PACIFIC OAK STRATEGIC OPPORTUNITY REIT, INC. The following discussion and analysis should be read in conjunction with the accompanying financial statements ofPacific Oak Strategic Opportunity REIT, Inc. and the notes thereto. As used herein, the terms "we," "our" and "us" refer toPacific Oak Strategic Opportunity REIT, Inc. , aMaryland corporation, and, as required by context,Pacific Oak Strategic Opportunity Limited Partnership , aDelaware 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 ofPacific Oak Strategic Opportunity REIT, 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:
•We depend on our advisor to conduct our operations and eventually dispose of our investments.
•Because our advisor,Pacific Oak Capital Advisors, LLC , was recently formed, it could face challenges with employee hiring and retention, information technology, vendor relationships, and funding; ifPacific Oak Capital Advisors faces challenges in performing its obligations to us, it could negatively impact our ability to achieve our investment objectives. •We depend on tenants for our revenue and, accordingly, our revenue is dependent upon the success and economic viability of our tenants. Revenues from our property investments could decrease due to a reduction in tenants (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, limiting our ability to pay distributions to our stockholders.
•Our opportunistic investment strategy involves a higher risk of loss than would a strategy of investing in some other types of real estate and real estate-related investments.
•We have paid distributions from financings and in the future we may not pay
distributions solely from our cash flow from operations or gains from asset
sales. To the extent that we pay distributions from sources other than our cash
flow from operations or gains from asset sales, we will have less funds
available for investment in loans, properties and other assets, the overall
return to our stockholders may be reduced and subsequent investors may
experience dilution.
•All of our executive officers and some 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, our dealer manager and other Pacific Oak-affiliated entities. As a
result, they face conflicts of interest, including significant conflicts created
by our advisor's compensation arrangements with us and other Pacific Oak-advised
programs and investors and conflicts in allocating time among us and these other
programs and investors. These conflicts could result in unanticipated actions.
Fees paid to our advisor in connection with transactions involving the
origination, acquisition and management of our investments are based on the cost
of the investment, not on the quality of the investment or services rendered to
us. This arrangement could influence our advisor to recommend riskier
transactions to us.
•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 our stockholders' risk of loss.
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) •We cannot predict with any certainty how much, if any, of our dividend reinvestment plan proceeds will be available for general corporate purposes, including, but not limited to, the redemption of shares under our share redemption program, future funding obligations under any real estate loans receivable we acquire, the funding of capital expenditures on our real estate investments or the repayment of debt. If such funds are not available from the dividend reinvestment plan offering, then we may have to use a greater proportion of our cash flow from operations to meet these cash requirements, which would reduce cash available for distributions and could limit our ability to redeem shares under our share redemption program. •We have focused, and may continue to focus, our investments in non-performing real estate and real estate-related loans, real estate-related loans secured by non-stabilized assets and real estate-related securities, which involve more risk than investments in performing real estate and real estate-related assets. 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 endedDecember 31, 2021 , as filed with theSecurities and Exchange Commission (the "SEC").
Overview
We were formed onOctober 8, 2008 as aMaryland corporation, elected to be taxed as a real estate investment trust ("REIT") beginning with the taxable year endedDecember 31, 2010 and intend to operate in such manner.Pacific Oak Capital Advisors, LLC ("Pacific Oak Capital Advisors ") is our advisor and as our advisor,Pacific Oak Capital Advisors manages our day-to-day operations and our portfolio of investments.Pacific Oak Capital Advisors also has the authority to make all of the decisions regarding our investments, subject to the limitations in our charter and the direction and oversight of our board of directors.Pacific Oak Capital Advisors also provides asset-management, marketing, investor-relations and other administrative services on our behalf. We have sought to invest in and manage a diverse portfolio of real estate-related loans, opportunistic real estate, real estate-related debt securities and other real estate-related investments. We conduct our business primarily through our operating partnership, of which we are the sole general partner. As ofSeptember 30, 2022 , we consolidated eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, two apartment properties, one hotel property, one residential home portfolio consisting of 2,458 residential homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned three investments in unconsolidated entities and three investments in real estate equity securities.
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 theU.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 on our variable rate debt to the extent the interest rates on such debt are not limited by interest rate caps. 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 exposure.
Liquidity and Capital Resources
Our principal demand for funds during the short and long-term is and will be for the acquisition of real estate and real estate-related investments, payment of operating expenses, capital expenditures and general and administrative expenses, payments under debt obligations, redemptions and purchases of our common stock and payments of distributions to stockholders. To date, we have had six primary sources of capital for meeting our cash requirements:
•Proceeds from the primary portion of our initial public offering;
•Proceeds from our dividend reinvestment plan;
•Proceeds from our public bond offering in
•Debt financing;
•Proceeds from the sale of real estate and the repayment of real estate-related investments; and
•Cash flow generated by our real estate and real estate-related investments.
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) We sold 56,584,976 shares of common stock in the primary portion of our initial public offering for gross offering proceeds of$561.7 million . We ceased offering shares in the primary portion of our initial public offering onNovember 14, 2012 . We continue to offer shares of common stock under the dividend reinvestment plan. As ofSeptember 30, 2022 , we had sold 6,851,969 shares of common stock under the dividend reinvestment plan for gross offering proceeds of$76.5 million . To date, we have invested all of the net proceeds from our initial public offering in real estate and real estate-related investments. We intend to use our cash on hand, proceeds from asset sales, proceeds from debt financing, cash flow generated by our real estate operations and real estate-related investments and proceeds from our dividend reinvestment plan as our primary sources of immediate and long-term liquidity. Our investments in real estate generate cash flow in the form of rental revenues and tenant reimbursements, which are reduced by operating expenditures and corporate general and administrative expenses. Cash flow from operations from our real estate investments is primarily dependent upon the occupancy levels of our properties, the net effective rental rates on our leases, the collectability of rent and operating recoveries from our tenants and how well we manage our expenditures. As ofSeptember 30, 2022 , our office properties were collectively 70% occupied, our residential home portfolio was 96% occupied and our apartment properties were 95% occupied. Our investments in hotel properties generate cash flow in the form of room, food, beverage and convention services, campground and other revenues, which are reduced by hotel expenses, capital expenditures, debt service payments, the payment of asset management fees and corporate general and administrative expenses. Cash flow from operations from our hotel properties are primarily dependent upon the occupancy levels of our hotels, the average daily rates and how well we manage our expenditures. The following table provides summary information regarding our hotel properties for the nine months endedSeptember 30, 2022 and 2021: Average Daily Rate for the
Nine Months Average Revenue per
Percentage Occupied for the Nine Months Ended September 30 , Ended September 30 , Months Ended September 30 ,
Property Number of Rooms 2022 2021 2022 2021 2022 2021
Springmaid Beach Resort (1) 453 61.4% 58.4% $226.60 $218.28 $139.05 $127.49
Q&C Hotel 196 59.3% 42.3% $192.73 $121.24 $114.30 $51.24
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(1)
Investments in real estate equity securities generate cash flow in the form of dividend income, which is reduced by asset management fees. As ofSeptember 30, 2022 , we had three investments in real estate equity securities outstanding with a total carrying value of$63.8 million . Under our charter, we are required to limit our total operating expenses to the greater of 2% of our average invested assets or 25% of our net income for the four most recently completed fiscal quarters, as these terms are defined in our charter, unless the conflicts committee has determined that such excess expenses were justified based on unusual and non-recurring factors. Operating expenses for the four fiscal quarters endedSeptember 30, 2022 did not exceed the charter-imposed limitation. For the nine months endedSeptember 30, 2022 , our cash needs for capital expenditures, redemptions of common stock and debt servicing were met with proceeds from dispositions of real estate, proceeds from debt financing and cash on hand. Operating cash needs during the same period were met through cash flow generated by our real estate and real estate-related investments and cash on hand. As ofSeptember 30, 2022 , we had outstanding debt obligations in the aggregate principal amount of$1.1 billion , with a weighted-average remaining term of 2.3 years. As ofSeptember 30, 2022 , we had a total of$386.9 million of debt obligations scheduled to mature within 12 months of that date. We plan to exercise our extension options available under our loan agreements or pay down or refinance the related notes payable prior to their maturity dates. We have elected to be taxed as a REIT and intend to operate as a REIT. To maintain our qualification as a REIT, we are required to make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain). Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. We have not established a minimum distribution level. 29
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Cash Flows from Operating Activities As ofSeptember 30, 2022 , we consolidated eight office properties, one office portfolio consisting of two office buildings and 14 acres of undeveloped land, two apartment properties, one hotel properties, one residential home portfolio consisting of 2,458 residential homes, three investments in undeveloped land with approximately 800 developable acres, one office/retail development property and owned three investments in unconsolidated entities and three investments in real estate equity securities. During the nine months endedSeptember 30, 2022 , net cash provided by operating activities was$8.7 million . We expect that our cash flows from operating activities will increase in future periods as a result of leasing additional space that is currently unoccupied and anticipated future acquisitions of real estate and real estate-related investments. However, our cash flows from operating activities may decrease to the extent that we dispose of additional assets.
Cash Flows from Investing Activities
Net cash provided by investing activities was
•Proceeds from sales of real estate, net of
•Contributions to unconsolidated entities of
•Earnest money received of
•Improvements to real estate of
•Proceeds from advances due from affiliates of
•Acquisitions of real estate of
•Funding of
Cash Flows from Financing Activities
Net cash used in financing activities was
•$11.0 million of cash distributions paid;
•$10.7 million of distributions paid to noncontrolling interests;
•$4.6 million of cash used for redemptions of common stock; and
•$3.5 million of net cash used for principal payments on notes payable of$190.5 million and payments of deferred financing costs of$4.7 million and partially offset by proceeds from notes payable of$191.7 million . In order to execute our investment strategy, we utilize secured debt and we may, to the extent available, utilize unsecured 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 refinancing and interest risks, are properly balanced with the benefit of using leverage. There is no limitation on the amount we may borrow for any single investment. Our charter limits our total liabilities such that our total liabilities may not exceed 75% of the cost of our tangible assets; however, we may exceed that limit if a majority of the conflicts committee approves each borrowing in excess of our charter limitation and we disclose such borrowing to our common stockholders in our next quarterly report with an explanation from the conflicts committee of the justification for the excess borrowing. As ofSeptember 30, 2022 , our borrowings and other liabilities were both approximately 70% of the cost (before depreciation and other noncash reserves) and the book value (before depreciation) of our tangible assets. 30
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) OnFebruary 16, 2020 , Pacific Oak Strategic Opportunity BVI issued 254.1 million Israeli new Shekels (approximately$74.1 million as ofFebruary 16, 2020 ) of the Series B Debentures to Israeli investors pursuant to a public offering registered with theIsrael Securities Authority . The Series B Debentures will bear interest at the rate of 3.93% per year. The Series B Debentures have principal installment payments equal to 33.33% of the face amount of the Series B Debentures onJanuary 31st of each year from 2024 to 2026. OnNovember 1, 2021 , Pacific Oak Strategic Opportunity BVI issued additional Series B Debentures in the amount of 536.4 million Israeli new Shekels par value through a public offering. The public offering Series B Debentures were issued at a 2.6% discount resulting in a total consideration of 522.4 million Israeli new Shekels ($166.8 million as ofNovember 1, 2021 ). OnNovember 8, 2021 , Pacific Oak Strategic Opportunity BVI also issued Series B Debentures in the amount of 53.6 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 3.1% discount resulting in a total consideration of 52.0 million Israeli new Shekels ($16.7 million as ofNovember 8, 2021 ). Additionally, onMay 2, 2022 , Pacific Oak Strategic Opportunity BVI also issued Series B Debentures in the amount of 320.4 million Israeli new Shekels par value through a private offering. The private offering Series B Debentures were issued at a 4.0% discount resulting in a total consideration of 307.6 million Israeli new Shekels ($95.3 million as ofMay 2, 2022 ). All additional Series B Debentures have an equal level of security, pari passu, amongst themselves and between them and the initial Series B Debentures, which were initially issued, without any right of precedence or preference between any of them. In addition to making investments in accordance with our investment objectives, we use or have used our capital resources to make certain payments to our advisor and our dealer manager. During our offering stage, these payments included payments to our dealer manager for selling commissions and dealer manager fees related to sales in our primary offering and payments to our dealer manager and our advisor for reimbursement of certain organization and other offering expenses related both to the primary offering and the dividend reinvestment plan. During our acquisition and development stage, we expect to continue to make payments to our advisor in connection with the selection and origination or purchase of investments, the management of our assets and costs incurred by our advisor in providing services to us as well as for any dispositions of assets (including the discounted payoff of non-performing loans). Among the fees payable to our advisor is an asset management fee. With respect to investments in loans and any investments other than real property, the asset management fee is a monthly fee calculated, each month, as one-twelfth of 0.75% of the lesser of (i) the amount actually paid or allocated to acquire or fund the loan or other investment, inclusive of fees and expenses related thereto and the amount of any debt associated with or used to acquire or fund such investment and (ii) the outstanding principal amount of such loan or other investment, plus the fees and expenses related to the acquisition or funding of such investment, as of the time of calculation. With respect to investments in real property, the asset management fee is a monthly fee equal to one-twelfth of 0.75% of the sum of the amount paid or allocated to acquire the investment, plus the cost of any subsequent development, construction or improvements to the property, and inclusive of fees and expenses related thereto and the amount of any debt associated with or used to acquire such investment. In the case of investments made through joint ventures, the asset management fee will be determined based on our proportionate share of the underlying investment, inclusive of our proportionate share of any fees and expenses related thereto.
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