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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 000-54382

______________________________________________________

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  ☒    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  ☒ 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. (Check one):

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) for the Act:

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

As of November 4, 2019, there were 66,081,167 outstanding shares of common stock of Pacific Oak Strategic Opportunity REIT, Inc.

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, 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 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

40

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

59

Item 4.

Controls and Procedures

60

PART II.

OTHER INFORMATION

61

Item 1.

Legal Proceedings

61

Item 1A.

Risk Factors

61

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 3.

Defaults upon Senior Securities

63

Item 4.

Mine Safety Disclosures

63

Item 5.

Other Information

64

Item 6.

Exhibits

64

SIGNATURES

65

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

See accompanying condensed notes to consolidated financial statements.

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, 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						$	21,669					$	22,332					$	59,879					$	61,771
Other operating income						1,317						1,426						4,219						3,640
Interest income from real estate debt securities						—						513						369						1,525
Dividend income from real estate equity securities						2,296						2,885						4,414						5,146
Total revenues						25,282						27,156						68,881						72,082
Expenses:
Operating, maintenance, and management						8,156						8,336						21,254						21,395
Real estate taxes and insurance						3,278						3,208						9,556						8,982
Asset management fees to affiliate						2,093						2,299						5,954						6,342
General and administrative expenses						2,038						1,914						5,586						6,215
Foreign currency transaction loss (gain), net						5,344						8						10,634						(9,106)
Depreciation and amortization						9,239						9,826						25,276						26,133
Interest expense						7,359						8,404						21,776						22,814
Total expenses						37,507						33,995						100,036						82,775
Other income (loss):
Income from unconsolidated joint venture						—						244						—						428
Equity in (loss) income of unconsolidated joint ventures, net						(419)						(2,644)						6,677						(7,394)
Casualty-related loss						—						—						(506)						—
Other interest income						536						253						1,862						1,602
Gain (loss) on real estate equity securities						3,845						741						19,304						(6,546)
Gain on sale of real estate						10,559						44,692						18,128						45,340
Loss on extinguishment of debt						(6)						(26)						(861)						(26)
Total other income, net						14,515						43,260						44,604						33,404
Net income						2,290						36,421						13,449						22,711
Net (income) loss attributable to noncontrolling interests						(1,518)						76						(2,145)						141
Net income attributable to common stockholders						$	772					$	36,497					$	11,304					$	22,852
Net income per common share, basic and diluted						$	0.01					$	0.67					$	0.17					$	0.38
Weighted-average number of common shares outstanding, basic and diluted						66,326,646						54,599,254						66,564,532						59,649,846

See accompanying condensed notes to consolidated financial statements.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONSOLIDATED STATEMENTS OF 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						Accumulated Other Comprehensive Income						Total Stockholders' Equity						Noncontrolling Interests						Total Equity
			Shares						Amounts
Balance, June 30, 2019			66,342,855						$	663					$	547,767					$	(247,603)					$	—					$	300,827					$	1,325					$	302,152
Net income			—						—						—						772						—						772						1,518						2,290
Issuance of common stock			27,434						—						271						—						—						271						—						271
Transfers from redeemable common stock			—						—						2,040						—						—						2,040						—						2,040
Redemptions of common stock			(245,571)						(2)						(2,324)						—						—						(2,326)						—						(2,326)
Distributions declared			—						—						—						(570)						—						(570)						—						(570)
Other offering costs			—						—						(4)						—						—						(4)						—						(4)
Distributions to noncontrolling interests			—						—						—						—						—						—						(1,969)						(1,969)
Balance, September 30, 2019			66,124,718						$	661					$	547,750					$	(247,401)					$	—					$	301,010					$	874					$	301,884
			Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income						Accumulated Other Comprehensive Income						Total Stockholders' Equity						Noncontrolling Interests						Total Equity
			Shares						Amounts
Balance, June 30, 2018			54,682,660						$	547					$	434,935					$	(143,397)					$	—					$	292,085					$	2,648					$	294,733
Net income (loss)			—						—						—						36,497						—						36,497						(76)						36,421
Issuance of common stock			39,433						—						454						—						—						454						—						454
Transfers to redeemable common stock			—						—						(1,298)						—						—						(1,298)						—						(1,298)
Redemptions of common stock			(490,829)						(5)						(5,468)						—						—						(5,473)						—						(5,473)
Distributions declared			—						—						—						(870)						—						(870)						—						(870)
Other offering costs			—						—						(1)						—						—						(1)						—						(1)
Noncontrolling interests contributions			—						—						—						—						—						—						17						17
Balance, September 30, 2018			54,231,264						$	542					$	428,622					$	(107,770)					$	—					$	321,394					$	2,589					$	323,983

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1. Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONSOLIDATED STATEMENTS OF EQUITY

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						Accumulated Other Comprehensive Income						Total Stockholders' Equity						Noncontrolling Interests						Total Equity
			Shares						Amounts
Balance, December 31, 2018			66,822,861						$	668					$	547,770					$	(256,984)					$	—					$	291,454					$	2,510					$	293,964
Net income			—						—						—						11,304						—						11,304						2,145						13,449
Issuance of common stock			84,248						1						834						—						—						835						—						835
Transfers from redeemable common stock			—						—						6,577						—						—						6,577						—						6,577
Redemptions of common stock			(782,391)						(8)						(7,425)						—						—						(7,433)						—						(7,433)
Distributions declared			—						—						—						(1,721)						—						(1,721)						—						(1,721)
Other offering costs			—						—						(6)						—						—						(6)						—						(6)
Noncontrolling interests contributions			—						—						—						—						—						—						12						12
Distributions to noncontrolling interests			—						—						—						—						—						—						(3,793)						(3,793)
Balance, September 30, 2019			66,124,718						$	661					$	547,750					$	(247,401)					$	—					$	301,010					$	874					$	301,884
			Common Stock																		Additional Paid-in Capital						Cumulative Distributions and Net Income						Accumulated Other Comprehensive Income						Total Stockholders' Equity						Noncontrolling Interests						Total Equity
			Shares						Amounts
Balance, December 31, 2017			52,053,817						$	521					$	388,800					$	(155,454)					$	25,146					$	259,013					$	1,970					$	260,983
Cumulative effect adjustments to retained earnings			—						—						—						27,618						(25,146)						2,472						—						2,472
Net income (loss)			—						—						—						22,852						—						22,852						(141)						22,711
Issuance of common stock			123,288						1						1,417						—						—						1,418						—						1,418
Stock distribution issued			13,069,487						130						150,169						—						—						150,299						—						150,299
Transfers from redeemable common stock			—						—						8,671						—						—						8,671						—						8,671
Redemptions of common stock			(11,015,328)						(110)						(120,434)						—						—						(120,544)						—						(120,544)
Distributions declared			—						—						—						(2,786)						—						(2,786)						—						(2,786)
Other offering costs			—						—						(1)						—						—						(1)						—						(1)
Noncontrolling interests contributions			—						—						—						—						—						—						760						760
Balance, September 30, 2018			54,231,264						$	542					$	428,622					$	(107,770)					$	—					$	321,394					$	2,589					$	323,983

See accompanying condensed notes to consolidated financial statements.

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

						Nine Months Ended September 30,
						2019						2018
Cash Flows from Operating Activities:
Net income						$	13,449					$	22,711
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Loss due to property damages						—						964
Casualty-related loss						506						—
Equity in (income) loss of unconsolidated joint ventures, net						(6,677)						7,394
Depreciation and amortization						25,276						26,133
(Gain) loss on real estate equity securities						(19,304)						6,546
Gain on sale of real estate						(18,128)						(45,340)
Loss on extinguishment of debt						861						26
Unrealized loss on interest rate caps						50						21
Deferred rent						(3,213)						(3,508)
Bad debt recovery						—						(5)
Amortization of above- and below-market leases, net						(856)						(853)
Amortization of deferred financing costs						2,683						2,675
Accretion of interest income on real estate debt securities						(13)						(104)
Net amortization of discount and (premium) on bond and notes payable						(73)						45
Foreign currency transaction gain (loss), net						10,634						(9,106)
Changes in assets and liabilities:
Rents and other receivables						(2,164)						(1,744)
Prepaid expenses and other assets						(4,527)						(5,901)
Accounts payable and accrued liabilities						(559)						37
Due to affiliates						8						39
Other liabilities						(97)						409
Net cash (used in) provided by operating activities						(2,144)						439
Cash Flows from Investing Activities:
Acquisitions of real estate						(90,266)						(312,348)
Improvements to real estate						(25,833)						(21,147)
Proceeds from sales of real estate, net						43,164						85,615
Reimbursement of construction costs						—						1,636
Insurance proceeds received for property damages						438						—
Purchase of interest rate cap						(28)						(163)
Contributions to unconsolidated joint venture						(5,050)						(1,320)
Distributions of capital from unconsolidated joint venture						8,051						2,199
Investment in real estate equity securities						(10,015)						(15,851)
Proceeds from the sale of real estate equity securities						24,076						633
Proceeds from principal repayment on real estate debt securities						7,750						—
Proceeds for future development obligations						—						1,055
Funding of development obligations						(134)						(1,162)
Net cash used in investing activities						(47,847)						(260,853)
Cash Flows from Financing Activities:
Proceeds from notes and bonds payable						84,268						184,351
Principal payments on notes and bonds payable						(73,250)						(34,348)
Payments of deferred financing costs						(1,121)						(2,791)
Payments to redeem common stock						(7,433)						(120,544)
Payment of prepaid other offering costs						(2)						(458)
Distributions paid						(886)						(38,983)
Noncontrolling interests contributions						12						760
Distributions to noncontrolling interests						(3,793)						—
Other financing proceeds, net						1,822						—
Net cash used in financing activities						(383)						(12,013)
Effect of exchange rate changes on cash, cash equivalents and restricted cash						2,367						1,127
Net decrease in cash, cash equivalents and restricted cash						(48,007)						(271,300)
Cash, cash equivalents and restricted cash, beginning of period						162,727						377,182
Cash, cash equivalents and restricted cash, end of period						$	114,720					$	105,882

See accompanying condensed notes to consolidated financial statements.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(unaudited)

1.ORGANIZATION

Pacific Oak Strategic Opportunity REIT, Inc. (formerly known as KBS Strategic Opportunity REIT, Inc.) (the “Company”) was formed on October 8, 2008 as a Maryland corporation and elected to be taxed as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2010. The Company conducts its business primarily through Pacific Oak Strategic Opportunity (BVI) Holdings, Ltd. (“Pacific Oak Strategic Opportunity BVI”), a private company limited by shares according to the British Virgin Islands Business Companies Act, 2004, which was incorporated on December 18, 2015 and is authorized to issue a maximum of 50,000 common shares with no par value. Upon incorporation, Pacific Oak Strategic Opportunity BVI issued one certificate containing 10,000 common shares with no par value to Pacific Oak Strategic Opportunity Limited Partnership (the “Operating Partnership”), a Delaware limited partnership formed on December 10, 2008. The Company is the sole general partner of, and owns a 0.1% partnership interest in, the Operating Partnership. Pacific Oak Strategic Opportunity Holdings LLC (“REIT Holdings”), a Delaware limited liability company formed on December 9, 2008, owns the remaining 99.9% interest in the Operating Partnership and is its sole limited partner. The Company is the sole member and manager of REIT Holdings.

Subject to certain restrictions and limitations, the business of the Company was externally 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 October 7, 2019 (the “Advisory Agreement”). The Advisor conducted the Company’s operations and manages its portfolio of real estate and other real estate-related investments. On October 31, 2019, the Advisor ceased to serve as the Company’s advisor or have any advisory responsibility to the Company immediately following the filing of the Company’s Quarterly Report on Form 10-Q for the period ending September 30, 2019 (the “Third Quarter 10-Q”) with the Securities and Exchange Commission (the “SEC”). On November 1, 2019, the Company entered into an advisory agreement with Pacific Oak Capital Advisors, LLC (“Pacific Oak Capital Advisors”). The new advisory agreement is effective as of November 1, 2019 through November 1, 2020; however the Company may terminate the advisory agreement without cause or penalty upon providing 30 days’ written notice and Pacific Oak Capital Advisors may terminate the new advisory agreement without cause or penalty upon providing 90 days’ written notice. The terms of the advisory agreement are consistent with those of the advisory agreement that was previously in effect with the Advisor, except as discussed in Note 11.

On January 8, 2009, the Company filed a registration statement on Form S-11 with the SEC to offer a minimum of 250,000 shares and a maximum of 140,000,000 shares of common stock for sale to the public (the “Offering”), of which 100,000,000 shares were registered in a primary offering and 40,000,000 shares were registered to be sold under the Company’s dividend reinvestment plan. The SEC declared the Company’s registration statement effective on November 20, 2009. The Company ceased offering shares of common stock in its primary offering on November 14, 2012 and continues to offer shares under its dividend reinvestment plan.

The Company sold 56,584,976 shares of common stock in its primary offering for gross offering proceeds of $561.7 million. As of September 30, 2019, the Company had sold 6,827,874 shares of common stock under its dividend reinvestment plan for gross offering proceeds of $76.3 million. Also, as of September 30, 2019, the Company had redeemed 23,561,121 shares for $282.8 million. As of September 30, 2019, the Company had issued 25,976,746 shares of common stock in connection with special dividends. Additionally, on December 29, 2011 and October 23, 2012, the Company issued 220,994 shares and 55,249 shares of common stock, respectively, for $2.0 million and $0.5 million, respectively, in private transactions exempt from the registration requirements pursuant to Section 4(2) of the Securities Act of 1933.

On March 2, 2016, Pacific Oak Strategic Opportunity BVI filed a final prospectus with the Israel Securities Authority for a proposed offering of up to 1,000,000,000 Israeli new Shekels of Series A debentures (the “Debentures”) at an annual interest rate not to exceed 4.25%. On March 1, 2016, Pacific Oak Strategic Opportunity BVI commenced the institutional tender of the Debentures and accepted application for 842.5 million Israeli new Shekels. On March 7, 2016, Pacific Oak Strategic Opportunity BVI commenced the public tender of the Debentures and accepted 127.7 million Israeli new Shekels.  In the aggregate, Pacific Oak Strategic Opportunity BVI accepted 970.2 million Israeli new Shekels (approximately $249.2 million as of March 8, 2016) in both the institutional and public tenders at an annual interest rate of 4.25%.  Pacific Oak Strategic Opportunity BVI issued the Debentures on March 8, 2016.

In connection with the above-referenced offering, on March 8, 2016, the Operating Partnership assigned to Pacific Oak Strategic Opportunity BVI all of its interests in the subsidiaries through which the Company indirectly owns all of its real estate and real estate-related investments.  The Operating Partnership owns all of the issued and outstanding equity of Pacific Oak Strategic Opportunity BVI.  As a result of these transactions, the Company now holds all of its real estate and real estate-related investments indirectly through Pacific Oak Strategic Opportunity BVI.

As of September 30, 2019, the Company consolidated seven office properties, one office portfolio consisting of four office buildings and 14 acres of undeveloped land, one apartment property and three investments in undeveloped land with approximately 1,000 developable acres and owned five investments in unconsolidated joint ventures and four investments in real estate equity securities.

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 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, REIT Holdings, the Operating Partnership, Pacific Oak Strategic Opportunity BVI and their direct and indirect wholly owned subsidiaries, joint ventures in which the Company has a controlling interest and VIEs in which the Company is the primary beneficiary. All significant intercompany balances and transactions are eliminated in consolidation.

Use of Estimates

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

Redeemable Common Stock

The Company limits the dollar value of shares that may be redeemed under the share redemption program. During the nine months ended September 30, 2019, the Company had redeemed $7.4 million of common stock under the share redemption program. The Company processed all redemption requests received in good order and eligible for redemption through the September 2019 redemption date, except for 4,595,566 shares totaling $43.3 million due to the limitations under the share redemption program. The Company recorded $3.4 million and $10.0 million of redeemable common stock payable on the Company’s balance sheet as of September 30, 2019 and December 31, 2018, respectively, related to unfulfilled redemption requests received in good order under the share redemption program. Based on the eleventh amended and restated share redemption program, the Company has $2.6 million available for redemptions in the remainder of 2019, including shares that are redeemed in connection with a stockholders’ death, “qualifying disability” or “determination of incompetence,” subject to the limitations under the share redemption program.

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.  During the nine months ended September 30, 2019, the Company sold one apartment property and one retail property. As a result, certain assets and liabilities were reclassified to held for sale on the consolidated balance sheets for all periods presented. 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 $2.7 million and $8.1 million of tenant reimbursement revenue for property taxes, insurance, and common area maintenance to rental income for comparability purposes.

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.

The Company leases apartment units under operating leases with terms generally of one year or less. Generally, credit investigations will be performed for prospective residents and security deposits will be obtained. The Company recognizes rental revenue, net of concessions, on a straight-line basis over the term of the lease, when collectibility is determined to be probable.

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 classify 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.

Segments

The Company has invested in opportunistic real estate, non-performing loans and other real estate-related assets. In general, the Company intends to hold its investments in opportunistic real estate, non-performing loans and other real estate-related assets for capital appreciation. Traditional performance metrics of opportunistic real estate, non-performing loans and other real estate-related assets may not be meaningful as these investments are generally non-stabilized and do not provide a consistent stream of interest income or rental revenue. These investments exhibit similar long-term financial performance and have similar economic characteristics. These investments typically involve a higher degree of risk and do not provide a constant stream of ongoing cash flows. As a result, the Company’s management views opportunistic real estate, non-performing loans and other real estate-related assets as similar investments. Substantially all of its revenue and net income (loss) is from opportunistic real estate, non-performing loans and other real estate-related assets, and therefore, the Company currently aggregates its operating segments into one reportable business segment.

Per Share Data

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) attributable to common stockholders 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 three and nine months ended September 30, 2019 and 2018.

Distributions declared per share were $0.00860000 and $0.02580000 during the three and nine months ended September 30, 2019, respectively, and $0.01597500 and $0.04792500 during the three and nine months ended September 30, 2018, respectively.

Square Footage, Occupancy and Other Measures

Any references to square footage, occupancy or annualized base rent 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 Updates

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 debt 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 debt 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 measurement.  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 owned seven office properties and one office portfolio consisting of four office buildings and 14 acres of undeveloped land, encompassing, in the aggregate, approximately 3.4 million rentable square feet. As of September 30, 2019, these properties were 81% occupied. In addition, the Company owned one apartment property, containing 317 units and encompassing approximately 0.3 million rentable square feet, which was 90% occupied. The Company also owned three investments in undeveloped land with approximately 1,000 developable acres. The following table summarizes the Company’s real estate held for investment as of September 30, 2019 and December 31, 2018, respectively (in thousands):

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1.  Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

The following table provides summary information regarding the Company’s real estate held for investment as of September 30, 2019 (in thousands):

Property						Date Acquired or Foreclosed on						City						State						Property Type						Land						Building and Improvements						Tenant Origination and Absorption						Total Real Estate, at Cost						Accumulated Depreciation and Amortization						Total Real Estate, Net						Ownership %
Richardson Portfolio:
Palisades Central I						11/23/2011						Richardson						TX						Office						$	1,037					$	11,656					$	—					$	12,693					$	(3,372)					$	9,321					90.0		%
Palisades Central II						11/23/2011						Richardson						TX						Office						810						20,134						—						20,944						(5,198)						15,746						90.0		%
Greenway I						11/23/2011						Richardson						TX						Office						561						2,145						—						2,706						(875)						1,831						90.0		%
Greenway III						11/23/2011						Richardson						TX						Office						702						3,725						—						4,427						(1,277)						3,150						90.0		%
Undeveloped Land						11/23/2011						Richardson						TX						Undeveloped Land						3,134						—						—						3,134						—						3,134						90.0		%
Total Richardson Portfolio																														6,244						37,660						—						43,904						(10,722)						33,182
Park Highlands (1)						12/30/2011						North Las Vegas						NV						Undeveloped Land						33,367						—						—						33,367						—						33,367						100.0%(1)
Park Centre						03/28/2013						Austin						TX						Office						3,251						34,274						—						37,525						(5,846)						31,679						100.0		%
1180 Raymond						8/20/2013						Newark						NJ						Apartment						8,292						39,062						—						47,354						(7,577)						39,777						100.0		%
Park Highlands II (1)						12/10/2013						North Las Vegas						NV						Undeveloped Land						26,782						—						—						26,782						—						26,782						100.0% (1)
Richardson Land II						09/04/2014						Richardson						TX						Undeveloped Land						3,418						—						—						3,418						—						3,418						90.0		%
Crown Pointe						02/14/2017						Dunwoody						GA						Office						22,590						66,928						4,876						94,394						(10,656)						83,738						100.0		%
125 John Carpenter (2)						09/15/2017						Irving						TX						Office						2,755						77,319						8,723						88,797						(9,102)						79,695						100.0		%
The Marq (3)						03/01/2018						Minneapolis						MN						Office						10,387						77,659						4,180						92,226						(6,055)						86,171						100.0		%
City Tower						03/06/2018						Orange						CA						Office						13,930						134,849						7,937						156,716						(10,987)						145,729						100.0		%
Eight & Nine Corporate Centre						06/08/2018						Franklin						TN						Office						17,401						57,420						4,572						79,393						(3,584)						75,809						100.0		%
Georgia 400 Center						05/23/2019						Alpharetta						GA						Office						11,431						72,374						7,574						91,379						(1,803)						89,576						100.0		%
																														$	159,848					$	597,545					$	37,862					$	795,255					$	(66,332)					$	728,923

_____________________

⁽¹⁾ The Company owns 100% of the common members’ equity of Park Highlands and Park Highlands II. On September 7, 2016 and January 8, 2019, a subsidiary of the Company that owns a portion of Park Highlands and Park Highlands II, sold 820 units of 10% Class A non-voting preferred membership units for $0.8 million and 1,927 units of 10% Class A2 non-voting preferred membership units for $1.9 million, respectively, to accredited investors. The amount of the Class A and A2 non-voting preferred membership units raised, net of offering costs, is included in other liabilities on the accompanying consolidated balance sheets.

⁽²⁾ On November 1, 2019, the Company sold this property. See note 15, “Subsequent Events - Real Estate Disposition Subsequent to September 30, 2019” for more information.

⁽³⁾ This property was formerly known as Marquette Plaza and was re-named The Marq in connection with the Company’s re-branding strategy for this property.

Operating Leases

Certain of the Company’s real estate properties are leased to tenants under operating leases for which the terms and expirations vary. As of September 30, 2019, the leases, excluding options to extend and apartment leases, which have terms that are generally one year or less, had remaining terms of up to 12.5 years with a weighted-average remaining term of 4.7 years. Some of the leases have provisions to extend the lease agreements, options for early termination after paying a specified penalty 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 tenants 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 leases and the creditworthiness of the tenant, but generally are not significant amounts. 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 and assumed in real estate acquisitions related to tenant leases are included in other liabilities in the accompanying consolidated balance sheets and totaled $3.9 million and $3.7 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 of $3.2 million and $3.5 million, respectively, net of lease incentive amortization. As of September 30, 2019 and December 31, 2018, the cumulative deferred rent receivable balance, including unamortized lease incentive receivables, was $14.9 million and $9.6 million, respectively, and is included in rents and other receivables on the accompanying balance sheets. The cumulative deferred rent balance included $3.3 million and $1.3 million of unamortized lease incentives as of September 30, 2019 and December 31, 2018, respectively.

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

As of September 30, 2019, the Company’s commercial real estate properties were leased to approximately 250 tenants over a diverse range of industries and geographic areas. The Company’s highest tenant industry concentrations (greater than 10% of annualized base rent) were as follows:

⁽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. No material tenant credit issues have been identified at this time. During the nine months ended September 30, 2019, the Company recorded an adjustment to rental income of $0.4 million for lease payments that were deemed not probable of collection. During the nine months ended September 30, 2019 and 2018, the Company recorded bad debt recoveries of $0.2 million and $5,000, respectively, which were included in operating, maintenance and management expense in the accompanying consolidated statements of operations.

Geographic Concentration Risk

As of September 30, 2019, the Company’s real estate investments in Georgia, Texas and California represented 17.2%, 14.7% and 14.4%, respectively, of the Company’s total assets.  As a result, the geographic concentration of the Company’s portfolio makes it particularly susceptible to adverse economic developments in the Georgia, Texas and California 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.

Recent Acquisition

Georgia 400 Center

On May 23, 2019, the Company, through an indirect wholly owned subsidiary, acquired an office property consisting of three buildings containing an aggregate of 416,463 rentable square feet located on approximately 24.4 acres of land in Alpharetta, Georgia (“Georgia 400 Center”). The seller is not affiliated with the Company or the Advisor. The purchase price (net of closing credits) of Georgia 400 Center was $90.3 million, which includes $1.2 million of capitalized acquisition costs. The Company recorded this acquisition as an asset acquisition and recorded $11.4 million to land, $72.0 million to building and improvements, $7.6 million to tenant origination and absorption costs and $0.7 million to below-market lease liabilities. The intangible assets and liabilities acquired in connection with this acquisition have weighted-average amortization periods as of the date of acquisition of 5.8 years for tenant origination and absorption costs and 2.4 years for below-market lease liabilities.

Sale of Real Estate

As of December 31, 2018 and September 30, 2019, the Company had recorded contract liabilities of $3.1 million related to deferred proceeds received from the buyers of the Park Highlands land sales and another developer for the value of land that was contributed to a master association that is consolidated by the Company, which was included in other liabilities on the accompanying consolidated balance sheets.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1.  Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, 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						$	37,862					$	31,221					$	3,714					$	3,714					$	(6,959)					$	(6,418)
Accumulated Amortization						(11,490)						(7,133)						(640)						(337)						2,400						1,471
Net Amount						$	26,372					$	24,088					$	3,074					$	3,377					$	(4,559)					$	(4,947)

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						$	(2,000)					$	(2,312)					$	(101)					$	(104)					$	421					$	457

						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						$	(5,324)					$	(5,937)					$	(303)					$	(259)					$	1,159					$	1,112

Additionally, as of September 30, 2019 and December 31, 2018, the Company had recorded tax abatement intangible assets, net of amortization, on real estate held for investment, which are included in prepaid expenses and other assets in the accompanying balance sheets, of $1.1 million and $1.6 million, respectively. Also, as of December 31, 2018, the Company had recorded tax abatement intangible assets, net of amortization, on real estate held for sale, which are included in assets related to real estate held for sale, net in the accompanying balance sheets, of $2.7 million. During the three and nine months ended September 30, 2019, the Company recorded amortization expense of $0.1 million and $0.5 million, respectively, related to tax abatement intangible assets. During the three and nine months ended September 30, 2018, the Company recorded amortization expense of $0.2 million and $0.7 million, respectively, related to tax abatement intangible assets.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1.  Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

5. REAL ESTATE EQUITY SECURITIES

As of September 30, 2019, the Company owned four investments in real estate equity securities. The following table sets forth the number of shares owned by the Company and the related carrying value of the shares as of September 30, 2019 and December 31, 2018 (dollars in thousands):

						September 30, 2019																		December 31, 2018
Real Estate Equity Security						Number of Shares Owned						Total Carrying Value						Number of Shares Owned						Total Carrying Value
Whitestone REIT						95,160						$	1,309					1,781,894						$	21,846
Keppel Pacific Oak US REIT						56,979,352						44,159						56,979,352						34,757
Franklin Street Properties Corp.						2,773,729						23,466						2,772,529						17,273
Plymouth Industrial REIT, Inc.						555,555						10,178						—						—
						60,403,796						$	79,112					61,533,775						$	73,876

During the nine months ended September 30, 2019, the Company purchased 555,555 shares of common stock of Plymouth Industrial REIT, Inc. (NYSE Ticker: PLYM) for an aggregate purchase price of $10.0 million. During the nine months ended September 30, 2019, the Company sold 1,686,734 shares of common stock of Whitestone REIT (NYSE Ticker: WSR) for an aggregate sale price of $24.1 million.

The following summarizes the portion of gain and loss for the period related to real estate equity securities held during the three and nine months ended September 30, 2019 and 2018 (in thousands):

During the three and nine months ended September 30, 2019, the Company recognized $2.2 million and $4.3 million, respectively, of dividend income from real estate equity securities. During the three and nine months ended September 30, 2018, the Company recognized $2.9 million and $5.1 million, respectively, of dividend income from real estate equity securities.

PART I. FINANCIAL INFORMATION (CONTINUED)

Item 1.  Financial Statements (continued)

PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

September 30, 2019

(unaudited)

6. REAL ESTATE DEBT SECURITIES

The information for real estate debt securities as of September 30, 2019 and December 31, 2018 is set forth below (in thousands):

Debt Securities Name						Dates Acquired						Debt Securities Type						Outstanding Principal Balance as of September 30, 2019						Book Value as of September 30, 2019						Book Value as of December 31, 2018						Contractual Interest Rate						Annualized Effective Interest Rate						Maturity Date
Battery Point Series B Preferred Units (4)						10/28/2016 / 03/30/2017 / 05/12/2017						Series B Preferred Units						$	—					$	—					$	10,859					(1)						(1)						(1)
																		$	—					$	—					$	10,859

_____________________

⁽¹⁾ On March 20, 2019, the Company, through an indirect wholly owned subsidiary, entered into a redemption agreement for the Battery Point Series B Preferred Units. The redemption agreement resulted in the redemption of 13,000 Series B Preferred Units with a per-unit price of $1,000. The Company received $8.6 million, of which $0.9 million relates to accrued interest and an exit fee. In addition, the Company received 210,000 shares of Battery Point Series A-3 Preferred Units with a per-unit price of $25. The Series A-3 Preferred Units were classified as an equity investment without a readily determinable fair value (see note 12 “Investment in Unconsolidated Joint Ventures” for further information).

The following summarizes the activity related to real estate debt securities for the nine months ended September 30, 2019 (in thousands):

For the three and nine months ended September 30, 2019 and 2018, interest income from real estate debt securities consisted of the following (in thousands):