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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

 

FORM 10-Q

______________________________________________________

(Mark One)

☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

OR

☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 000-53649

______________________________________________________

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐  No  ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class			Trading Symbol(s)			Name of each exchange on which registered
None			N/A			N/A

As of November 8, 2019, there were 185,461,792 outstanding shares of common stock of the registrant.

KBS REAL ESTATE INVESTMENT TRUST II, INC.

FORM 10-Q

September 30, 2019

INDEX 

PART I.

FINANCIAL INFORMATION

2

Item 1.

Financial Statements

2

Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018

2

Consolidated Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018

3

Consolidated Statements of Stockholders’ Equity (unaudited) for the Three and Nine Months Ended September 30, 2019 and 2018

4

Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2019 and 2018

6

Condensed Notes to Consolidated Financial Statements as of September 30, 2019 (unaudited)

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

39

Item 4.

Controls and Procedures

39

PART II.

OTHER INFORMATION

40

Item 1.

Legal Proceedings

40

Item 1A.

Risk Factors

40

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

41

Item 3.

Defaults upon Senior Securities

43

Item 4.

Mine Safety Disclosures

43

Item 5.

Other Information

43

Item 6.

Exhibits

44

SIGNATURES

45

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

See accompanying condensed notes to consolidated financial statements.

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except share and per share amounts)

						Three Months Ended September 30,																		Nine Months Ended September 30,
						2019						2018						2019						2018
Revenues:
Rental income						$	24,943					$	30,411					$	78,619					$	95,578
Interest income from real estate loans receivable						—						—						—						434
Other operating income						1,480						2,271						5,359						6,968
Total revenues						26,423						32,682						83,978						102,980
Expenses:
Operating, maintenance, and management						7,991						8,773						25,867						25,379
Real estate taxes and insurance						4,294						4,387						13,959						13,634
Asset management fees to affiliate						2,469						2,688						7,707						8,192
General and administrative expenses						1,342						1,416						4,204						4,452
Depreciation and amortization						11,050						12,077						33,053						38,427
Interest expense						4,418						4,175						13,262						13,494
Impairment charges on real estate						14,300						—						14,300						—
Total expenses						45,864						33,516						112,352						103,578
Other income:
Other interest income						114						380						477						867
Loss from extinguishment of debt						(165)						—						(471)						(212)
Gain on sale of real estate, net						—						—						30,754						24,884
Total other (loss) income						(51)						380						30,760						25,539
Net (loss) income						$	(19,492)					$	(454)					$	2,386					$	24,941
Net (loss) income per common share, basic and diluted						$	(0.10)					$	—					$	0.01					$	0.13
Weighted-average number of common shares outstanding, basic and diluted						185,770,646						186,968,315						186,064,468						187,293,455

See accompanying condensed notes to consolidated financial statements.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the Three Months Ended September 30, 2019 and 2018 (unaudited)

(dollars in thousands)

						Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income (Loss)						Total Stockholders’ Equity
						Shares						Amounts
Balance, June 30, 2019						185,871,023						$	1,859					$	1,667,903					$	(1,093,129)					$	576,633
Net loss						—						—						—						(19,492)						(19,492)
Redemptions of common stock						(319,587)						(3)						(1,435)						—						(1,438)
Transfers from redeemable common stock						—						—						1,438						—						1,438
Distributions declared						—						—						—						(10,450)						(10,450)
Balance, September 30, 2019						185,551,436						$	1,856					$	1,667,906					$	(1,123,071)					$	546,691

						Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income (Loss)						Total Stockholders’ Equity
						Shares						Amounts
Balance, June 30, 2018						187,162,274						$	1,872					$	1,673,772					$	(988,396)					$	687,248
Net loss						—						—						—						(454)						(454)
Redemptions of common stock						(416,615)						(4)						(2,033)						—						(2,037)
Transfers from redeemable common stock						—						—						2,037						—						2,037
Distributions declared						—						—						—						(11,523)						(11,523)
Balance, September 30, 2018						186,745,659						$	1,868					$	1,673,776					$	(1,000,373)					$	675,271

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (CONTINUED)

For the Nine Months Ended September 30, 2019 and 2018 (unaudited)

(dollars in thousands)

						Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income (Loss)						Total Stockholders’ Equity
						Shares						Amounts
Balance, December 31, 2018						186,464,794						$	1,865					$	1,667,897					$	(1,008,288)					$	661,474
Net income						—						—						—						2,386						2,386
Redemptions of common stock						(913,358)						(9)						(4,336)						—						(4,345)
Transfers from redeemable common stock						—						—						4,345						—						4,345
Distributions declared						—						—						—						(117,169)						(117,169)
Balance, September 30, 2019						185,551,436						$	1,856					$	1,667,906					$	(1,123,071)					$	546,691

						Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income (Loss)						Total Stockholders’ Equity
						Shares						Amounts
Balance, December 31, 2017						187,666,302						$	1,877					$	1,673,767					$	(991,062)					$	684,582
Net income						—						—						—						24,941						24,941
Redemptions of common stock						(920,643)						(9)						(4,493)						—						(4,502)
Transfers from redeemable common stock						—						—						4,502						—						4,502
Distributions declared						—						—						—						(34,252)						(34,252)
Balance, September 30, 2018						186,745,659						$	1,868					$	1,673,776					$	(1,000,373)					$	675,271

See accompanying condensed notes to consolidated financial statements.

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

						Nine Months Ended September 30,
						2019						2018
Cash Flows from Operating Activities:
Net income						$	2,386					$	24,941
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization						33,053						38,427
Impairment charges on real estate						14,300						—
Noncash interest income on real estate-related investments						—						3
Deferred rent						2,761						3,096
Bad debt expense						—						213
Amortization of above- and below-market leases, net						(65)						948
Amortization of deferred financing costs						1,169						940
Loss from extinguishment of debt						471						212
Gain on sale of real estate, net						(30,754)						(24,884)
Changes in operating assets and liabilities:
Rents and other receivables						(14,841)						(2,391)
Prepaid expenses and other assets						(13,469)						(2,601)
Accounts payable and accrued liabilities						18,574						3,180
Due to affiliate						47						29
Other liabilities						(2,685)						8,478
Net cash provided by operating activities						10,947						50,591
Cash Flows from Investing Activities:
Proceeds from sale of real estate						130,285						94,015
Improvements to real estate						(30,943)						(24,205)
Principal repayments on real estate loans receivable						—						13,920
Net cash provided by investing activities						99,342						83,730
Cash Flows from Financing Activities:
Proceeds from notes payable						134,350						375,000
Principal payments on notes payable						(133,681)						(460,446)
Payments of deferred financing costs						(924)						(2,810)
Payments to redeem common stock						(4,345)						(4,502)
Distributions paid to common stockholders						(117,562)						(34,874)
Net cash used in financing activities						(122,162)						(127,632)
Net (decrease) increase in cash and cash equivalents and restricted cash						(11,873)						6,689
Cash and cash equivalents and restricted cash, beginning of period						75,687						86,643
Cash and cash equivalents and restricted cash, end of period						$	63,814					$	93,332
Supplemental Disclosure of Cash Flow Information:
Interest paid						$	12,131					$	12,663
Supplemental Disclosure of Noncash Transactions:
Accrued improvements to real estate						$	6,748					$	7,517
Distributions payable						$	3,481					$	3,754

See accompanying condensed notes to consolidated financial statements.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(unaudited)

1.ORGANIZATION

KBS Real Estate Investment Trust II, Inc. (the “Company”) was formed on July 12, 2007 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2008. The Company conducts its business primarily through KBS Limited Partnership II, a Delaware limited partnership formed on August 23, 2007 (the “Operating Partnership”), and its subsidiaries. The Company is the sole general partner of and directly owns a 0.1% partnership interest in the Operating Partnership. The Company’s wholly-owned subsidiary, KBS REIT Holdings II LLC, a Delaware limited liability company formed on August 23, 2007 (“KBS REIT Holdings II”), owns the remaining 99.9% partnership interest in the Operating Partnership and is its sole limited partner.

The Company invested in a diverse portfolio of real estate and real estate-related investments. As of September 30, 2019, the Company owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings.

Subject to certain restrictions and limitations, the business of the Company is managed by KBS Capital Advisors LLC (the “Advisor”), an affiliate of the Company, pursuant to an advisory agreement the Company renewed with the Advisor on June 6, 2019 (the “Advisory Agreement”). The Advisory Agreement is effective through May 21, 2020 and may be renewed for an unlimited number of one-year periods upon the mutual consent of the Advisor and the Company. Either party may terminate the Advisory Agreement upon 60 days’ written notice. The Advisor owns 20,000 shares of the Company’s common stock.

Upon commencing its initial public offering (the “Offering”), the Company retained KBS Capital Markets Group LLC (the “Dealer Manager”), an affiliate of the Advisor, to serve as the dealer manager of the Offering. The Company ceased offering shares of common stock in its primary offering on December 31, 2010 and terminated its primary offering on March 22, 2011. The Company terminated its dividend reinvestment plan effective May 29, 2014.

The Company sold 182,681,633 shares of common stock in its primary offering for gross offering proceeds of $1.8 billion. The Company sold 30,903,504 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $298.2 million. Also as of September 30, 2019, the Company had redeemed 28,053,701 shares sold in the Offering for $256.1 million.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

There have been no significant changes to the Company’s accounting policies since it filed its audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2018, except for the Company’s adoption of the lease accounting standards issued by the Financial Accounting Standards Board (“FASB”) effective on January 1, 2019. For further information about the Company’s accounting policies, refer to the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements and condensed notes thereto have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information as contained within the FASB Accounting Standards Codification (“ASC”) and the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for audited financial statements. In the opinion of management, the financial statements for the unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair and consistent presentation of the results for such periods. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

The consolidated financial statements include the accounts of the Company, KBS REIT Holdings II, the Operating Partnership, and their direct and indirect wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements and condensed notes thereto in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and condensed notes. Actual results could materially differ from those estimates.

Per Share Data

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) by the weighted-average number of shares of common stock issued and outstanding during such period. Diluted net income (loss) per share of common stock equals basic net income (loss) per share of common stock as there were no potentially dilutive securities outstanding during the nine months ended September 30, 2019 and 2018.

Distributions declared per common share were $0.056 and $0.630 in the aggregate for the three and nine months ended September 30, 2019, respectively, and consisted of the following:

•For each month commencing January 2019 through June 2019, the Company’s board of directors declared distributions per common share in the amount of $0.02062500 per share of common stock to stockholders of record based on a monthly record date.

•On June 12, 2019, the Company’s board of directors declared a special distribution in the amount of $0.45 per share of common stock to stockholders of record as of the close of business on June 17, 2019.

•For each month commencing July 2019 through September 2019, the Company’s board of directors declared distributions per common share in the amount of $0.01875000 per share of common stock to stockholders of record based on a monthly record date.

Distributions declared per common share were $0.062 and $0.183 in the aggregate for the three and nine months ended September 30, 2018, respectively. Distributions declared per common share assumes each share was issued and outstanding each day that was a record date for distributions and were based on a monthly record date for each month during the periods commencing January 2018 through September 2018.

Segments

The Company invested in core real estate properties and real estate-related investments with the goal of acquiring a portfolio of income-producing investments. The Company’s real estate properties exhibit similar long-term financial performance and have similar economic characteristics to each other. As of September 30, 2019, the Company aggregated its investments in real estate properties into one reportable business segment.

Reclassifications

Certain amounts in the Company’s prior period consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications have not changed the results of operations of prior periods. Upon adoption of the lease accounting standards of Topic 842 on January 1, 2019 (described below), the Company accounted for tenant reimbursements for property taxes, insurance and common area maintenance as variable lease payments and recorded these amounts as rental income on the statement of operations. For the three and nine months ended September 30, 2018, the Company reclassified $2.0 million and $7.6 million, respectively, of tenant reimbursement revenue for property taxes, insurance, and common area maintenance to rental income for comparability purposes.

In addition, during the nine months ended September 30, 2019, the Company sold two office properties and classified two office properties as held for sale. As a result, certain assets and liabilities were reclassified to held for sale on the consolidated balance sheets for all periods presented.

Revenue Recognition - Operating Leases

Real Estate

On January 1, 2019, the Company adopted the lease accounting standards under Topic 842 including the package of practical expedients for all leases that commenced before the effective date of January 1, 2019. Accordingly, the Company (i) did not reassess whether any expired or existing contracts are or contain leases, (ii) did not reassess the lease classification for any expired or existing lease, and (iii) did not reassess initial direct costs for any existing leases. The Company did not elect the practical expedient related to using hindsight to reevaluate the lease term. In addition, the Company adopted the practical expedient for land easements and did not assess whether existing or expired land easements that were not previously accounted for as leases under the lease accounting standards of Topic 840 are or contain a lease under Topic 842.

In addition, Topic 842 provides an optional transition method to allow entities to apply the new lease accounting standards at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. The Company adopted this transition method upon its adoption of the lease accounting standards of Topic 842, which did not result in a cumulative effect adjustment to the opening balance of retained earnings on January 1, 2019. The Company’s comparative periods presented in the financial statements will continue to be reported under the lease accounting standards of Topic 840.

In accordance with Topic 842, tenant reimbursements for property taxes and insurance are included in the single lease component of the lease contract (the right of the lessee to use the leased space) and therefore are accounted for as variable lease payments and are recorded as rental income on the Company’s statement of operations beginning January 1, 2019. In addition, the Company adopted the practical expedient available under Topic 842 to not separate nonlease components from the associated lease component and instead to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue recognition standard (Topic 606) and if certain conditions are met, specifically related to tenant reimbursements for common area maintenance which would otherwise be accounted for under the revenue recognition standard. The Company believes the two conditions have been met for tenant reimbursements for common area maintenance as (i) the timing and pattern of transfer of the nonlease components and associated lease components are the same and (ii) the lease component would be classified as an operating lease. Accordingly, tenant reimbursements for common area maintenance are also accounted for as variable lease payments and recorded as rental income on the Company’s statement of operations beginning January 1, 2019.

The Company recognizes minimum rent, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectibility is probable and records amounts expected to be received in later years as deferred rent receivable. If the lease provides for tenant improvements, the Company determines whether the tenant improvements, for accounting purposes, are owned by the tenant or the Company. When the Company is the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical use of the leased asset until the tenant improvements are substantially completed. When the tenant is the owner of the tenant improvements, any tenant improvement allowance (including amounts that can be taken in the form of cash or a credit against the tenant’s rent) that is funded is treated as a lease incentive and amortized as a reduction of rental revenue over the lease term. Tenant improvement ownership is determined based on various factors including, but not limited to:

•whether the lease stipulates how a tenant improvement allowance may be spent;

•whether the lessee or lessor supervises the construction and bears the risk of cost overruns;

•whether the amount of a tenant improvement allowance is in excess of market rates;

•whether the tenant or landlord retains legal title to the improvements at the end of the lease term;

•whether the tenant improvements are unique to the tenant or general purpose in nature; and

•whether the tenant improvements are expected to have any residual value at the end of the lease.

In accordance with Topic 842, the Company makes a determination of whether the collectibility of the lease payments in an operating lease is probable. If the Company determines the lease payments are not probable of collection, the Company would fully reserve for any contractual lease payments, deferred rent receivable, and variable lease payments and would recognize rental income only if cash is received. Beginning January 1, 2019, these changes to the Company’s collectibility assessment are reflected as an adjustment to rental income. Prior to January 1, 2019, bad debt expense related to uncollectible accounts receivable and deferred rent receivable was included in operating, maintenance, and management expense in the statement of operations. Any subsequent changes to the collectibility of the allowance for doubtful accounts as of December 31, 2018, which was recorded prior to the adoption of Topic 842, are recorded in operating, maintenance, and management expense in the statement of operations.

Beginning January 1, 2019, the Company, as a lessor, records costs to negotiate or arrange a lease that would have been incurred regardless of whether the lease was obtained, such as legal costs incurred to negotiate an operating lease, as an expense and classifies such costs as operating, maintenance, and management expense on the Company’s consolidated statement of operations, as these costs are no longer capitalizable under the definition of initial direct costs under Topic 842.

Square Footage, Occupancy and Other Measures

Square footage, occupancy, number of tenants and other similar measures, including annualized base rent and annualized base rent per square foot, used to describe real estate investments included in these condensed notes to the consolidated financial statements are unaudited and outside the scope of the Company’s independent registered public accounting firm’s review of the Company’s financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board.

Recently Issued Accounting Standards Update

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments (“ASU No. 2016-13”). ASU No. 2016-13 affects entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. The amendments in ASU No. 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. ASU No. 2016-13 also amends the impairment model for available-for-sale securities. An entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. ASU No. 2016-13 also requires new disclosures. For financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance for credit losses, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes. For financing receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year of the asset’s origination for as many as five annual periods. For available-for-sale securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due. ASU No. 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is still evaluating the impact of adopting ASU No. 2016-13 on its financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework -Changes to the Disclosure Requirements for Fair Value Measurement (“ASU No. 2018-13”). The primary focus of ASU 2018-13 is to improve the effectiveness of the disclosure requirements for fair value measurements. ASU No. 2018-13 removes the requirement to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for the timing of transfers between levels and the valuation processes for Level 3 fair value measurements. It also adds a requirement to disclose changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and to disclose the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements. For certain unobservable inputs, entities may disclose other quantitative information in lieu of the weighted average if the other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop the Level 3 fair value measurements. In addition, public entities are required to provide information about the measurement uncertainty of recurring Level 3 fair value measurements from the use of significant unobservable inputs if those inputs reasonably could have been different at the reporting date. ASU No. 2018-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities are permitted to early adopt either the entire standard or only the provisions that eliminate or modify the requirements. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company is still evaluating the impact of adopting ASU No. 2018-13 on its financial statements, but does not expect the adoption of ASU No. 2018-13 to have a material impact on its financial statements.

3. REAL ESTATE HELD FOR INVESTMENT

As of September 30, 2019, the Company’s portfolio of real estate held for investment was composed of four office properties and an office campus consisting of five office buildings, encompassing in the aggregate approximately 2.7 million rentable square feet. As of September 30, 2019, the Company’s real estate portfolio was 74% occupied. The following table summarizes the Company’s real estate portfolio as of September 30, 2019 (in thousands):

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

As of September 30, 2019, the following properties represented more than 10% of the Company’s total assets:

Property						Location						Rentable Square Feet						Total Real Estate, Net (in thousands)						Percentage of Total Assets						Annualized Base Rent (in thousands) (1)						Average Annualized Base Rent per Sq. Ft.						Occupancy
Union Bank Plaza						Los Angeles, CA						701,888						$	160,834					15.2		%				$	23,798					$	42.29					80		%
Corporate Technology Centre						San Jose, CA						415,492						134,052						12.7		%				5,774						33.39						42		%
Granite Tower						Denver, CO						591,070						112,780						10.7		%				18,884						34.86						92		%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of September 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term. Annualized base rent excludes leases that have been executed but have not commenced as of September 30, 2019.

Operating Leases

The Company’s real estate properties held for investment are leased to tenants under operating leases for which the terms and expirations vary. As of September 30, 2019, the leases had remaining terms, excluding options to extend, of up to 15.7 years with a weighted-average remaining term of 6.6 years. Some of the leases have provisions to extend the term of the leases, options for early termination for all or part of the leased premises after paying a specified penalty, rights of first refusal to purchase the property at competitive market rates, and other terms and conditions as negotiated. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. Generally, upon the execution of a lease, the Company requires a security deposit from the tenant in the form of a cash deposit and/or a letter of credit. The amount required as a security deposit varies depending upon the terms of the respective lease and the creditworthiness of the tenant, but generally is not a significant amount. Therefore, exposure to credit risk exists to the extent that a receivable from a tenant exceeds the amount of its security deposit. Security deposits received in cash related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets and totaled $3.4 million and $2.5 million as of September 30, 2019 and December 31, 2018, respectively.

During the nine months ended September 30, 2019 and 2018, the Company recognized deferred rent from tenants, net of lease incentive amortization, which reduced rental income by $2.8 million and $3.1 million, respectively. As of September 30, 2019 and December 31, 2018, the cumulative deferred rent balance was $78.8 million and $61.7 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $54.8 million and $38.6 million of unamortized lease incentives as of September 30, 2019 and December 31, 2018, respectively. As of September 30, 2019 and December 31, 2018, lease incentive payable was $52.1 million and $35.2 million, respectively, and is included in accounts payable and accrued liabilities on the accompanying balance sheets.

As of September 30, 2019, the future minimum rental income from the Company’s properties held for investment under non-cancelable operating leases was as follows (in thousands):

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

As of September 30, 2019, the Company had approximately 80 tenants over a diverse range of industries and geographic areas in its portfolio of real estate held for investment. The Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:

Industry						Number of Tenants						Annualized Base Rent (1) (in thousands)						Percentage of Annualized Base Rent
Finance						12						$	19,363					28.1		%
Mining, Oil & Gas Extraction						3						13,154						19.1		%
Educational Services						1						11,728						17.0		%
												$	44,245					64.2		%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of September 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

No other tenant industries accounted for more than 10% of annualized base rent. The Company had not identified any material tenant credit issues as of September 30, 2019. During the nine months ended September 30, 2019, the Company recorded an adjustment to rental income of $0.9 million for lease payments that were deemed not probable of collection and a net recovery of bad debt of $0.1 million, which was included in operating, maintenance, and management expense in the accompanying consolidated statements of operations. During the nine months ended September 30, 2018, the Company recorded bad debt expense of $0.2 million, which was included in operating, maintenance, and management expense in the accompanying consolidated statements of operations.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

As of September 30, 2019, the Company had a concentration of credit risk related to the following tenant leases that represented more than 10% of the Company’s annualized base rent:

																														Annualized Base Rent Statistics
Tenant						Property						Tenant Industry						Square Feet						% of Portfolio (Net Rentable Sq. Ft.)						Annualized Base Rent (in thousands) (1)						% of Portfolio Annualized Base Rent						Annualized Base Rent per Sq. Ft.						Lease Expiration
Union Bank						Union Bank Plaza						Finance						295,563						14.6%						$	15,730					22.8%						$	53.22					05/31/2020 03/31/2021/ 05/31/2021/ 05/31/2022 05/31/2035 (2)(3)
The University of Phoenix						Fountainhead Plaza						Educational Services						445,957						22.0%						11,728						17.0%						26.30						08/31/2023 (4)
Anadarko Petroleum Corporation						Granite Tower						Mining, Oil & Gas Extraction						360,584						17.8%						12,256						17.8%						33.99						04/30/2021 / 04/30/2033 (5)

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of September 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term.

⁽²⁾ Represents the expiration dates of the lease as of September 30, 2019 and does not take into account any tenant renewal options. Pursuant to a lease amendment that the Company entered into with Union Bank on December 31, 2017, Union Bank surrendered 15,829 rentable square feet of its total rentable square footage on March 31, 2018 and 31,320 rentable square feet of its total rentable square footage on June 30, 2018. In addition, Union Bank also surrendered 321 parking area passes on March 31, 2018. During the year ended December 31, 2018, the Company received $11.4 million of lease termination fees from Union Bank, of which $8.5 million was deferred as of December 31, 2018. During the nine months ended September 30, 2018, $1.4 million was recognized as rental income and $0.8 million was recognized as other operating income in the accompanying consolidated statement of operations. During the nine months ended September 30, 2019, $1.4 million was recognized as rental income and $0.7 million was recognized as other operating income in the accompanying consolidated statements of operations, and $6.4 million was deferred as of September 30, 2019 and included in other liabilities on the accompanying consolidated balance sheets.

⁽³⁾ On August 2, 2019, the Company entered into amended and restated lease agreements with Union Bank relating to Union Bank’s office, retail, and storage spaces, which amended the terms of the leases as follows: (i) remeasured the existing rentable square footage from 295,563 rentable square feet to 307,729 rentable square feet effective June 1, 2020, (ii) of the 307,729 rentable square feet, a total of 131,135 rentable square feet of office space and 11,985 rentable square feet of retail space will be surrendered at various dates between May 31, 2020 and May 31, 2022 and the remaining 164,609 rentable square feet will expire on May 31, 2035, and (iii) the addition of 3,152 rentable square feet of retail space for a 15-year lease term expiring on May 31, 2035. Each of Union Bank’s amended and restated office and retail lease agreements has two five-year extension options on all or a portion of the leased space and a one-time option to terminate and cancel the lease in its entirety effective May 31, 2032, by delivering eighteen months’ notice and subject to payment of lease termination fees. Union Bank also has two one-time options to terminate and cancel a portion of its lease.

⁽⁴⁾ The University of Phoenix has two options to extend the term of this lease for five years per option term.

⁽⁵⁾ Per the lease agreement, 64,841 rentable square feet will expire on April 30, 2021 and the remainder will expire on April 30, 2033. Anadarko Petroleum Corporation has an option to terminate all or a portion of its leased space effective April 30, 2028 or April 30, 2030.

No other tenant accounted for more than 10% of annualized base rent.

Geographic Concentration Risk

As of September 30, 2019, the Company’s net investments in real estate in California and Colorado represented 27.9% and 10.7% of the Company’s total assets, respectively.  As a result, the geographic concentration of the Company’s portfolio makes it particularly susceptible to adverse economic developments in the California and Colorado real estate markets.  Any adverse economic or real estate developments in these markets, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics and other factors, or any decrease in demand for office space resulting from the local business climate, could adversely affect the Company’s operating results and its ability to make distributions to stockholders.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

4. TENANT ORIGINATION AND ABSORPTION COSTS, ABOVE-MARKET LEASE ASSETS AND BELOW-

MARKET LEASE LIABILITIES

As of September 30, 2019 and December 31, 2018, the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities (excluding fully amortized assets and liabilities and accumulated amortization) were as follows (in thousands):

						Tenant Origination and Absorption Costs																		Above-Market Lease Assets																		Below-Market Lease Liabilities
						September 30, 2019						December 31, 2018						September 30, 2019						December 31, 2018						September 30, 2019						December 31, 2018
Cost						$	28,025					$	30,846					$	835					$	835					$	(1,154)					$	(2,635)
Accumulated amortization						(16,785)						(16,869)						(666)						(611)						964						2,327
Net amount						$	11,240					$	13,977					$	169					$	224					$	(190)					$	(308)

Increases (decreases) in net income as a result of amortization of the Company’s tenant origination and absorption costs, above-market lease assets and below-market lease liabilities for the three and nine months ended September 30, 2019 and 2018 were as follows (in thousands):

						Tenant Origination and Absorption Costs																		Above-Market Lease Assets																		Below-Market Lease Liabilities
						For the Three Months Ended September 30,																		For the Three Months Ended September 30,																		For the Three Months Ended September 30,
						2019						2018						2019						2018						2019						2018
Amortization						$	(920)					$	(1,410)					$	(18)					$	(555)					$	27					$	144

						Tenant Origination and Absorption Costs																		Above-Market Lease Assets																		Below-Market Lease Liabilities
						For the Nine Months Ended September 30,																		For the Nine Months Ended September 30,																		For the Nine Months Ended September 30,
						2019						2018						2019						2018						2019						2018
Amortization						$	(2,761)					$	(5,815)					$	(55)					$	(1,697)					$	120					$	749

5. REAL ESTATE HELD FOR SALE

During the nine months ended September 30, 2019, the Company sold two office properties and as of September 30, 2019, the Company had classified two office properties as held for sale. During the year ended December 31, 2018, the Company sold three office buildings that were part of an eight-building office campus. The results of operations for the properties sold during the nine months ended September 30, 2019 and the year ended December 31, 2018 and the two office properties classified as held for sale as of September 30, 2019 are included in continuing operations on the Company’s consolidated statements of operations. The following table summarizes certain revenue and expenses related to the Company’s real estate properties that were sold during the year ended December 31, 2018 and the three and nine months ended September 30, 2019 and the two office properties that were classified as held for sale as of September 30, 2019, which were included in continuing operations (in thousands):

The following summary presents the major components of assets and liabilities related to real estate held for sale as of September 30, 2019 and December 31, 2018 (in thousands).

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

As of September 30, 2019, the following properties held for sale represented more than 10% of the Company’s total assets:

Property						Location						Rentable Square Feet						Total Real Estate, Net (in thousands)						Percentage of Total Assets						Annualized Base Rent (in thousands) (1)						Average Annualized Base Rent per Sq. Ft.						Occupancy
Campus Drive Buildings (2)						Florham Park, NJ						1,168,846						$	257,164					24.3		%				$	32,181					$	32.78					84		%

_____________________

⁽¹⁾ Annualized base rent represents annualized contractual base rental income as of September 30, 2019, adjusted to straight-line any contractual tenant concessions (including free rent), rent increases and rent decreases from the lease’s inception through the balance of the lease term. Annualized base rent excludes leases that have been executed but have not commenced as of September 30, 2019.

⁽²⁾ Subsequent to September 30, 2019, the Company entered into a purchase and sale agreement for the 100 & 200 Campus Driving Buildings and the 300-600 Campus Buildings (together, the “Campus Drive Buildings”) with a buyer unaffiliated with the Company or the Advisor. See Note 10, “Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.”

During the three and nine months ended September 30, 2019, the Company recorded non-cash impairment charges of $14.3 million to write down the carrying value of the Company’s investment in the Campus Drive Buildings to their contractual sales price less estimated costs to sell. The impairment was primarily due to estimated closing costs and disposition fees, which are reflected upon classification of the Campus Drive Buildings to held for sale. Subsequent to September 30, 2019, the Company entered into a purchase and sale agreement for the Campus Drive Buildings with a buyer unaffiliated with the Company or the Advisor. See Note 10, “Subsequent Events - Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC.”

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

6. NOTES PAYABLE

As of September 30, 2019 and December 31, 2018, the Company’s notes payable, including notes payable related to real estate held for sale, consisted of the following (dollars in thousands):

						Book Value as of September 30, 2019						Book Value as of December 31, 2018						Contractual Interest Rate as of September 30, 2019 (1)						Effective Interest Rate  as of September 30, 2019 (1)						Payment Type						Maturity Date (2)
Corporate Technology Centre Mortgage Loan (3)						$	40,894					$	41,868					3.50%						3.5%						Principal & Interest						04/01/2020
Portfolio Loan Facility (4)						281,293						375,000						One-month LIBOR + 1.45%						3.6%						Interest Only						03/29/2020
Granite Tower Mortgage Loan (5)						95,350						—						One-month LIBOR + 1.65%						3.8%						(5)						09/01/2023
Total notes payable principal outstanding						$	417,537					$	416,868
Deferred financing costs, net						(944)						(1,660)
Total notes payable, net						$	416,593					$	415,208

_____________________

⁽¹⁾ Contractual interest rate represents the interest rate in effect under the loan as of September 30, 2019. Effective interest rate is calculated as the actual interest rate in effect as of September 30, 2019, using interest rate indices as of September 30, 2019, where applicable.

⁽²⁾ Represents the initial maturity date or the maturity date as extended as of September 30, 2019; subject to certain conditions, the maturity dates of certain loans may be extended beyond the maturity date shown.

⁽³⁾ The loan documents require the Company to reserve for the annual charges for real estate taxes by making monthly deposits to an account held by the lender, subject to certain terms and conditions contained in the loan documents.

⁽⁴⁾ On August 30, 2019, the Company repaid $62.0 million due under this loan and Granite Tower was released as security from the Portfolio Loan Facility. See below, “- Recent Financing Transactions - Granite Tower Mortgage Loan.” As of September 30, 2019, the Portfolio Loan Facility is secured by the 100 & 200 Campus Drive Buildings, the 300-600 Campus Drive Buildings, Willow Oaks Corporate Center, Union Bank Plaza and Fountainhead Plaza. As of September 30, 2019, $281.3 million of term debt of the Portfolio Loan Facility was outstanding and $62.4 million of revolving debt remained available for future disbursements, subject to certain terms and conditions set forth in the loan documents.

⁽⁵⁾ See below, “- Recent Financing Transaction - Granite Tower Mortgage Loan.”

During the three and nine months ended September 30, 2019, the Company incurred $4.4 million and $13.3 million of interest expense, respectively. During the three and nine months ended September 30, 2018, the Company incurred $4.2 million and $13.5 million of interest expense, respectively. As of September 30, 2019 and December 31, 2018, $1.3 million of interest expense was payable. Included in interest expense for the three and nine months ended September 30, 2019 were $0.4 million and $1.2 million of amortization of deferred financing costs, respectively. Included in interest expense for the three and nine months ended September 30, 2018 were $0.3 million and $0.9 million of amortization of deferred financing costs, respectively. Also included in interest expense for the nine months ended September 30, 2018 was $0.3 million of debt refinancing costs.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

KBS REAL ESTATE INVESTMENT TRUST II, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

The following is a schedule of maturities, including principal amortization payments, for all notes payable outstanding as of September 30, 2019 (in thousands):

October 1, 2019 through December 31, 2019						$	330
2020						321,857
2021						—
2022						—
2023						95,350
Thereafter						—
						$	417,537

Certain of the Company’s notes payable contain financial debt covenants. As of September 30, 2019, the Company was in compliance with these debt covenants.

Recent Financing Transaction

Granite Tower Mortgage Loan

On August 30, 2019, in connection with the partial principal repayment of the Portfolio Loan Facility, the Company, through an indirect wholly owned subsidiary (the “Granite Tower Mortgage Loan Borrower”), entered into a four-year mortgage loan with an unaffiliated lender (the “Granite Tower Mortgage Loan Agent”) for borrowings of up to $145.0 million (the “Granite Tower Mortgage Loan”). As of September 30, 2019, $95.4 million had been disbursed to the Company with the remaining loan balance of $49.6 million available for future disbursements, subject to certain conditions set forth in the loan agreement. The Granite Tower Mortgage Loan matures on September 1, 2023. The Granite Tower Mortgage Loan bears interest at a floating rate of 165 basis points over one-month LIBOR during the term of the loan. Monthly payments are initially interest-only. On January 1, 2022, monthly payments for the Granite Tower Mortgage Loan will begin to include principal and interest with principal payments calculated using an amortization schedule of 30 years for the balance of the loan term, with the remaining principal balance, all accrued and unpaid interest and any other amounts due at maturity. The Company has the right to repay all or a portion of the Granite Tower Mortgage Loan without fee, premium or penalty, subject to certain conditions contained in the loan agreement.

KBS REIT Properties II, LLC (“REIT Properties II”), the Company’s wholly owned subsidiary, is providing a guaranty of (i) payment of, and agrees to protect, defend, indemnify and hold harmless the Granite Tower Mortgage Loan Agent and each lender for, from and against, any liability, obligation, deficiency, loss, damage, costs and expenses (including reasonable attorney’s fees), and any litigation which may at any time be imposed upon, incurred or suffered by the Granite Tower Mortgage Loan Agent or any lender because of (a) certain intentional actions committed by the Granite Tower Mortgage Loan Borrower, (b) fraud or intentional misrepresentations by the Granite Tower Mortgage Loan Borrower or REIT Properties II in connection with the loan documents as described in the guaranty agreement, and (c) certain bankruptcy or insolvency proceedings involving the Granite Tower Mortgage Loan Borrower, as such acts are described in the guaranty, and (ii) upon and subject to the events and conditions described in the guaranty, payment of certain indemnity obligations of the Granite Tower Mortgage Loan Borrower related to environmental matters.

REIT Properties II also provides a limited completion guaranty of all obligations of the Granite Tower Mortgage Loan Borrower under an amendment of a major tenant’s lease up to a maximum guaranteed amount of $45.7 million.

7. FAIR VALUE DISCLOSURES

Under GAAP, the Company is required to measure certain financial instruments at fair value on a recurring basis. In addition, the Company is required to measure other non-financial and financial assets at fair value on a non-recurring basis (e.g., carrying value of impaired long-lived assets). Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP fair value framework uses a three-tiered approach. Fair value measurements are classified and disclosed in one of the following three categories:

•Level 1: unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities;

•Level 2: quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

•Level 3: prices or valuation techniques where little or no market data is available that requires inputs that are both significant to the fair value measurement and unobservable.

The fair value for certain financial instruments is derived using a combination of market quotes, pricing models and other valuation techniques that involve significant management judgment. The price transparency of financial instruments is a key determinant of the degree of judgment involved in determining the fair value of the Company’s financial instruments. Financial instruments for which actively quoted prices or pricing parameters are available and for which markets contain orderly transactions will generally have a higher degree of price transparency than financial instruments for which markets are inactive or consist of non-orderly trades. The Company evaluates several factors when determining if a market is inactive or when market transactions are not orderly. The following is a summary of the methods and assumptions used by management in estimating the fair value of each class of assets and liabilities for which it is practicable to estimate the fair value:

Cash and cash equivalents, restricted cash, rent and other receivables, and accounts payable and accrued liabilities: These balances approximate their fair values due to the short maturities of these items.

Notes payable: The fair value of the Company’s notes payable is estimated using a discounted cash flow analysis based on management’s estimates of current market interest rates for instruments with similar characteristics, including remaining loan term, loan-to-value ratio, type of collateral and other credit enhancements. Additionally, when determining the fair value of liabilities in circumstances in which a quoted price in an active market for an identical liability is not available, the Company measures fair value using (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets or (ii) another valuation technique that is consistent with the principles of fair value measurement, such as the income approach or the market approach. The Company classifies these inputs as Level 3 inputs.

The following were the face values, carrying amounts and fair values of the Company’s notes payable as of September 30, 2019 and December 31, 2018, which carrying amounts do not generally approximate the fair values (in thousands):

Disclosure of the fair values of financial instruments is based on pertinent information available to the Company as of the period end and requires a significant amount of judgment. Low levels of transaction volume for certain financial instruments have made the estimation of fair values difficult and, therefore, both the actual results and the Company’s estimate of value at a future date could be materially different.

Assets Recorded at Fair Value

During the nine months ended September 30, 2019, the Company measured the following assets at fair value on a nonrecurring basis (in thousands):

As of September 30, 2019, the Campus Drive Buildings classified as held for sale were measured at estimated fair value as these properties were impaired and the carrying values of these properties were adjusted to estimated fair value. The Company estimated the fair value for these impaired real estate properties held for sale based on the contractual sales price, less estimated costs to sell.

8. RELATED PARTY TRANSACTIONS

The Company has entered into the Advisory Agreement with the Advisor. This agreement entitles the Advisor to specified fees upon the provision of certain services with regard to the management of the Company’s investments, among other services, and the disposition of investments, as well as reimbursement of certain costs incurred by the Advisor in providing services to the Company. In addition, the Advisor is entitled to certain other fees, including an incentive fee upon achieving certain performance goals, as detailed in the Advisory Agreement. The Company has also entered into a fee reimbursement agreement with the Dealer Manager pursuant to which the Company agreed to reimburse the Dealer Manager for certain fees and expenses it incurs for administering the Company’s participation in the Depository Trust & Clearing Corporation Alternative Investment Product Platform with respect to certain accounts of the Company’s investors serviced through the platform. The Advisor and Dealer Manager also serve or served as the advisor and dealer manager, respectively, for KBS Real Estate Investment Trust, Inc. (“KBS REIT I”) (which liquidated in December 2018), KBS Real Estate Investment Trust III, Inc. (“KBS REIT III”), Pacific Oak Strategic Opportunity REIT, Inc., formerly KBS Strategic Opportunity REIT, Inc., (“Pacific Oak Strategic Opportunity REIT”) (advisory agreement terminated as of October 31, 2019 and the dealer manager agreement will terminate as of December 31, 2019), KBS Legacy Partners Apartment REIT, Inc. (“KBS Legacy Partners Apartment REIT”) (which liquidated in December 2018), Pacific Oak Strategic Opportunity REIT II, Inc., formerly KBS Strategic Opportunity REIT II, Inc., (“Pacific Oak Strategic Opportunity REIT II”) (advisory agreement terminated as of October 31, 2019 and the dealer manager agreement will terminate as of December 31, 2019) and KBS Growth & Income REIT, Inc. (“KBS Growth & Income REIT”).

On November 1, 2019, Pacific Oak Strategic Opportunity REIT and Pacific Oak Strategic Opportunity REIT II each entered into advisory agreements with a new external advisor, Pacific Oak Capital Advisors, LLC. Pacific Oak Capital Advisors, LLC is part of a group of companies formed, owned and managed by Keith D. Hall and Peter McMillan III. Together, through GKP Holding LLC, Messrs. Hall and McMillan, indirectly own a 33 1/3% interest in the Advisor and the Dealer Manager.

As of January 1, 2018, the Company, together with KBS REIT III, KBS Growth & Income REIT, Pacific Oak Strategic Opportunity REIT, KBS Legacy Partners Apartment REIT, Pacific Oak Strategic Opportunity REIT II, the Dealer Manager, the Advisor and other KBS-affiliated entities, had entered into an errors and omissions and directors and officers liability insurance program where the lower tiers of such insurance coverage were shared. The cost of these lower tiers is allocated by the Advisor and its insurance broker among each of the various entities covered by the program, and is billed directly to each entity. At the June 2018 renewal, Pacific Oak Strategic Opportunity REIT, Pacific Oak Strategic Opportunity REIT II and Legacy Partners Apartment REIT elected to cease participation in the program and obtained separate insurance coverage. In June 2019, the Company renewed its participation in the program. The program is effective through June 30, 2020.

During the nine months ended September 30, 2019 and 2018, no other business transactions occurred between the Company and KBS REIT I, KBS REIT III, Pacific Oak Strategic Opportunity REIT, KBS Legacy Partners Apartment REIT, Pacific Oak Strategic Opportunity REIT II, KBS Growth & Income REIT, the Advisor, the Dealer Manager or other KBS-affiliated entities.

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the nine months ended September 30, 2019 and 2018, respectively, and any related amounts payable as of September 30, 2019 and December 31, 2018 (in thousands):

⁽¹⁾ Reimbursable operating expenses primarily consists of internal audit personnel costs, accounting software and cybersecurity related expenses incurred by the Advisor under the Advisory Agreement. The Company has reimbursed the Advisor for the Company’s allocable portion of the salaries, benefits and overhead of internal audit department personnel providing services to the Company. These amounts totaled $55,000 and $53,000 for the three months ended September 30, 2019 and 2018, respectively, and $170,000 and $181,000 for the nine months ended September 30, 2019 and 2018, respectively, and were the only type of employee costs reimbursed under the Advisory Agreement for the nine months ended September 30, 2019 and 2018. The Company will not reimburse for employee costs in connection with services for which the Advisor earns acquisition, origination or disposition fees (other than reimbursement of travel and communication expenses) or for the salaries or benefits the Advisor or its affiliates may pay to the Company’s executive officers. In addition to the amounts above, the Company reimburses the Advisor for certain of the Company’s direct costs incurred from third parties that were initially paid by the Advisor on behalf of the Company.

⁽²⁾ Disposition fees with respect to real estate sold are included in the gain on sale of real estate, net, in the accompanying consolidated statements of operations.

During the nine months ended September 30, 2018, the Advisor reimbursed the Company for a $0.1 million property insurance rebate.

9. COMMITMENTS AND CONTINGENCIES

Economic Dependency

The Company is dependent on the Advisor for certain services that are essential to the Company, including the disposition of real estate investments; management of the daily operations of the Company’s real estate investment portfolio; and other general and administrative responsibilities. In the event the Advisor is unable to provide any of these services, the Company will be required to obtain such services from other sources.

Environmental

As an owner of real estate, the Company is subject to various environmental laws of federal, state and local governments. Compliance with existing environmental laws is not expected to have a material adverse effect on the Company’s financial condition and results of operations as of September 30, 2019.

Legal Matters

From time to time, the Company is party to legal proceedings that arise in the ordinary course of its business. Management is not aware of any legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on the Company’s results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.

10. SUBSEQUENT EVENTS

The Company evaluates subsequent events up until the date the consolidated financial statements are issued.

Distributions Paid

On October 1, 2019, the Company paid distributions of $3.5 million, which related to distributions declared for September 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on September 20, 2019. On November 1, 2019, the Company paid distributions of $3.5 million, which related to distributions declared for October 2019 in the amount of $0.01875000 per share of common stock to stockholders of record as of the close of business on October 21, 2019.

Purchase and Sale Agreement for Sale of the Membership Interests in KBSII 100-200 Campus Drive, LLC and KBSII 300-600 Campus Drive, LLC

On September 9, 2008, the Company, through an indirect wholly owned subsidiary, KBSII 100-200 Campus Drive, LLC, purchased two four-story office buildings located at 100 & 200 Campus Drive in Florham Park, New Jersey containing 590,458 rentable square feet on an approximate 71.1-acre parcel of land (the “100 & 200 Campus Drive Buildings”). On October 10, 2008, the Company, through an indirect wholly owned subsidiary, KBSII 300-600 Campus Drive, LLC, purchased four four-story office buildings containing 578,388 rentable square feet (the “300-600 Campus Drive Buildings”). The 300-600 Campus Drive Buildings are located at 300, 400, 500 and 600 Campus Drive in Florham Park, New Jersey on an approximate 64.80-acre parcel of land.

On October 22, 2019, the Company, through indirect wholly owned subsidiaries, entered into a membership interest purchase and sale agreement and escrow instructions (the “Agreement”) for the sale of all of the membership interests of KBSII 300-600 Campus Drive, LLC (the owner of the 300-600 Campus Drive Buildings) and KBSII 100-200 Campus Drive, LLC (the owner of the 100 & 200 Campus Drive Buildings)(together, the “Property Owners”) to a buyer unaffiliated with the Company or the Advisor (the “Purchaser”). Pursuant to the Agreement, the total purchase price for the Property Owners is $320.0 million.

On October 30, 2019, the Company, through indirect wholly owned subsidiaries, entered into the first amendment to the Agreement (the “First Amendment”) with the Purchaser to extend the ending date of the due diligence period from October 30, 2019 to October 31, 2019, and on October 31, 2019, the Company, through indirect wholly owned subsidiaries, entered into the second amendment to the Agreement (the “Second Amendment”) with the Purchaser to reduce the total purchase price for the Property Owners to $311.0 million.

Per the Agreement, the closing date is expected to be on or before December 16, 2019.  Under the Second Amendment, the Purchaser has an option to extend the closing date to January 16, 2020 and a second option to extend the closing date to January 31, 2020, subject to certain conditions set forth in the Second Amendment. There can be no assurance that the Company will complete the sale of the Property Owners. The Purchaser would be obligated to purchase the Property Owners only after satisfaction of agreed upon closing conditions. In some circumstances, if the Purchaser fails to complete the acquisition, it may forfeit up to $4.0 million of earnest money.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the accompanying financial statements of KBS Real Estate Investment Trust II, Inc. and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to KBS Real Estate Investment Trust II, Inc., a Maryland corporation, and, as required by context, KBS Limited Partnership II, a Delaware limited partnership, which we refer to as the “Operating Partnership,” and to their subsidiaries.

Forward-Looking Statements

Certain statements included in this Quarterly Report on Form 10-Q are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of KBS Real Estate Investment Trust II, Inc. and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law.

The following are some of the risks and uncertainties, although not all of the risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:

•All of our executive officers, one of our directors and other key real estate and debt finance professionals are also officers, directors, managers, key professionals and/or holders of a direct or indirect controlling interest in our advisor, the entity that acted as our dealer manager and/or other KBS-affiliated entities. As a result, they face conflicts of interest, including significant conflicts created by our advisor’s compensation arrangements with us and other KBS-sponsored programs and KBS-advised investors and conflicts in allocating time among us and these other programs and investors. These conflicts could result in unanticipated actions.

•We pay substantial fees to and expenses of our advisor and its affiliates. These payments increase the risk that our stockholders will not earn a profit on their investment in us and increase the risk of loss to our stockholders.

•We have used proceeds from financings, when necessary, to fund a portion of our distributions during our operational stage. We currently expect that our distributions will generally be paid from cash flow from operations and funds from operations from current or prior periods, except with respect to distributions paid from the net proceeds from the sale of real estate. We can give no assurance regarding the timing, amount or source of future distributions.

•We depend on tenants for the revenue generated by our real estate investments and, accordingly, the revenue generated by our real estate investments is dependent upon the success and economic viability of our tenants. Revenues from our properties could decrease due to a reduction in occupancy (caused by factors including, but not limited to, tenant defaults, tenant insolvency, early termination of tenant leases and non-renewal of existing tenant leases) and/or lower rental rates, making it more difficult for us to meet our debt service obligations and reducing our stockholders’ returns.

•Our investments in real estate may be affected by unfavorable real estate market and general economic conditions, which could decrease the value of those assets and reduce the investment return to our stockholders. Revenues from our properties could decrease. Such events would make it more difficult for us to meet our debt service obligations and could reduce our stockholders’ returns.

•Disruptions in the financial markets and uncertain economic conditions could adversely affect our ability to implement our business strategy and generate returns to our stockholders.

•As of September 30, 2019, we have $376.6 million of variable debt outstanding, and we may incur additional variable rate debt in the future. The interest and related payments on our variable rate debt will vary with the movement of LIBOR or other indexes. Increases in one-month LIBOR or other indexes would increase the amount of our debt payments and could reduce our stockholders’ returns.

•Our share redemption program provides only for redemptions sought upon a stockholder’s death, “qualifying disability” or “determination of incompetence” (each as defined in the share redemption program document, and, together with redemptions sought in connection with a stockholder’s death, “Special Redemptions”). The dollar amounts available for such redemptions are determined by the board of directors and may be reviewed and adjusted from time to time. Additionally, redemptions are further subject to limitations described in our share redemption program. We currently do not expect to have funds available for ordinary redemptions in the future.

•Since we have terminated our dividend reinvestment plan, we may have to use a greater proportion of our cash flow from operations and proceeds from the sales of real estate properties to meet cash requirements for general corporate purposes, including, but not limited to, capital expenditures, tenant improvement costs and leasing costs related to our real estate properties; reserves required by financings of our real estate properties; the repayment of debt; and Special Redemptions under our share redemption program. This may reduce our stockholders’ returns.

•As of September 30, 2019, we had classified two office properties as held for sale, which were under contract to sell as of November 12, 2019. During the year ended December 31, 2018, we sold three office buildings that were part of an eight-building office campus and received the repayment on one real estate loan receivable. During the nine months ended September 30, 2019, we sold two office properties. As a result of our disposition activity, our general and administrative expenses, which are not directly related to the size of our portfolio, have increased as a percentage of our cash flow from operations and will continue to increase to the extent we sell additional assets.

•Although the Special Committee (defined below) engaged a financial advisor to assist us and the Special Committee with the exploration of strategic alternatives for us, we are not obligated to enter into any particular transaction or any transaction at all. While we anticipate that our exploration of strategic alternatives and marketing of some of our remaining assets for sale will result in additional stockholder liquidity, there is no assurance that this will be the case, nor can we give assurance that it will provide a return to stockholders that equals or exceeds our estimated value per share. We do not expect to provide additional updates regarding our review of strategic alternatives until such time, if any, that we are prepared to announce a material transaction or to conclude the strategic review.

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission (the “SEC”), and in Part II, Item 1A herein.

Overview

We were formed on July 12, 2007 as a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2008 and we intend to continue to operate in such a manner. We conduct our business primarily through our Operating Partnership, of which we are the sole general partner. Subject to certain restrictions and limitations, our business is managed by our advisor, KBS Capital Advisors LLC, pursuant to an advisory agreement. KBS Capital Advisors conducts our operations and manages our portfolio of real estate investments. Our advisor owns 20,000 shares of our common stock. We have no paid employees.

We invested in a diverse portfolio of real estate and real estate-related investments. As of September 30, 2019, we owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings.

On September 27, 2007, we filed a registration statement on Form S-11 with the SEC to offer a maximum of 280,000,000 shares of common stock for sale to the public, of which 200,000,000 shares were registered in our primary offering and 80,000,000 shares were registered under our dividend reinvestment plan. We ceased offering shares of common stock in our primary offering on December 31, 2010. We sold 182,681,633 shares of common stock in our primary offering for gross offering proceeds of $1.8 billion. We terminated the offering under our dividend reinvestment plan effective May 29, 2014. We sold 30,903,504 shares of common stock under our dividend reinvestment plan for gross offering proceeds of $298.2 million. Also as of September 30, 2019, we had redeemed 28,053,701 shares sold in our offering for $256.1 million.

On January 27, 2016, our board of directors formed the Special Committee composed of all of our independent directors to explore the availability of strategic alternatives involving us. As part of the process of exploring strategic alternatives, on February 23, 2016, the Special Committee engaged Evercore to act as our financial advisor and to assist us and the Special Committee with this process. Under the terms of the engagement, Evercore provided various financial advisory services, as requested by the Special Committee as customary for an engagement in connection with exploring strategic alternatives. Although the Special Committee engaged Evercore to assist us and the Special Committee with the exploration of strategic alternatives for us, we are not obligated to enter into any particular transaction or any transaction at all.

The Special Committee determined that it would be in our best interest and the best interest of our stockholders to market some of our assets for sale while it continues to explore strategic alternatives for us. Based on the results of this sales effort, the board of directors may conclude that it would be in our best interest and the best interest of our stockholders to sell additional assets and, depending on the scope of the proposed asset sales, thereafter to adopt a plan of liquidation that would involve the sale of our remaining assets. In the event of such a determination, the proposed plan of liquidation would be presented to our stockholders for approval. While we anticipate that our exploration of strategic alternatives and marketing of some of our remaining assets for sale will result in additional stockholder liquidity, there is no assurance that this will be the case, nor can we give assurance that it will provide a return to stockholders that equals or exceeds our estimated value per share.

Our charter requires that we seek stockholder approval of our liquidation if our shares of common stock are not listed on a national securities exchange by March 31, 2018, unless a majority of our independent directors determines that liquidation is not then in the best interest of our stockholders. On March 12, 2019, the conflicts committee unanimously determined to postpone approval of our liquidation while the Special Committee continues to explore strategic alternatives for us. Our charter requires that the conflicts committee revisit the issue of liquidation at least annually.

Our focus in 2019 is to: continue to strategically sell assets and consider special distributions to stockholders; negotiate lease renewals or new leases that facilitate the sales process and enhance property stability for prospective buyers; complete capital projects, such as renovations or amenity enhancements, to attract quality buyers; and finalize our assessment of strategic alternatives.

Market Outlook – Real Estate and Real Estate Finance Markets

Volatility in global financial markets and changing political environments can cause fluctuations in the performance of the U.S. commercial real estate markets. Possible future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to renew tenants early, to retain tenants who are up for renewal or to attract new tenants, may result in decreases in cash flows from investment properties. To the extent there are increases in the cost of financing due to higher interest rates, this may cause difficulty in refinancing debt obligations at terms as favorable as the terms of existing indebtedness.  Further, increases in interest rates would increase the amount of our debt payments under our variable rate debt obligations. Market conditions can change quickly, potentially negatively impacting the value of real estate investments. Management continuously reviews our investment and debt financing strategies to optimize our portfolio and the cost of our debt.

Liquidity and Capital Resources

Our principal demands for funds during the short- and long-term are and will be for: the payment of operating expenses, capital expenditures and general and administrative expenses; payments under debt obligations; Special Redemptions of common stock pursuant to our share redemption program; and payments of distributions to stockholders. We intend to use our cash on hand, cash flow generated by our real estate properties, proceeds from debt financing and proceeds from the sale of real estate properties as our primary sources of immediate and long-term liquidity.

Our share redemption program provides only for Special Redemptions. During each calendar year, such Special Redemptions are limited to an annual dollar amount determined by the board of directors, which may be reviewed during the year and increased or decreased upon ten business days’ notice to our stockholders. Special Redemptions are made at a price per share equal to the most recent estimated value per share of our common stock as of the applicable redemption date. We currently do not expect to make ordinary redemptions in the future. On December 3, 2018, our board of directors approved an annual dollar limitation of $10.0 million in the aggregate for the calendar year 2019 for Special Redemptions (subject to review and adjustment during the year by the board of directors), and further subject to the limitations described in the share redemption program. As of September 30, 2019, we had $5.7 million available for Special Redemptions for the remainder of 2019.

Our investments in real estate generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our real estate investments is primarily dependent upon the occupancy level of our portfolio, the net effective rental rates on our leases, the collectibility of rent and operating recoveries from our tenants and how well we manage our expenditures. As of September 30, 2019, our real estate properties were 74% occupied.

For the nine months ended September 30, 2019, our cash needs for capital expenditures and the payment of debt obligations were met with cash on hand. Operating cash needs during the same period were met with cash flow generated by our real estate. We paid distributions to our stockholders during the nine months ended September 30, 2019 using current period cash flow from operations, cash flow from operations in excess of distributions paid from prior periods, proceeds from debt financing and the net proceeds from the sales of two of our properties. We believe that our cash on hand, cash flow from operations, availability under our portfolio loan facility and mortgage loan and proceeds from the sales of real estate properties will be sufficient to meet our liquidity needs for the foreseeable future.

On June 12, 2019, our board of directors declared a special distribution in the amount of $0.45 per share of common stock to stockholders of record as of the close of business on June 17, 2019 (the “Special Distribution”). The Special Distribution was funded primarily from the net proceeds from the sales of Pierre Laclede Center and Emerald View at Vista Center on May 23, 2019. We paid the Special Distribution on June 21, 2019. Also on June 12, 2019, our board of directors approved an updated estimated value per share of our common stock of $4.50, effective June 17, 2019, to reflect the impact of the payment of the Special Distribution. The June 2019 estimated value per share was based solely on the December 3, 2018 estimated value per share reduced for the impact of the payment of the Special Distribution. This was the sole adjustment to the estimated value per share. For a full description of the methodologies and assumptions used in June 2019 estimated value per share determination, see our Current Report on Form 8-K filed with SEC on December 7, 2018 and our Current Report on Form 8-K filed with the SEC on June 14, 2019.

Our cash flow from operations has decreased and will continue to decrease in future periods as a result of our disposition activity, and we have adjusted our distribution policy with respect to the amount of monthly distribution payments to take into account our disposition activity and current real estate investments. We may continue to make additional strategic asset sales as opportunities become available in the market and may further adjust our distribution policy as a result. Any future special distributions we make from the proceeds of dispositions will reduce our estimated value per share and this reduction will be reflected in our updated estimated value per share, which we expect to update no later than December 2019. As of September 30, 2019, we had classified two office properties as held for sale.

Cash Flows from Operating Activities

As of September 30, 2019, we owned six office properties (of which two were held for sale) and an office campus consisting of five office buildings. During the nine months ended September 30, 2019, net cash provided by operating activities was $10.9 million, compared to $50.6 million during the nine months ended September 30, 2018. The decrease in net cash provided by operating activities was primarily due to lease termination fees received in 2018, the disposition of assets and the lease expiration of a tenant that occupied 100% of Corporate Technology Centre. Cash flows from operating activities will decrease in the future as a result of future asset sales.

Cash Flows from Investing Activities

Net cash provided by investing activities was $99.3 million for the nine months ended September 30, 2019 and consisted of the following:

•$130.3 million of net proceeds from the sale of two office properties; and

•$31.0 million used for improvements to real estate.

Cash Flows from Financing Activities

During the nine months ended September 30, 2019, net cash used in financing activities was $122.2 million and consisted of the following:

•$134.4 million of proceeds from notes payable;

•$133.7 million of principal payments on notes payable;

•$117.6 million of cash used for distributions;

•$4.4 million of cash used for redemptions of common stock; and

•$0.9 million of payments of deferred financing costs.

In addition to using our capital resources to meet our debt service obligations, for capital expenditures and for operating costs, we use our capital resources to make certain payments to our advisor. We paid our advisor fees in connection with the acquisition and origination of our assets and pay our advisor fees in connection with the management and disposition of our assets and for certain costs incurred by our advisor in providing services to us. Among the fees payable to our advisor is an asset management fee. With respect to investments in real estate, we pay our advisor a monthly asset management fee equal to one-twelfth of 0.75% of the amount paid or allocated to acquire the investment, plus the cost of any subsequent development, construction or improvements to the property. This amount includes any portion of the investment that was debt financed and is inclusive of acquisition fees and expenses related thereto. With respect to investments in loans and any investments other than real estate, we paid our advisor a monthly asset management fee calculated, each month, as one-twelfth of 0.75% of the lesser of (i) the amount paid or allocated to acquire or fund the loan or other investment (which amount included any portion of the investment that was debt financed and was inclusive of acquisition or origination fees and expenses related thereto) and (ii) the outstanding principal amount of such loan or other investment, plus the acquisition or origination fees and expenses related to the acquisition or funding of such investment, as of the time of calculation. We also continue to reimburse our advisor and our dealer manager for certain stockholder services.

As of September 30, 2019, we had $48.1 million of cash and cash equivalents and up to $112.0 million available for future disbursements under our portfolio loan facility and one of our mortgage loans, subject to certain conditions and restrictions set forth in the loan agreements, to meet our operational and capital needs.

In order to execute our investment strategy, we primarily utilized secured debt to finance a portion of our investment portfolio. Management remains vigilant in monitoring the risks inherent with the use of debt in our portfolio and is taking actions to ensure that these risks, including refinance and interest rate risks, are properly balanced with the benefit of using leverage. We limit our total liabilities to 75% of the cost (before deducting depreciation and other noncash reserves) of our tangible assets; however, we may exceed that limit if the majority of the conflicts committee approves each borrowing in excess of such limitation and we disclose such borrowings to our stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. As of September 30, 2019, our borrowings and other liabilities were approximately 37% of both the cost (before deducting depreciation and other noncash reserves) and book value (before deducting depreciation) of our tangible assets.

Contractual Commitments and Contingencies

The following is a summary of our contractual obligations as of September 30, 2019 (in thousands):