
CCHI Limited, Inc., a Delaware corporation*
CCHI Limited Partnership, a Delaware limited partnership**
______________
* Owned 100% directly by the Company
** Owned 100% indirectly by the Company
<PAGE>
Exhibit 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement on Form S-11 (File No.
333-47887) of Clarion Commercial Holdings, Inc. of our report dated April 15,
1998 appearing in the Prospectus, which is part of this Registration Statement.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
DELOITTE & TOUCHE LLP
New York, New York
April 21, 1998
