CCPT II 09.30.2012 10-Q

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
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 000-51963
_______________________________________________
COLE CREDIT PROPERTY TRUST II, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________
Maryland
  
20-1676382
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification Number)
 
 
 
2325 East Camelback Road, Suite 1100
Phoenix, Arizona, 85016
  
(602) 778-8700
(Address of principal executive offices; zip code)
  
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
______________________________________________________________________________
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).     Yes  x   No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
Non-accelerated filer
 
x (Do not check if smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x
As of November 9, 2012, there were 209,587,353 shares of common stock, par value $0.01, of Cole Credit Property Trust II, Inc. outstanding.
 
 

Table of Contents

COLE CREDIT PROPERTY TRUST II, INC.
INDEX
 
 
 
 
 
Item 1. Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II — OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2
Table of Contents

PART I
FINANCIAL INFORMATION
The accompanying condensed consolidated unaudited interim financial statements as of and for the three and nine months ended September 30, 2012 have been prepared by Cole Credit Property Trust II, Inc. (the “Company,” “we,” “us” or “our”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements, and should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The financial statements herein should also be read in conjunction with the notes to the financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this Quarterly Report on Form 10-Q. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the operating results expected for the full year. The information furnished in our accompanying condensed consolidated unaudited balance sheets and condensed consolidated unaudited statements of operations, comprehensive income, stockholders’ equity, and cash flows reflects all adjustments that are, in our opinion, necessary for a fair presentation of the aforementioned financial statements. Such adjustments are of a normal recurring nature.
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. We caution readers not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q. We make no representation or warranty (expressed or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q. Additionally, 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. The forward-looking statements should be read in light of the risk factors identified in the “Item 1A – Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.


3
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COLE CREDIT PROPERTY TRUST II, INC.
CONDENSED CONSOLIDATED UNAUDITED BALANCE SHEETS
(in thousands, except share and per share amounts)

 
 
September 30, 2012
 
December 31, 2011
ASSETS
 
 
 
 
Investment in real estate assets:
 
 
 
 
Land
 
$
863,088

 
$
863,257

Buildings and improvements, less accumulated depreciation of $283,708 and $238,688, respectively
 
1,923,064

 
1,959,922

Real estate assets under direct financing leases, less unearned income of $11,926 and $13,342, respectively
 
35,224

 
35,999

Acquired intangible lease assets, less accumulated amortization of $152,021 and $128,544, respectively
 
299,687

 
323,298

Total investment in real estate assets, net
 
3,121,063

 
3,182,476

Investment in mortgage notes receivable, net
 
74,314

 
76,745

Total investment in real estate and mortgage assets, net
 
3,195,377

 
3,259,221

Cash and cash equivalents
 
47,923

 
53,205

Restricted cash
 
7,786

 
11,811

Investment in unconsolidated joint venture
 
—

 
22,334

Rents and tenant receivables, less allowance for doubtful accounts of $169 and $547, respectively
 
62,511

 
57,403

Prepaid expenses and other assets
 
3,213

 
3,739

Deferred financing costs, less accumulated amortization of $19,201 and $17,751, respectively
 
21,009

 
22,609

Total assets
 
$
3,337,819

 
$
3,430,322

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Notes payable and line of credit
 
$
1,762,666

 
$
1,767,591

Accounts payable and accrued expenses
 
19,421

 
16,100

Due to affiliates
 
1,235

 
1,069

Acquired below market lease intangibles, less accumulated amortization of $50,982 and $42,880, respectively
 
122,359

 
130,680

Distributions payable
 
10,763

 
11,157

Deferred rental income, derivative and other liabilities
 
8,864

 
17,530

Total liabilities
 
1,925,308

 
1,944,127

Commitments and contingencies
 


 


Redeemable common stock
 
14,193

 
14,482

STOCKHOLDERS’ EQUITY:
 
 
 
 
Preferred stock, $0.01 par value; 10,000,000 shares authorized, none issued and outstanding
 
—

 
—

Common stock, $0.01 par value; 240,000,000 shares authorized, 210,115,674 and 210,151,692 shares issued and outstanding, respectively
 
2,101

 
2,101

Capital in excess of par value
 
1,883,185

 
1,882,971

Accumulated distributions in excess of earnings
 
(484,372
)
 
(409,801
)
Accumulated other comprehensive loss
 
(2,596
)
 
(3,558
)
Total stockholders’ equity
 
1,398,318

 
1,471,713

Total liabilities and stockholders’ equity
 
$
3,337,819

 
$
3,430,322

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

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COLE CREDIT PROPERTY TRUST II, INC.
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental and other property income
$
64,300

 
$
63,613

 
$
194,829

 
$
187,449

Tenant reimbursement income
3,882

 
3,568

 
11,665

 
12,261

Earned income from direct financing leases
472

 
486

 
1,416

 
1,457

Interest income on mortgage notes receivable
1,514

 
1,604

 
4,627

 
4,836

Interest income on marketable securities
—

 
—

 
—

 
2,459

Total revenue
70,168

 
69,271

 
212,537

 
208,462

Expenses:
 
 
 
 
 
 
 
General and administrative expenses
2,873

 
2,237

 
8,368

 
6,180

Property operating expenses
5,853

 
5,346

 
17,164

 
16,813

Property and asset management expenses
4,365

 
4,238

 
13,307

 
12,700

Acquisition related expenses
—

 
382

 
17

 
2,700

Depreciation
15,210

 
15,077

 
45,627

 
44,646

Amortization
6,975

 
6,989

 
21,285

 
21,463

Impairment of real estate assets
—

 
—

 
1,979

 
—

Total operating expenses
35,276

 
34,269

 
107,747

 
104,502

Operating income
34,892

 
35,002

 
104,790

 
103,960

Other income (expense):
 
 
 
 
 
 
 
Equity in income of unconsolidated joint ventures and other income
701

 
36

 
1,241

 
572

Gain on sale of marketable securities
—

 
—

 
—

 
15,587

Gain on sale of unconsolidated joint venture interests
—

 
5,111

 
—

 
5,111

Impairment of investment in unconsolidated joint venture
(1,156
)
 
—

 
(1,156
)
 
—

Interest expense
(27,233
)
 
(27,197
)
 
(81,113
)
 
(80,616
)
Total other expense
(27,688
)
 
(22,050
)
 
(81,028
)
 
(59,346
)
Net income
$
7,204

 
$
12,952

 
$
23,762

 
$
44,614

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
210,119,067

 
209,827,734

 
210,145,928

 
209,567,498

Diluted
210,120,163

 
209,827,734

 
210,147,025

 
206,567,498

Net income per common share:
 
 
 
 
 
 
 
Basic and diluted
$
0.03

 
$
0.06

 
$
0.11

 
$
0.21

Distributions declared per common share
$
0.16

 
$
0.16

 
$
0.47

 
$
0.47


The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

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COLE CREDIT PROPERTY TRUST II, INC.
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
7,204

 
$
12,952

 
$
23,762

 
$
44,614

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized loss on marketable securities
—

 
—

 
—

 
(1,713
)
Reclassification of previous unrealized gain on marketable securities into net income
—

 
—

 
—

 
(14,654
)
Unrealized (loss) gain on interest rate swaps
(39
)
 
(224
)
 
749

 
(921
)
Reclassification of previous unrealized loss on interest rate swaps into net income
213

 
—

 
213

 
—

Total other comprehensive income (loss)
174

 
(224
)
 
962

 
(17,288
)
Comprehensive income
$
7,378

 
$
12,728

 
$
24,724

 
$
27,326

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

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COLE CREDIT PROPERTY TRUST II, INC.
CONDENSED CONSOLIDATED UNAUDITED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
 
 
 
Common Stock
 
Capital in Excess
of Par Value
 
Accumulated
Distributions in Excess of
Earnings
 
Accumulated
Other Comprehensive
Loss
 
Total Stockholders’
Equity
 
 
Number of
Shares
 
Par Value
 
 
 
 
Balance, January 1, 2012
 
210,151,692

 
$
2,101

 
$
1,882,971

 
$
(409,801
)
 
$
(3,558
)
 
$
1,471,713

Issuance of common stock
 
4,616,840

 
46

 
43,121

 
—

 
—

 
43,167

Distributions to investors
 
—

 
—

 
—

 
(98,333
)
 
—

 
(98,333
)
Redemptions of common stock
 
(4,652,858
)
 
(46
)
 
(43,196
)
 
—

 
—

 
(43,242
)
Changes in redeemable common stock
 
—

 
—

 
289

 
—

 
—

 
289

Comprehensive income
 
—

 
—

 
—

 
23,762

 
962

 
24,724

Balance, September 30, 2012
 
210,115,674

 
$
2,101

 
$
1,883,185

 
$
(484,372
)
 
$
(2,596
)
 
$
1,398,318

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

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COLE CREDIT PROPERTY TRUST II, INC.
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(in thousands)
 
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
23,762

 
$
44,614

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
45,627

 
44,646

Amortization of intangible lease assets and below market lease intangibles, net
16,275

 
16,626

Amortization of deferred financing costs
5,310

 
5,106

Amortization of premiums on mortgage notes receivable
540

 
527

Accretion of discount on marketable securities
—

 
(846
)
Amortization of fair value adjustments of mortgage notes payable assumed
1,428

 
1,397

Bad debt expense
42

 
(73
)
Impairment of real estate assets and joint venture investment
3,135

 
—

Equity in income of unconsolidated joint ventures
(1,157
)
 
(407
)
Return on investment from unconsolidated joint ventures
1,157

 
452

Property condemnation gain
(55
)
 
(92
)
Gain on sale of marketable securities
—

 
(15,587
)
Gain on sale of unconsolidated joint venture interests
—

 
(5,111
)
Changes in assets and liabilities:
 
 
 
Rents and tenant receivables
(5,150
)
 
(7,422
)
Prepaid expenses and other assets
526

 
507

Accounts payable and accrued expenses
2,056

 
4,756

Due to affiliates, deferred rental income and other liabilities
(7,538
)
 
(1,629
)
Net cash provided by operating activities
85,958

 
87,464

Cash flows from investing activities:
 
 
 
Investment in real estate and related assets and other capital expenditures
(10,369
)
 
(109,175
)
Proceeds from sale of marketable securities
—

 
82,061

Proceeds from sale of unconsolidated joint venture interests
21,228

 
19,100

Principal repayments from mortgage notes receivable and real estate assets under direct financing leases
2,666

 
2,432

Return of investment from unconsolidated joint ventures
—

 
1,989

Refund of property escrow deposits
—

 
1,340

Payment of property escrow deposits
—

 
(1,340
)
Proceeds from easement of real estate assets
75

 
247

Change in restricted cash
4,025

 
(2,900
)
Net cash provided by (used in) investing activities
17,625

 
(6,246
)
Cash flows from financing activities:
 
 
 
Redemptions of common stock
(43,242
)
 
(38,381
)
Distributions to investors
(55,560
)
 
(53,342
)
Proceeds from notes payable, line of credit and repurchase agreement
253,300

 
203,796

Repayment of notes payable, line of credit and repurchase agreement
(259,653
)
 
(182,331
)
Payment of loan deposits
(1,015
)
 
—

Refund of loan deposits
1,015

 
—

Deferred financing costs paid
(3,710
)
 
(2,167
)
Net cash used in financing activities
(108,865
)
 
(72,425
)
Net (decrease) increase in cash and cash equivalents
(5,282
)
 
8,793

Cash and cash equivalents, beginning of period
53,205

 
45,791

Cash and cash equivalents, end of period
$
47,923

 
$
54,584

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
September 30, 2012
NOTE 1 —
ORGANIZATION AND BUSINESS
Cole Credit Property Trust II, Inc. (the “Company”) is a Maryland corporation formed on September 29, 2004, that has elected to be taxed, and currently qualifies, as a real estate investment trust (“REIT”) for federal income tax purposes. Substantially all of the Company’s business is conducted through Cole Operating Partnership II, LP (“Cole OP II”), a Delaware limited partnership. The Company is the sole general partner of and owns a 99.99% partnership interest in Cole OP II. Cole REIT Advisors II, LLC (“Cole Advisors II”), the advisor to the Company, is the sole limited partner and owner of an insignificant noncontrolling partnership interest of less than 0.01% of Cole OP II.
As of September 30, 2012, the Company owned 753 properties comprising 21.2 million rentable square feet of single and multi-tenant retail and commercial space located in 45 states and the U.S. Virgin Islands. As of September 30, 2012, the rentable space at these properties was 96% leased. As of September 30, 2012, the Company also owned 69 mortgage notes receivable secured by 43 restaurant properties and 26 single-tenant retail properties, each of which is subject to a net lease.
The Company ceased offering shares of common stock in its initial primary offering (the “Initial Offering”) on May 22, 2007, and ceased offering shares of common stock in its follow-on offering (the “Follow-on Offering”) on January 2, 2009. The Company continues to issue shares of common stock under its distribution reinvestment plan (the “DRIP Offering”, and collectively with the Initial Offering and the Follow-on Offering, the “Offerings”). As of September 30, 2012, the Company had issued approximately 229.7 million shares of common stock in its Offerings for aggregate gross proceeds of $2.3 billion (including proceeds from the issuance of shares pursuant to the DRIP Offering of $247.4 million), before share redemptions of $178.0 million. As of September 30, 2012, the Company had incurred an aggregate of $188.3 million in offering costs, selling commissions, and dealer manager fees in the Offerings.
The Company’s stock is not currently listed on a national securities exchange. The Company may seek to list its common stock for trading on a national securities exchange only if a majority of its independent directors believes listing would be in the best interest of its stockholders. The Company disclosed in its prospectus a targeted liquidity event by May 22, 2017 and in the event it does not obtain listing prior to such date, its charter requires that it either (1) seek stockholder approval of an extension or elimination of this listing deadline; or (2) seek stockholder approval to adopt a plan of liquidation. If neither proposal is approved, the Company may continue to operate as before. The Company is actively exploring options to successfully exit its portfolio. The potential exit strategies the Company is evaluating include, but are not limited to, a sale of the Company or all or a portion of its portfolio, a merger or other business combination, or a listing of the Company’s stock on a national securities exchange. However, the Company has not yet finalized a plan for, or had, a liquidity event.
NOTE 2 —
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The condensed consolidated unaudited financial statements of the Company have been prepared in accordance with the rules and regulations of the SEC, including the instructions to Form 10-Q and Article 10 of Regulation S-X, and do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the statements for the interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair presentation of the results for such periods. Results for these interim periods are not necessarily indicative of full year results. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2011, and related notes thereto set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
The condensed consolidated unaudited financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

The Company evaluates its relationships and investments to determine if it has variable interests. A variable interest is an investment or other interest that will absorb portions of an entity’s expected losses or receive portions of the entity’s expected residual returns. If the Company determines that it has a variable interest in an entity, it evaluates whether such interest is in a variable interest entity (“VIE”). A VIE is broadly defined as an entity where either (1) the equity investors as a group, if any, lack the power through voting or similar rights to direct the activities of an entity that most significantly impact the entity’s economic performance or (2) the equity investment at risk is insufficient to finance that entity’s activities without additional subordinated financial support. The Company consolidates any VIEs when it is determined to be the primary beneficiary of the VIE’s operations.
A variable interest holder is considered to be the primary beneficiary of a VIE if it has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and has the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to the VIE. The Company qualitatively assesses whether it is (or is not) the primary beneficiary of a VIE. Consideration of various factors include, but are not limited to, the Company’s ability to direct the activities that most significantly impact the entity’s economic performance, its form of ownership interest, its representation on the entity’s governing body, the size and seniority of its investment, its ability and the rights of other investors to participate in policy making decisions and to replace the manager of and/or liquidate the entity.
The Company continually evaluates the need to consolidate joint ventures, if any, based on standards set forth in GAAP. In determining whether the Company has a controlling interest in a joint venture and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, power to make decisions and contractual and substantive participating rights of the partners/members as well as whether the entity is a VIE for which the Company is the primary beneficiary. The Company has no relationship, investment or other interests in entities that are or were required to be consolidated because the Company has no variable interests in an entity that qualifies as a VIE.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Valuation of Real Estate and Related Assets
The Company continually monitors events and changes in circumstances that could indicate that the carrying amounts of its real estate and related assets may not be recoverable. Impairment indicators that the Company considers include, but are not limited to, bankruptcy or other credit concerns of a property’s major tenant, such as a history of late payments, rental concessions, and other factors, a significant decrease in a property’s revenues due to lease terminations, vacancies, co-tenancy clauses, reduced lease rates or other circumstances. When indicators of potential impairment are present, the Company assesses the recoverability of the assets by determining whether the carrying amount of the assets will be recovered through the undiscounted future cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying amount, the Company will adjust the real estate and related assets to their respective fair values and recognize an impairment loss. Generally, fair value is determined using a discounted cash flow analysis and recent comparable sales transactions.
The Company continually monitors certain properties for which it has identified impairment indicators. As of September 30, 2012, the Company had seven properties with an aggregate book value of $50.8 million for which it had assessed the recoverability of the carrying amounts. For each of these properties, the undiscounted future cash flows expected as a result of the use of the real estate and related assets and the eventual disposition of the assets continued to exceed their carrying amount as of September 30, 2012. Should the conditions related to any of these, or any of the Company’s other properties change, the underlying assumptions used to determine the expected undiscounted future cash flows may change and adversely affect the recoverability of the respective real estate and related assets’ carrying amounts. No impairment losses were recorded during the three months ended September 30, 2012. The Company identified one property during the nine months ended September 30, 2012 with impairment indicators for which the undiscounted future cash flows expected as a result of the use and eventual disposition of the real estate and related assets were less than the carrying amount of the property. As a result, the Company reduced the carrying amount of the real estate and related assets to their estimated fair value by recognizing an impairment loss of $2.0 million during the nine months ended September 30, 2012. No impairment indicators were identified and no impairment losses were recorded during the three and nine months ended September 30, 2011.

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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

When developing estimates of expected future cash flows, the Company makes certain assumptions regarding future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, terminal capitalization and discount rates, the expected number of months it takes to re-lease the property, required tenant improvements and the number of years the property will be held for investment. The use of alternative assumptions in estimating expected future cash flows could result in a different determination of the property’s expected future cash flows and a different conclusion regarding the existence of an impairment, the extent of such loss, if any, as well as the fair value of the real estate and related assets.
When a real estate asset is identified by the Company as held for sale, the Company ceases depreciation and amortization of the assets related to the property and estimates the fair value, net of selling costs. If, in management’s opinion, the fair value, net of selling costs, of the asset is less than the carrying amount of the asset, an adjustment to the carrying amount would be recorded to reflect the estimated fair value of the property, net of selling costs. There were no assets identified as held for sale as of September 30, 2012 or December 31, 2011.
Concentration of Credit Risk
As of September 30, 2012, the Company had cash on deposit, including restricted cash, in four financial institutions, all of which had deposits in excess of federally insured levels totaling $27.5 million; however, the Company has not experienced any losses in such accounts. The Company limits significant cash deposits to accounts held by financial institutions with high credit standing; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits.
Investment in Unconsolidated Joint Venture
The Company did not have an investment in any unconsolidated joint ventures as of September 30, 2012. The investment in unconsolidated joint venture as of December 31, 2011 consisted of the Company’s non-controlling majority interest in a joint venture that owned a 386,000 square foot multi-tenant property in Independence, Missouri (“Independence Commons”), which was sold on September 28, 2012. As of December 31, 2011, the aggregate carrying amount of assets held within the unconsolidated joint venture was $59.3 million and the face value of the non-recourse mortgage note payable was $34.1 million.
The Company accounted for the unconsolidated joint venture using the equity method of accounting as the Company had the ability to exercise significant influence, but not control, over operating and financial policies of the venture. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the joint venture’s earnings and distributions. The Company is required to determine whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of its investment in the joint venture. If an event or change in circumstance has occurred, the Company is required to evaluate the joint venture for potential impairment and determine if the carrying amount of its investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other than temporary. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying amount is fully recovered. The evaluation of an investment in a joint venture for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. On September 28, 2012, the Company sold 100% of its interest in Independence Commons to its joint venture partner for cash proceeds of $21.2 million. In connection with the transaction, the Company evaluated the terms of the purchase and sale agreement and respective sales price, and determined that its investment in Independence Commons was impaired because the carrying amount of its investment exceeded its fair value. As a result, the Company evaluated whether the impairment was other-than-temporary. Because the Company agreed to sell its interest, and it did not have the intent to hold the investment until the carrying amount was fully recovered, the Company determined that the impairment was other-than-temporary and recorded an impairment loss of $1.2 million. No impairment indicators were identified and no impairment losses were recorded related to the unconsolidated joint venture for the three and nine months ended September 30, 2011. The Company recognizes gains or losses on the sale of interests in joint ventures to the extent the economic substance of the transaction is a sale.
New Accounting Pronouncements
In June 2011, the U.S. Financial Accounting Standards Board issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income, which requires the presentation of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The Company elected to present two separate but consecutive statements herein.

11
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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

NOTE 3 —
FAIR VALUE MEASUREMENTS
GAAP defines fair value, establishes a framework for measuring fair value and requires disclosures about fair value measurements. GAAP emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e. interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).
Level 3 – Unobservable inputs, which are only used to the extent that observable inputs are not available, reflect the Company’s assumptions about the pricing of an asset or liability.
During the nine months ended September 30, 2012, real estate assets with a carrying amount of $3.8 million related to one property were deemed to be impaired and their carrying amounts were reduced to their estimated fair value of $1.8 million, resulting in an impairment charge of $2.0 million, which is included in impairment of real estate assets on the condensed consolidated unaudited statement of operations for the nine months ended September 30, 2012. In addition, during the nine months ended September 30, 2012, the Company’s investment in its unconsolidated joint venture was deemed to be impaired and its carrying amount was reduced to its estimated fair value of $21.2 million, resulting in an impairment charge of $1.2 million, which is included in impairment of joint venture investment on the condensed consolidated unaudited statement of operations for the three and nine months ended September 30, 2012.
A summary of real estate and other assets measured at fair value on a non-recurring basis during the nine months ended September 30, 2012 is as follows (in thousands):
 
 
Balance as of
September 30, 2012
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Losses
Description:
 
 
 
 
 
 
 
 
 
 
Investment in real estate assets
 
$
1,751

 
$
—

 
$
—

 
$
1,751

 
$
1,979

Investment in unconsolidated joint venture (1)
 
$
—

 
$
—

 
$
—

 
$
—

 
$
1,156

(1) The Company sold its interest in its unconsolidated joint venture on September 28, 2012, as discussed in Note 2 to these condensed consolidated unaudited financial statements.
During the year ended December 31, 2011, there were no real estate assets or joint venture investments measured at fair value on a non-recurring basis.
The Company’s estimated fair value of its real estate assets was primarily based upon a discounted cash flow analysis and an estimated sales price provided by a third party broker. The discounted cash flow analysis was comprised of unobservable inputs, including internally prepared probability-weighted cash flow estimates, which included estimated future market rental income, property operating expenses, the expected number of months to re-lease the property and estimated tenant improvements, which are all considered Level 3 inputs. In addition, the discounted cash flow analysis utilized observable discount rates and terminal capitalization rates, which were based on available information obtained from third-party service provider reports, which are considered Level 2 inputs. The Company’s estimated fair value of its joint venture investment was primarily based upon an indicative offer by the Company’s joint venture partner, which is considered to be a Level 1 input.

12
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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

The following describes the methods the Company uses to estimate the fair value of the Company’s financial assets and liabilities:
Cash and cash equivalents and restricted cash – The Company considers the carrying amounts of these financial assets to approximate fair value because of the short period of time between their origination and their expected realization.
Mortgage notes receivable – The fair value is estimated by discounting the expected cash flows on the notes at rates at which management believes similar loans would be made as of September 30, 2012 and December 31, 2011. The estimated fair value of these notes was $85.0 million and $85.3 million as September 30, 2012 and December 31, 2011, respectively, as compared to the carrying amount of $74.3 million and $76.7 million as of September 30, 2012 and December 31, 2011, respectively. The fair value of the Company’s mortgage notes receivable is estimated using Level 2 inputs.
Notes payable and line of credit – The fair value is estimated by discounting the expected cash flows based on estimated borrowing rates available to the Company as of September 30, 2012 and December 31, 2011. The estimated fair value of the notes payable and line of credit was $1.9 billion and $1.8 billion as of September 30, 2012 and December 31, 2011, respectively, as compared to the carrying amount of $1.8 billion, as of as both September 30, 2012 and December 31, 2011. The fair value of the Company’s notes payable and line of credit is estimated using Level 2 inputs.
Derivative Instruments – The Company’s derivative instruments represent interest rate swaps. All derivative instruments are carried at fair value and are valued using Level 2 inputs. The fair value of these instruments is determined using interest rate market pricing models. The Company includes the impact of credit valuation adjustments on derivative instruments measured at fair value.
Considerable judgment is necessary to develop estimated fair values of financial assets and liabilities. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize, or be liable for, on disposition of the financial assets and liabilities. As of September 30, 2012, there have been no transfers of financial assets or liabilities between levels.
In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011(in thousands):
 
Balance as of
September 30, 2012
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
2,596

 
$
—

 
$
2,596

 
$
—


 
 
Balance as of
December 31, 2011
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
3,558

 
$
—

 
$
3,558

 
$
—

The following table shows a reconciliation of the change in fair value of the Company’s financial assets and liabilities with significant unobservable inputs (Level 3) for the nine months ended September 30, 2012 and 2011 (in thousands):
 

13
Table of Contents
COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

 
Nine Months Ended
September 30,
 
2012
 
2011
Balance at beginning of period
$
—

 
$
81,995

Total gains or losses
 
 
 
Realized gain included in earnings
—

 
15,587

Reclassification of previous unrealized gain out of other comprehensive income
—

 
(14,654
)
Unrealized loss included in other comprehensive income
—

 
(1,713
)
Purchases, issuances, settlements, sales and accretion
 
 
 
Purchases
—

 
—

Issuances
—

 
—

Settlements
—

 
(82,061
)
Accretion of discount included in earnings
—

 
846

Balance at end of period
$
—

 
$
—

NOTE 4 —
INVESTMENT IN DIRECT FINANCING LEASES
The components of investment in direct financing leases as of September 30, 2012 and December 31, 2011 were as follows (in thousands): 
 
 
September 30, 2012
 
December 31, 2011
Minimum lease payments receivable
 
$
19,296

 
$
21,487

Estimated residual value of leased assets
 
27,854

 
27,854

Unearned income
 
(11,926
)
 
(13,342
)
Total
 
$
35,224

 
$
35,999

NOTE 5 —
REAL ESTATE TRANSACTIONS
2012 Property Acquisitions
The Company made no property acquisitions during the nine months ended September 30, 2012.
2011 Property Acquisitions
During the nine months ended September 30, 2011, the Company acquired a 100% interest in 26 commercial properties for an aggregate purchase price of $90.1 million (the “2011 Acquisitions”). The Company purchased the 2011 Acquisitions with a combination of proceeds from the DRIP Offering, cash flows from operations and net proceeds from borrowings. The Company allocated the purchase price of the 2011 Acquisitions to the fair value of the assets acquired and liabilities assumed. The following table summarizes the purchase price allocation (in thousands):
 
 
September 30, 2011
Land
$
27,272

Building and improvements
50,203

Acquired in-place leases
13,043

Acquired above-market leases
805

Acquired below-market leases
(1,232
)
Total purchase price
$
90,091

The Company recorded revenue for the three and nine months ended September 30, 2011 of $2.1 million and $3.5 million, respectively, and a net loss for the three and nine months ended September 30, 2011 of $1.0 million and $203,000, respectively, related to the 2011 Acquisitions. In addition, the Company recorded $382,000 and $2.7 million of acquisition related expenses for the three and nine months ended September 30, 2011, respectively.


14
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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

2011 Other Investment in Real Estate
During the nine months ended September 30, 2011, the Company paid a tenant improvement allowance of $12.0 million for an expansion and improvements to an existing property, including the conversion of an existing warehouse into office space and the construction of a parking area, for which the Company will receive additional rents. Such costs were capitalized to buildings and improvements and will be depreciated over their estimated useful life.
2012 Disposition
On September 28, 2012, the Company sold 100% of its interest in an unconsolidated joint venture that owned a 386,000 square foot multi-tenant retail building, Independence Commons, for cash proceeds of $21.2 million, as discussed in Note 2 to these condensed consolidated unaudited financial statements.
2011 Disposition
On September 30, 2011, the Company sold 100% of its interest in an unconsolidated joint venture that owned and operated ten self-storage properties located in Arizona for cash proceeds of $19.1 million. The Company recorded a gain on the sale of $5.1 million for the three and nine months ended September 30, 2011.
NOTE 6 —
INVESTMENT IN MORTGAGE NOTES RECEIVABLE
As of September 30, 2012, the Company owned 69 mortgage notes receivable, which were secured by 43 restaurant properties and 26 single-tenant retail properties (each, a “Mortgage Note”, and collectively, the “Mortgage Notes”). As of September 30, 2012, the Mortgage Notes balance of $74.3 million consisted of the face amount of the Mortgage Notes of $68.7 million, a $6.9 million premium, $2.0 million of acquisition costs, and was net of accumulated amortization of premium and acquisition costs of $3.3 million. As of December 31, 2011, the Mortgage Notes balance of $76.7 million consisted of the face amount of the Mortgage Notes of $70.6 million, a $6.9 million premium, $2.0 million of acquisition costs, and was net of accumulated amortization of premium and acquisition costs of $2.8 million. The premium and acquisition costs are amortized into interest income over the term of each Mortgage Note using the effective interest rate method. The Mortgage Notes mature on various dates from August 1, 2020 to January 1, 2021. Interest and principal are due each month at interest rates ranging from 8.60% to 10.47% per annum with a weighted average interest rate of 9.89%. There were no amounts past due as of September 30, 2012.
The Company evaluates the collectability of both interest and principal on each Mortgage Note to determine whether it is collectible, primarily through the evaluation of credit quality indicators, such as underlying collateral and payment history. No impairment losses were recorded related to the Mortgage Notes for the nine months ended September 30, 2012 or 2011. In addition, no allowances for uncollectability were recorded related to the Mortgage Notes as of September 30, 2012 or December 31, 2011.
NOTE 7 —
MARKETABLE SECURITIES
During the nine months ended September 30, 2011, the Company sold all six of its investments in commercial mortgage backed securities (“CMBS”) for $82.1 million, and realized a gain on the sale of $15.6 million. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. The Company had no investments in CMBS as of and during the nine months ended September 30, 2012.
NOTE 8 —
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, the Company uses certain types of derivative instruments for the purpose of managing or hedging its interest rate risks. The following table summarizes the notional amount and fair value of the Company’s derivative instruments (in thousands):
  

15
Table of Contents
COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

 
 
 
 
 
 
 
 
 
 
 
 
Fair Value of Liability
Derivatives designated
 
Balance Sheet
 
Notional
 
Interest
 
Effective
 
Maturity
 
September 30, 2012
 
December 31, 2011
as hedging instruments        
 
Location
 
Amount
 
Rate
 
Date
 
Date
 
 
Interest Rate Swap (1)
 
Deferred rental income, derivative and other liabilities
 
$
31,781

 
6.2%
 
11/04/2008
 
10/31/2012
 
$
—

 
$
(869
)
Interest Rate Swap
 
Deferred rental income, derivative and other liabilities
 
14,847

 
6.2%
 
06/12/2009
 
06/11/2012
 
—

 
(172
)
Interest Rate Swap
 
Deferred rental income, derivative and other liabilities
 
7,003

 
5.8%
 
02/20/2009
 
03/01/2016
 
(516
)
 
(497
)
Interest Rate Swap (1)
 
Deferred rental income, derivative and other liabilities
 
30,000

 
6.0%
 
11/24/2009
 
10/16/2012
 
—

 
(310
)
Interest Rate Swap
 
Deferred rental income, derivative and other liabilities
 
111,111

 
4.9%
 
02/28/2011
 
11/30/2013
 
(1,424
)
 
(1,558
)
Interest Rate Swap
 
Deferred rental income, derivative and other liabilities
 
38,250

 
3.5%
 
09/26/2011
 
09/26/2014
 
(378
)
 
(152
)
Interest Rate Swap
 
Deferred rental income, derivative and other liabilities
 
32,400

 
3.2%
 
09/05/2012
 
09/05/2015
 
(278
)
 
—

 
 
 
 
$
265,392

 
 
 
 
 
 
 
$
(2,596
)
 
$
(3,558
)
(1)
The associated loan was paid on September 28, 2012, resulting in termination of the interest rate swap.
Additional disclosures related to the fair value of the Company’s derivative instruments are included in Note 3 to these condensed consolidated unaudited financial statements. The notional amount under the agreements is an indication of the extent of the Company’s involvement in each instrument, but does not represent exposure to credit, interest rate or market risks.
Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swaps as cash flow hedges, to hedge the variability of the anticipated cash flows on its variable rate notes payable. The change in fair value of the effective portion of the derivative instruments that are designated as hedges is recorded in other comprehensive income or loss. The ineffective portion of the change in fair value of the derivative instruments is recorded in interest expense.
The following table summarizes the gains and losses on the Company’s derivative instruments and hedging activities (in thousands):
 
  
 
Amount of Gain (Loss) Recognized in Other
Comprehensive Income
 
Amount of Loss Reclassified from Accumulated Other Comprehensive Income to Interest Expense (1)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
Derivatives in Cash Flow Hedging Relationships
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Interest Rate Swaps
 
$
(39
)
 
$
(224
)
 
$
749

 
$
(921
)
 
$
213

 
$
—

 
$
213

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
On September 28, 2012, the Company repaid $61.8 million of variable rate debt prior to its maturity, which was subject to interest rate swap agreements. As a result, the interest rate swap agreements were terminated and the Company reclassified $213,000 of unrealized losses previously recorded in accumulated other comprehensive income into interest expense. The remaining interest rate swaps were considered effective during the nine months ended September 30, 2012. In addition, there were no portions of the change in the fair value of the interest rate swap agreements that were considered ineffective during the nine months ended September 30, 2011.


16
Table of Contents
COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

The Company has agreements with each of its derivative counterparties that contain a provision whereby, if the Company defaults on certain of its unsecured indebtedness, then the Company could also be declared in default on its derivative obligations resulting in an acceleration of payment. In addition, the Company is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company believes it mitigates its credit risk by entering into agreements with credit-worthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. There were no events of default related to the remaining interest rate swaps as of September 30, 2012 and 2011 .
NOTE 9 —
NOTES PAYABLE, LINE OF CREDIT AND REPURCHASE AGREEMENT
As of September 30, 2012, the Company had $1.8 billion of debt outstanding, consisting of (1) $1.5 billion in fixed rate mortgage loans (the “Fixed Rate Debt”), (2) $4.3 million in variable rate mortgage loans (the “Variable Rate Debt”) and (3) $306.1 million outstanding under a senior unsecured line of credit entered into on December 17, 2010 (the “Credit Facility”). The aggregate balance of gross real estate assets, net of gross intangible lease liabilities, securing the Fixed Rate Debt and the Variable Rate Debt, was $2.7 billion as of September 30, 2012. Additionally, the aggregate balance of gross real estate assets that are part of the Credit Facility’s unencumbered borrowing base was $635.8 million. The combined weighted average interest rate was 5.42% and the weighted average years to maturity was 4.0 years as of September 30, 2012.
The Credit Facility and certain notes payable contain customary affirmative, negative and financial covenants, including requirements for minimum net worth and debt service coverage ratios, in addition to limits on the Company’s overall leverage ratios and Variable Rate Debt. These agreements also include usual and customary events of default and remedies for facilities of this nature. Based on the Company’s analysis and review of its results of operations and financial condition, the Company believes it was in compliance with the covenants of the Credit Facility and such notes payable as of September 30, 2012.
Notes Payable
The Fixed Rate Debt has annual interest rates ranging from 3.15% to 7.22%, with a weighted average annual interest rate of 5.69%, and various maturity dates ranging from September, 2014 through August, 2031. The Variable Rate Debt has an annual interest rate of LIBOR plus 275 basis points, and matures in September, 2014. The notes payable are secured by properties in the portfolio and their related tenant leases, as well as other real estate-related assets on which the debt was placed. During the nine months ended September 30, 2012, the Company issued $81.9 million of fixed rate debt, with annual interest rates ranging from 3.90% to 4.67% and maturity dates ranging from July, 2019 to September, 2022. In addition, the Company issued $32.4 million of variable rate debt, which has been effectively fixed at an interest rate of 3.15% pursuant to a swap agreement. Refer to Note 8 to these condensed consolidated unaudited financial statements for further details of the new interest rate swap agreement. During the nine months ended September 30, 2012, the Company repaid $133.7 million of fixed rate debt, including monthly principal payments on amortizing loans.
Line of Credit
The Credit Facility provides for up to $350.0 million of unsecured borrowings and allows the Company to borrow up to $238.9 million in revolving loans (the “Revolving Loans”) and $111.1 million in a term loan (the “Term Loan”). The Credit Facility matures on December 17, 2013.
During the nine months ended September 30, 2012, the Company borrowed $139.0 million and repaid $126.0 million under the Credit Facility. As of September 30, 2012, the Company had $111.1 million outstanding under the Term Loan and an additional $195.0 million in Revolving Loans outstanding. Additionally, the Company has established a letter of credit in the amount of $476,000 from the Credit Facility lenders to support an escrow agreement relating to a certain property with that property’s lender. This letter of credit reduces the amount of borrowings available under the Credit Facility. The Company executed an interest rate swap agreement on February 24, 2011, which fixed LIBOR for amounts outstanding under the Term Loan to 1.44%. The all-in rate for the Term Loan includes a spread of 275 to 400 basis points, as determined by the leverage ratio of the Company, which was equal to a spread of 350 basis points as of September 30, 2012. Revolving Loans outstanding as of September 30, 2012 bore interest at a weighted average interest rate of 3.72%.
Repurchase Agreement
Prior to the sale of the Company’s investment in CMBS, the CMBS were pledged as collateral to a bank under a repurchase agreement (the “Repurchase Agreement”), which provided secured borrowings. As of September 30, 2012, there were no amounts outstanding or available under the Repurchase Agreement. During the nine months ended September 30, 2011, the Company borrowed $10.7 million under the Repurchase Agreement and repaid the total amount outstanding of $65.0 million in connection with the sale of all the Company’s investments in CMBS.

17
Table of Contents
COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

NOTE 10 —
SUPPLEMENTAL CASH FLOW DISCLOSURES
Supplemental cash flow disclosures for the nine months ended September 30, 2012 and 2011 are as follows (in thousands):
  
 
 
Nine Months Ended
September 30,
 
 
2012
 
2011
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
 
 
 
 
Distributions declared and unpaid
 
$
10,763

 
$
10,782

Common stock issued through the DRIP Offering
 
$
43,167

 
$
44,939

Net unrealized loss on marketable securities
 
$
—

 
$
(1,713
)
Reclassification of unrealized gain on marketable securities into net income
 
$
—

 
$
14,654

Net unrealized gain (loss) on interest rate swaps
 
$
749

 
$
(921
)
Accrued capital expenditures
 
$
1,215

 
$
598

Accrued deferred financing costs
 
$
—


$
545

Accrued real estate commission
 
$
—

 
$
382

Supplemental Cash Flow Disclosures:
 
 
 
 
Interest paid
 
$
74,660

 
$
73,932

NOTE 11 —
COMMITMENTS AND CONTINGENCIES
Litigation
In the ordinary course of business, the Company may become subject to litigation or claims. The Company is not aware of any pending legal proceedings of which the outcome is reasonably possible to have a material effect on its results of operations, financial condition or liquidity.
Environmental Matters
In connection with the ownership and operation of real estate, the Company potentially may be liable for costs and damages related to environmental matters. The Company owns certain properties that are subject to environmental remediation. In each case, the seller of the property, the tenant of the property and/or another third party has been identified as the responsible party for environmental remediation costs related to the respective property. Additionally, in connection with the purchase of certain of the properties, the respective sellers and/or tenants have indemnified the Company against future remediation costs. In addition, the Company carries environmental liability insurance on its properties that provides limited coverage for remediation liability and pollution liability for third-party bodily injury and property damage claims. Accordingly, the Company does not believe that it is reasonably possible that the environmental matters identified at such properties will have a material effect on its results of operations, financial condition or liquidity, nor is it aware of any environmental matters at other properties which it believes are reasonably possible to have a material effect on its results of operations, financial condition or liquidity.

18
Table of Contents
COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

NOTE 12 —
RELATED-PARTY TRANSACTIONS AND ARRANGEMENTS
The Company has incurred commissions, fees and expenses payable to Cole Advisors II and its affiliates in connection with the Offerings, and has incurred and will continue to incur commissions, fees and expenses in connection with the acquisition, management and sale of the assets of the Company.
DRIP Offering
During the three and nine months ended September 30, 2012 and 2011, the Company did not pay any amounts to Cole Advisors II for selling commissions, dealer manager fees, or other organization and offering expense reimbursements incurred in connection with the DRIP Offering.
Acquisitions and Operations
Cole Advisors II or its affiliates receive acquisition and advisory fees of up to 2.0% of the contract purchase price of each asset for the acquisition, development or construction of properties, and are reimbursed for acquisition expenses incurred in the process of acquiring properties, so long as the total acquisition fees and expenses relating to the transaction do not exceed 4.0% of the contract purchase price.
The Company paid, and expects to continue to pay, Cole Advisors II an annualized asset management fee of 0.25% of the aggregate asset value of the Company’s aggregate invested assets, as reasonably estimated by the Company’s board of directors. The Company also reimburses certain costs and expenses incurred by Cole Advisors II in providing asset management services.
The Company paid, and expects to continue to pay, Cole Realty Advisors, Inc. (“Cole Realty Advisors”), its property manager and an affiliate of its advisor, up to (1) 2.0% of gross revenues received from the Company’s single tenant properties and (2) 4.0% of gross revenues received from the Company’s multi-tenant properties, plus leasing commissions at prevailing market rates; provided however, that the aggregate of all property management and leasing fees paid to affiliates plus all payments to third parties do not exceed the amount that other nonaffiliated management and leasing companies generally charge for similar services in the same geographic location. Cole Realty Advisors may subcontract certain of its duties for a fee that may be less than the fee provided for in the property management agreement. The Company also reimburses Cole Realty Advisors’ costs of managing and leasing the properties.
The Company will reimburse Cole Advisors II for all expenses it paid or incurred in connection with the services provided to the Company, subject to the limitation that the Company will not reimburse Cole Advisors II for any amount by which its operating expenses (including the asset management fee) at the end of the four preceding fiscal quarters exceeds the greater of (1) 2% of average invested assets, or (2) 25% of net income other than any additions to reserves for depreciation, bad debts or other similar non-cash reserves and excluding any gain from the sale of assets for that period, unless the Company’s independent directors find that a higher level of expense is justified for that year based on unusual and non-recurring factors. The Company will not reimburse Cole Advisors II for personnel costs in connection with services for which Cole Advisors II receives acquisition fees and real estate commissions.
If Cole Advisors II provides services in connection with the origination or refinancing of any debt financing obtained by the Company that is used to acquire properties or to make other permitted investments, or that is assumed, directly or indirectly, in connection with the acquisition of properties, the Company will pay Cole Advisors II or its affiliates a financing coordination fee equal to 1.0% of the amount available under such financing; provided however, that Cole Advisors II or its affiliates shall not be entitled to a financing coordination fee in connection with the refinancing of any loan secured by any particular property that was previously subject to a refinancing in which Cole Advisors II or its affiliates received such a fee. Financing coordination fees payable from loan proceeds from permanent financing are paid to Cole Advisors II or its affiliates as the Company acquires and/or assumes such permanent financing.

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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

The Company recorded fees and expense reimbursements as shown in the table below for services provided by Cole Advisors II and its affiliates related to the services described above during the periods indicated (in thousands):

 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2012
 
2011
 
2012
 
2011
Acquisitions and Operations:
 
 
 
 
 
 
 
 
Acquisition and advisory fees and expenses
 
$
—

 
$
280

 
$
12

 
$
2,103

Asset management fees and expenses
 
$
2,322

 
$
2,285

 
$
6,920

 
$
6,584

Property management and leasing fees and expenses
 
$
1,967

 
$
1,870

 
$
6,164

 
$
5,839

Operating expenses
 
$
298

 
$
385

 
$
1,087

 
$
1,172

Financing coordination fees
 
$
1,143

 
$
1,055

 
$
1,313

 
$
2,136

Liquidation/Listing
If Cole Advisors II or its affiliates provides a substantial amount of services, as determined by the Company’s independent directors, in connection with the sale of one or more properties, including those held indirectly through joint ventures, the Company will pay Cole Advisors II up to one-half of the brokerage commission paid, but in no event to exceed an amount equal to 2% of the sales price of each property sold (the “Real Estate Commission”). In no event will the combined real estate commission paid to Cole Advisors II, its affiliates and unaffiliated third parties exceed 6% of the contract sales price.
If the Company’s portfolio is liquidated, after investors have received a return of their net capital contributions and an 8% annual cumulative, non-compounded return, then Cole Advisors II is entitled to receive 10% of the remaining net sale proceeds.
If the Company’s common stock is listed on a national securities exchange, a fee equal to 10% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing, exceeds the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate an 8% annual cumulative, non-compounded return to investors will be paid to Cole Advisors II.
If the advisory agreement with Cole Advisors II is terminated, other than termination by the Company because of a material breach of the advisory agreement by Cole Advisors II, a performance fee of 10% of the amount, if any, by which (1) the appraised asset value at the time of such termination plus total distributions paid to stockholders through the termination date exceeds (2) the aggregate capital contribution contributed by investors less distributions from sale proceeds plus payment to investors of an 8% annual, cumulative, non-compounded return on capital. No subordinated performance fee will be paid to the extent that the Company has already paid or become obligated to pay Cole Advisors II a subordinated participation in net sale proceeds or the Subordinated Incentive Listing Fee.
During the nine months ended September 30, 2012, no commissions or fees were incurred for services provided by Cole Advisors II and its affiliates related to the services described above. During the nine months ended September 30, 2011, the Company incurred a Real Estate Commission of $382,000 for services provided by Cole Advisors II and its affiliates in connection with the sale of the Company’s interest in an unconsolidated joint venture.
Due to Affiliates
As of September 30, 2012 and December 31, 2011, $1.2 million and $1.1 million, respectively, had been incurred, primarily for asset management fees and expenses, general and administrative expenses and finance coordination fees, by Cole Advisors II and its affiliates, but had not yet been reimbursed by the Company and were included in due to affiliates on the condensed consolidated unaudited balance sheets.
NOTE 13 —
ECONOMIC DEPENDENCY
Under various agreements, the Company has engaged or will engage Cole Advisors II and its affiliates to provide certain services that are essential to the Company, including asset management services, supervision of the management and leasing of properties owned by the Company, asset acquisition and disposition decisions, the sale of shares of the Company’s common stock available for issuance, as well as other administrative responsibilities for the Company, including accounting services and investor relations. As a result of these relationships, the Company is dependent upon Cole Advisors II and its affiliates. In the event that these companies are unable to provide the Company with these services, the Company would be required to find alternative providers of these services.

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COLE CREDIT PROPERTY TRUST II, INC.
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS - (Continued)
September 30, 2012

NOTE 14 —
INDEPENDENT DIRECTORS’ STOCK OPTION PLAN
The Company has a stock option plan, the Independent Director’s Stock Option Plan (the “IDSOP”), which authorizes the grant of non-qualified stock options to the Company’s independent directors, subject to the discretion of the board of directors and the applicable limitations of the IDSOP. The term of the IDSOP is ten years, at which time any outstanding options will be forfeited. The exercise price for the options granted under the IDSOP was $9.15 per share for 2005 and 2006, and $9.10 per share for 2007, 2008 and 2009. The Company does not intend to continue to grant options under the IDSOP; however, the exercise price for any future options granted under the IDSOP will be at least 100% of the fair market value of the Company’s common stock as of the date the option is granted. As of September 30, 2012, the Company had granted options to purchase 50,000 shares under the IDISOP and options to purchase 45,000 shares at a weighted average exercise price of $9.12 per share remained outstanding with a weighted average contractual remaining life of five years. No shares were granted or exercised pursuant to the IDSOP for the three and nine months ended September 30, 2012 and 2011. A total of 1,000,000 shares have been authorized and reserved for issuance under the IDSOP.
During the three and nine months ended September 30, 2012 and 2011, the Company did not record any stock-based compensation charges, as all stock-based compensation charges related to unvested share-based compensation awards granted under the IDSOP had previously been recognized. Stock-based compensation expense is based on awards ultimately expected to vest and reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s calculations assume no forfeitures.
NOTE 15 —
SUBSEQUENT EVENTS
Issuance of Shares of Common Stock in the DRIP Offering
The Company continues to issue shares of common stock under the DRIP Offering. As of November 9, 2012, the Company had issued approximately 28.4 million shares pursuant to the DRIP Offering, resulting in gross proceeds to the Company of $256.7 million.
Redemption of Shares of Common Stock
Subsequent to September 30, 2012, the Company redeemed approximately 1.5 million shares for $14.2 million at an average price per share of $9.33.
Line of Credit
Subsequent to September 30, 2012, the Company borrowed $10.0 million and repaid $24.0 million of the amounts outstanding under the Credit Facility. As of November 9, 2012, the Company had $292.1 million outstanding under the Credit Facility and $57.4 million available for borrowing.


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Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated unaudited financial statements, the notes thereto, and the other unaudited financial data included in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements, and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011. The terms “we,” “us,” “our” and the “Company” refer to Cole Credit Property Trust II, Inc. and unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our condensed consolidated unaudited financial statements and the notes thereto.
Forward-Looking Statements
Except for historical information, this section contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including discussion and analysis of our financial condition and our subsidiaries, our anticipated capital expenditures, amounts of anticipated cash distributions to our stockholders in the future and other matters. These forward-looking statements are not historical facts but are the intent, belief or current expectations of our management based on their knowledge and understanding of our business and industry. Words such as “may,” “will,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “could,” “should” or comparable words, variations and similar expressions are intended to identify forward-looking statements. All statements not based on historical fact are forward looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or implied in the forward-looking statements. A full discussion of our risk factors may be found under Part I Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.
Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. Investors are cautioned not to place undue reliance on forward-looking statements, which reflect our management’s view only as of the date of this Quarterly Report on Form 10-Q. 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. Factors that could cause actual results to differ materially from any forward-looking statements made in this Quarterly Report on Form 10-Q include, among others, changes in general economic conditions, changes in real estate conditions, construction costs that may exceed estimates, construction delays, increases in interest rates, lease-up risks, rent relief, inability to obtain new tenants upon the expiration or termination of existing leases, inability to obtain financing or refinance existing debt and the potential need to fund tenant improvements or other capital expenditures out of operating cash flows. The forward-looking statements should be read in light of the risk factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2011.
Management’s discussion and analysis of financial condition and results of operations are based upon our condensed consolidated unaudited financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
Overview
We were formed on September 29, 2004 to acquire and operate commercial real estate primarily consisting of freestanding, single-tenant, retail properties net leased to investment grade and other creditworthy tenants located throughout the United States. We commenced our principal operations on September 23, 2005, when we issued the initial 486,000 shares of our common stock in our Initial Offering. We have no paid employees and are externally advised and managed by Cole Advisors II, our advisor. We currently qualify, and intend to continue to elect to qualify, as a REIT for federal income tax purposes.

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Our operating results and cash flows are primarily influenced by rental income from our commercial properties and interest expense on our property indebtedness. Rental and other property income accounted for 92% of our total revenue for the three and nine months ended September 30, 2012 and accounted for 92% and 90% of our total revenue during the three and nine months ended September 30, 2011, respectively. As 96% of our rentable square feet was under lease as of September 30, 2012, with a weighted average remaining lease term of 10.0 years, we believe our exposure to changes in commercial rental rates on our portfolio is substantially mitigated, except for vacancies caused by tenant bankruptcies or other factors. Our advisor regularly monitors the creditworthiness of our tenants by reviewing the tenant’s financial results, credit rating agency reports (if any) on the tenant or guarantor, the operating history of the property with such tenant, the tenant’s market share and track record within its industry segment, the general health and outlook of the tenant’s industry segment, and other information for changes and possible trends. If our advisor identifies significant changes or trends that may adversely affect the creditworthiness of a tenant, it will gather a more in-depth knowledge of the tenant’s financial condition and, if necessary, attempt to mitigate the tenant’s credit risk by evaluating the possible sale of the property, or identifying a possible replacement tenant should the current tenant fail to perform on the lease.
As of September 30, 2012, the debt leverage ratio of our consolidated real estate assets, which is the ratio of debt to total gross real estate and related assets, net of gross intangible lease liabilities, was 51%, with 11% of the debt, or $199.3 million, including $195.0 million in Revolving Loans outstanding under the Credit Facility, subject to variable interest rates. Should we acquire additional commercial real estate, we will be subject to changes in real estate prices and changes in interest rates on any refinancings or new indebtedness used to acquire the properties. We may manage our risk of changes in real estate prices on future property acquisitions, if any, by entering into purchase agreements and loan commitments simultaneously so that our operating yield is determinable at the time we enter into a purchase agreement, by contracting with developers for future delivery of properties, or by entering into sale-leaseback transactions. We manage our interest rate risk by monitoring the interest rate environment in connection with our future property acquisitions, if any, or upcoming debt maturities to determine the appropriate financing or refinancing terms, which may include fixed rate loans, variable rate loans or interest rate hedges. If we are unable to acquire suitable properties or obtain suitable financing terms for future acquisitions or refinancing, our results of operations may be adversely affected.
Recent Market Conditions and Portfolio Strategies
Beginning in late 2007, domestic and international financial markets experienced significant disruptions that were brought about in large part by challenges in the world-wide banking system. These disruptions severely impacted the availability of credit and contributed to rising costs associated with obtaining credit. Since 2010, the volume of mortgage lending for commercial real estate has been increasing and lending terms have improved and they continue to improve; however, such lending activity continues to be significantly less than previous levels. Although lending market conditions have improved, certain factors continue to negatively affect the lending environment, including the sovereign credit issues of certain countries in the European Union. We have experienced, and may continue to experience, more stringent lending criteria, which may affect our ability to finance certain property acquisitions or refinance our debt at maturity. Additionally, for properties for which we are able to obtain financing, the interest rates and other terms on such loans may be unacceptable. Additionally, if we are able to refinance our existing debt as it matures, it may be at lower leverage levels or at rates and terms which are less favorable than our existing debt or, if we elect to extend the maturity dates of the mortgage notes in accordance with any hyper-amortization provisions, the interest rates charged to us will be higher, each of which may adversely affect our results of operations and the distribution rate we are able to pay to our investors. We have managed, and expect to continue to manage, the current mortgage lending environment by utilizing borrowings on our Credit Facility, and considering alternative lending sources, including the securitization of debt, utilizing fixed rate loans, short-term variable rate loans, assuming existing mortgage loans in connection with property acquisitions, or entering into interest rate lock or swap agreements, or any combination of the foregoing.
The economic downturn led to high unemployment rates and a decline in consumer spending. These economic trends have adversely impacted the retail and real estate markets by causing higher tenant vacancies, declining rental rates and declining property values. In 2011 and through September 30, 2012, the economy improved and continues to show signs of recovery. Additionally, the real estate markets have experienced an improvement in property values, occupancy and rental rates; however, in many markets property values, occupancy and rental rates continue to be below those previously experienced before the economic downturn. As of September 30, 2012, 96% of our rentable square feet was under lease. During the three months ended September 30, 2012, our percentage of rentable square feet under lease remained stable. However, if the recent improvements in economic conditions do not continue, we may experience additional vacancies or be required to reduce rental rates on occupied space. Our advisor is actively seeking to lease all of our vacant space, however, as many retailers and other tenants have been delaying or eliminating their store expansion plans, the amount of time required to re-lease a property has increased.

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As a result of these improvements in market conditions, we have been actively evaluating potential strategies to exit our portfolio. Potential exit strategies we are evaluating include, but are not limited to, a sale of the Company or all or a portion of its portfolio, a merger or other business combination, or a listing of the Company’s stock on a national securities exchange.
Results of Operations
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate investments. The following table shows the property statistics of our consolidated real estate assets as of September 30, 2012 and 2011: 
  
 
September 30,
 
 
2012
 
2011
Number of commercial properties
 
753

 
751

Approximate rentable square feet (1)
 
21.2 million

 
21.1 million

Percentage of rentable square feet leased
 
96
%
 
96
%
 
 
 
 
 
 
(1)
Including square feet of the buildings on land that are subject to ground leases.
The following table summarizes our consolidated real estate investment activity during the three and nine months ended September 30, 2012 and 2011:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2012
 
2011
 
2012
 
2011
Commercial properties acquired
 
—

 
2

 
—

 
26

Approximate purchase price of acquired properties
 
$
—

 
$ 13.5 million

 
$
—

 
$ 90.1 million

Approximate rentable square feet (1)
 
—

 
95,000

 
—

 
439,000

 
 
 
 
 
 
 
 
 
(1)
Including square feet of the buildings on land that are subject to ground leases.
Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011
Revenue. Revenue increased $897,000, or 1%, to $70.2 million for the three months ended September 30, 2012, compared to $69.3 million for the three months ended September 30, 2011. Our revenue consisted primarily of rental and other property income from net leased commercial properties, which accounted for 92% of total revenues during the three months ended September 30, 2012 and 2011.
Rental and other property income increased $687,000, or 1%, to $64.3 million for the three months ended September 30, 2012, compared to $63.6 million for the three months ended September 30, 2011. The increase was primarily due to the acquisition of two properties during the three months ended September 30, 2011 and two properties acquired subsequent to September 30, 2011 combined with lease termination income received during the three months ended September 30, 2012. We also pay certain operating expenses subject to reimbursement by the tenant. Tenant reimbursement income increased $314,000, or 9%, to $3.9 million for the three months ended September 30, 2012, compared to $3.6 million for the three months ended September 30, 2011, primarily due to an increase in reimbursable real estate tax expense during the three months ended September 30, 2012.
Earned income from direct financing leases remained relatively constant, decreasing $14,000, or 3%, to $472,000 for the three months ended September 30, 2012, compared to $486,000 for the three months ended September 30, 2011. We owned 13 properties accounted for as direct financing leases for each of the three months ended September 30, 2012 and 2011.
Interest income on mortgage notes receivable decreased $90,000, or 6%, to $1.5 million for the three months ended September 30, 2012, compared to $1.6 million for the three months ended September 30, 2011, as we recorded interest income on mortgages receivable on 69 amortizing mortgage notes receivable during each of the three months ended September 30, 2012 and 2011. We expect interest income to decrease in future periods as the proportion of principal payments received increases.



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General and Administrative Expenses. General and administrative expenses increased $636,000, or 28%, to $2.9 million for the three months ended September 30, 2012, compared to $2.2 million for the three months ended September 30, 2011. The increase was primarily due to an increase in professional fees incurred in connection with the Company’s evaluation of potential exit strategies, combined with an increase in insurance expense and fees paid to our independent directors for the three months ended September 30, 2012, compared to the three months ended September 30, 2011. This increase was partially offset by lower fees for unused amounts under our Credit Facility due to an increase in the amount outstanding on the line of credit. The primary general and administrative expense items are professional fees, board of directors costs, insurance, state franchise and income taxes, escrow and trustee fees, unused fees on our line of credit, operating expenses reimbursable to our advisor, and other licenses and fees.
Property Operating Expenses. Property operating expenses increased $507,000, or 9%, to $5.9 million for the three months ended September 30, 2012, compared to $5.3 million for the three months ended September 30, 2011. The increase was primarily due to an increase in reimbursable property tax expense. The primary property operating expense items are property taxes, repairs and maintenance, property insurance and bad debt expense.
Property and Asset Management Expenses. Pursuant to the advisory agreement with our advisor, as amended, we are required to pay to our advisor a monthly asset management fee equal to one-twelfth of 0.25% of the aggregate valuation of our invested assets, as determined by our board of directors. Additionally, we reimburse costs incurred by our advisor in providing asset management services, subject to certain limitations, as set forth in the advisory agreement. Pursuant to the property management agreement with our property manager, which is an affiliate of our advisor, we are required to pay to our property manager a property management fee in an amount up to 2% of gross revenues received from each of our single-tenant properties and up to 4% of gross revenues received from each of our multi-tenant properties, less all payments to third-party management subcontractors. We reimburse Cole Realty Advisors’ costs of managing and leasing the properties, subject to certain limitations as set forth in the property management agreement.
Property and asset management expenses remained relatively constant, increasing $127,000, or 3%, to $4.4 million for the three months ended September 30, 2012, compared to $4.2 million for the three months ended September 30, 2011. Of this amount, property management expenses remained constant at $2.0 million for the three months ended September 30, 2012 and September 30, 2011 and asset management expenses increased to $2.4 million for the three months ended September 30, 2012, from $2.3 million for the three months ended September 30, 2011. The increase in asset management fees was primarily due to an increase in our asset base related to the board of directors’ determination of the share value of $9.35 as of July 27, 2011, compared to the previously determined share value of $8.05.
Acquisition Related Expenses. We recorded no acquisition related expenses during the three months ended September 30, 2012, compared to $382,000 recorded for the three months ended September 30, 2011. During the three months ended September 30, 2012 we made no real estate acquisitions and during the three months ended September 30, 2011 we acquired two properties for $13.5 million.
Depreciation and Amortization Expenses. Depreciation and amortization expenses remained relatively consistent, increasing $119,000, or 1%, to $22.2 million for the three months ended September 30, 2012, compared to $22.1 million for the three months ended September 30, 2011. The increase was primarily related to depreciation and amortization on two properties acquired during the three months ended September 30, 2011 and two properties acquired subsequent to September 30, 2011.
Equity in Income of Unconsolidated Joint Ventures and Other Income. Equity in income of unconsolidated joint ventures and other income increased $665,000 to $701,000 during the three months ended September 30, 2012, compared to $36,000 during the three months ended September 30, 2011. The increase was primarily due to the sale of our interest in one of our unconsolidated joint ventures, which was operating at a loss throughout the prior year, on September 30, 2011.
Gain on Sale of Unconsolidated Joint Venture Interests. We recorded a gain on the sale of our interest in an unconsolidated joint venture of $5.1 million during the three months ended September 30, 2011 as discussed in Note 5 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. No gain was recorded on the sale of our interest in an unconsolidated joint venture during the three months ended September 30, 2012.
Impairment of Joint Venture Investment. We recorded an impairment of $1.2 million related to an unconsolidated joint venture during the three months ended September 30, 2012 as discussed in Note 5 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. No impairment was recorded on our interest in unconsolidated joint ventures during the three months ended September 30, 2011.
Interest Expense. Interest expense remained constant at $27.2 million for both the three months ended September 30, 2012 and 2011. Our average outstanding debt balance was relatively constant in each of the three months ended September 30, 2012 and 2011.

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Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011
Revenue. Revenue increased $4.0 million, or 2%, to $212.5 million for the nine months ended September 30, 2012, compared to $208.5 million for the nine months ended September 30, 2011. Our revenue consisted primarily of rental and other property income from net leased commercial properties, which accounted for 92% and 90% of total revenues during the nine months ended September 30, 2012 and 2011, respectively.
Rental and other property income increased $7.4 million, or 4%, to $194.8 million for the nine months ended September 30, 2012, compared to $187.4 million for the nine months ended September 30, 2011. The increase was primarily due to the acquisition of 26 properties during the nine months ended September 30, 2011 and two properties acquired subsequent to September 30, 2011 combined with additional revenue from the expansion and improvements to an existing property as discussed in Note 5 to our condensed consolidated unaudited financial statements included in this Quarterly Report on Form 10-Q. We also pay certain operating expenses subject to reimbursement by the tenant. Tenant reimbursement income decreased $596,000, or 5%, to $11.7 million for the nine months ended September 30, 2012, compared to $12.3 million for the nine months ended September 30, 2011, primarily due to a change in our expected reimbursements from tenants for recoverable real estate taxes and operating expenses during the nine months ended September 30, 2012.
Earned income from direct financing leases remained relatively constant, decreasing $41,000, or 3%, to $1.4 million for the nine months ended September 30, 2012, compared to $1.5 million for the nine months ended September 30, 2011. We owned 13 properties accounted for as direct financing leases for each of the nine months ended September 30, 2012 and 2011.
Interest income on mortgage notes receivable remained relatively constant, decreasing $209,000, or 4%, to $4.6 million for the nine months ended September 30, 2012, compared to $4.8 million for the nine months ended September 30, 2011, as we recorded interest income on mortgages receivable on 69 amortizing mortgage notes receivable during each of the nine months ended September 30, 2012 and 2011. We expect interest income to decrease in future periods as the proportion of principal payments received increases.
There was no interest income recorded on marketable securities during the nine months ended September 30, 2012, compared to $2.5 million for the nine months ended September 30, 2011. The decrease was due to the sale of all of our CMBS during the year ended December 31, 2011.
General and Administrative Expenses. General and administrative expenses increased $2.2 million, or 35%, to $8.4 million for the nine months ended September 30, 2012, compared to $6.2 million for the nine months ended September 30, 2011. The increase was primarily due to an increase in professional fees incurred in connection with the Company’s evaluation of potential exit strategies, combined with an increase in insurance expense and fees paid to our independent directors during the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011. This increase was partially offset by lower fees for unused amounts under our Credit Facility due to an increase in the amount outstanding on the line of credit. The primary general and administrative expense items are professional fees, board of directors costs, insurance, state franchise and income taxes, escrow and trustee fees, unused fees on our line of credit, operating expenses reimbursable to our advisor, and other licenses and fees.
Property Operating Expenses. Property operating expenses remained relatively constant, increasing $351,000, or 2%, to $17.2 million for the nine months ended September 30, 2012, compared to $16.8 million for the nine months ended September 30, 2011. The primary property operating expense items are property taxes, repairs and maintenance, property insurance and bad debt expense.
Property and Asset Management Expenses. Pursuant to the advisory agreement with our advisor, as amended, we are required to pay to our advisor a monthly asset management fee equal to one-twelfth of 0.25% of the aggregate valuation of our invested assets, as determined by our board of directors. Additionally, we reimburse costs incurred by our advisor in providing asset management services, subject to certain limitations, as set forth in the advisory agreement. Pursuant to the property management agreement with our property manager, which is an affiliate of our advisor, we are required to pay to our property manager a property management fee in an amount up to 2% of gross revenues received from each of our single-tenant properties and up to 4% of gross revenues received from each of our multi-tenant properties, less all payments to third-party management subcontractors. We reimburse Cole Realty Advisors’ costs of managing and leasing the properties, subject to certain limitations as set forth in the property management agreement.

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Property and asset management expenses increased $607,000, or 5%, to $13.3 million for the nine months ended September 30, 2012, compared to $12.7 million for the nine months ended September 30, 2011. Of this amount, property management expenses increased to $6.4 million for the nine months ended September 30, 2012 from $6.1 million for the nine months ended September 30, 2011, and asset management expenses increased to $6.9 million for the nine months ended September 30, 2012, from $6.6 million for the nine months ended September 30, 2011. These increases were primarily due to an increase in property and asset management fees related to the acquisition of 26 properties throughout the nine months ended September 30, 2011 and two properties acquired subsequent to September 30, 2011, combined with an increase in our asset base related to the board of directors’ determination of the share value of $9.35 as of July 27, 2011, compared to the previously determined share value of $8.05.
Acquisition Related Expenses. We recorded $17,000 in acquisition related expenses for the nine months ended September 30, 2012, compared to $2.7 million recorded for the nine months ended September 30, 2011. During the nine months ended September 30, 2012 we made no real estate acquisitions and during the nine months ended September 30, 2011 we acquired 26 properties for $90.1 million.
Depreciation and Amortization Expenses. Depreciation and amortization expenses remained relatively consistent, increasing $803,000, or 1%, to $66.9 million for the nine months ended September 30, 2012, compared to $66.1 million for the nine months ended September 30, 2011. The increase was primarily related to depreciation and amortization on 26 properties acquired throughout the nine months ended September 30, 2011 and two properties acquired subsequent to September 30, 2011.
Impairment of Real Estate Assets. An impairment loss of $2.0 million was recorded relating to one property during the nine months ended September 30, 2012, as discussed in Note 2 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. There were no real estate impairment losses recorded during the nine months ended September 30, 2011.
Equity in Income of Unconsolidated Joint Ventures and Other Income. Equity in income of unconsolidated joint ventures and other income increased $669,000, or 117%, to $1.2 million during the nine months ended September 30, 2012, compared to $572,000 during the nine months ended September 30, 2011. The increase was primarily due to the sale of our interest in one of our unconsolidated joint ventures, which was operating at a loss throughout the prior year, on September 30, 2011.
Gain on Sale of Unconsolidated Joint Venture Interests. We recorded a gain on the sale of our interest in an unconsolidated joint venture of $5.1 million during the nine months ended September 30, 2011 as discussed in Note 5 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. No gain was recorded on the sale of our interest in an unconsolidated joint venture during the nine months ended September 30, 2012.
Impairment of Joint Venture Investment. We recorded an impairment of $1.2 million related to an unconsolidated joint venture during the nine months ended September 30, 2012 as discussed in Note 5 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. No impairment was recorded on our interest in unconsolidated joint ventures during the nine months ended September 30, 2011.
Gain on Sale of Marketable Securities. During the nine months ended September 30, 2011, we recorded a gain on sale of marketable securities of $15.6 million in connection with the sale of six CMBS. No similar transactions occurred during the nine months ended September 30, 2012.
Interest Expense. Interest expense remained relatively constant, decreasing $497,000, or less than 1%, to $81.1 million for the nine months ended September 30, 2012, compared to $80.6 million during the nine months ended September 30, 2011, primarily due to a decrease in the weighted average interest rate, which was partially offset by an increase of $26.1 million in the average outstanding debt balance resulting from borrowings incurred to acquire 26 properties during the nine months ended September 30, 2011.

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Funds From Operations and Modified Funds From Operations
Funds From Operations (“FFO”) is a non-GAAP financial performance measure defined by the National Association of Real Estate Investment Trusts (“NAREIT”) and widely recognized by investors and analysts as one measure of operating performance of a real estate company. The FFO calculation excludes items such as real estate depreciation and amortization, gains and losses on the sale of depreciable real estate, impairments of depreciable real estate and impairments of joint ventures. Depreciation and amortization as applied in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, it is management’s view, and we believe the view of many industry investors and analysts, that the presentation of operating results for real estate companies by using the historical cost method alone is insufficient. In addition, FFO also excludes gains and losses from the sale of depreciable real estate, which we believe provides management and investors with a helpful additional measure of the performance of our real estate portfolio, as it allows for comparisons, year to year, that reflect the impact on operations from trends in items such as occupancy rates, rental rates, operating costs, general and administrative expenses and interest costs. FFO also excludes real estate impairments of depreciable real estate and impairments of joint ventures that are attributable to measurable decreases in the fair value of depreciable real estate held by the venture. Impairment write-downs are items that management does not include in its evaluation of the historical operating performance of its real estate investments, as management believes that the impact of these items will be reflected over time through changes in rental income or other related costs. We compute FFO in accordance with NAREIT’s definition.
In addition to FFO, we use Modified Funds From Operations (“MFFO”) as a non-GAAP supplemental financial performance measure to evaluate the operating performance of our real estate portfolio. MFFO, as defined by our company, excludes from FFO acquisition related costs, which are required to be expensed in accordance with GAAP. In evaluating the performance of our portfolio over time, management employs business models and analyses that differentiate the costs to acquire investments from the investments’ revenues and expenses. Management believes that excluding acquisition costs from MFFO provides investors with supplemental performance information that is consistent with the performance models and analysis used by management, and provides investors a view of the performance of our portfolio over time, including after the Company ceases to acquire properties on a frequent and regular basis. MFFO also allows for a comparison of the performance of our portfolio with other REITs that are not currently engaging in acquisitions, as well as a comparison of our performance with that of other non-traded REITs, as MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes.
For all of these reasons, we believe FFO and MFFO, in addition to net income and cash flows from operating activities, as defined by GAAP, are helpful supplemental performance measures and useful in understanding the various ways in which our management evaluates the performance of our real estate portfolio over time. However, not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. FFO and MFFO should not be considered as alternatives to net income or to cash flows from operating activities, and are not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs.
MFFO may provide investors with a useful indication of our future performance, particularly after our acquisition stage, and of the sustainability of our current distribution policy. However, because MFFO excludes acquisition expenses, which are an important component in an analysis of the historical performance of a property, MFFO should not be construed as a historic performance measure. Neither the SEC, NAREIT, nor any other regulatory body has evaluated the acceptability of the exclusions contemplated to adjust FFO in order to calculate MFFO and its use as a non-GAAP financial performance measure.
Our calculation of FFO and MFFO, and reconciliation to net income, which is the most directly comparable GAAP financial measure, is presented in the table below for the three and nine months ended September 30, 2012 and 2011 (in thousands). FFO and MFFO are influenced by the timing of acquisitions and the operating performance of our real estate investments.

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Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2012
 
2011
 
2012
 
2011
NET INCOME
 
$
7,204

 
$
12,952

 
$
23,762

 
$
44,614

Depreciation of real estate assets
 
15,210

 
15,077

 
45,627

 
44,646

Amortization of lease related costs
 
6,975

 
6,989

 
21,285

 
21,463

Depreciation and amortization of real estate assets in unconsolidated joint ventures
 
314

 
263

 
995

 
1,094

Impairment of real estate assets
 
—

 
—

 
1,979

 
—

Impairment of joint venture investment
 
1,156

 
—

 
1,156

 
—

Gain on sale of unconsolidated joint venture interests
 
—

 
(5,111
)
 
—

 
(5,111
)
Gain on property condemnation
 
—

 
—

 
(55
)
 
(92
)
Funds from operations (FFO)
 
$
30,859

 
$
30,170

 
$
94,749

 
$
106,614

Acquisition related expenses
 
—

 
382

 
17

 
2,700

Modified funds from operations (MFFO)
 
$
30,859

 
$
30,552

 
$
94,766

 
$
109,314

Set forth below is additional information that may be helpful in assessing our operating results:
•
During the nine months ended September 30, 2011, we sold six CMBS for $82.1 million, and realized a gain on the sale of $15.6 million, of which $14.7 million had previously been recorded in other comprehensive income. No sales of CMBS occurred during the three months ended September 30, 2011 or the three and nine months ended September 30, 2012.
•
In order to recognize rental income on a straight-line basis over the terms of the respective leases, we recognized additional rental income by straight-lining rental income of $1.6 million and $7.2 million during the three and nine months ended September 30, 2012, respectively, and $2.9 million and $8.3 million during the three and nine months ended September 30, 2011, respectively. In addition, related to our unconsolidated joint ventures, straight-line revenue of $41,000 and $50,000 for the three and nine months ended September 30, 2012, respectively, and $3,000 and $17,000 for the three and nine months ended September 30, 2011, respectively, is included in equity in income of unconsolidated joint ventures and other income on the condensed consolidated unaudited statements of operations.
•
Amortization of deferred financing costs and amortization of fair value adjustments of mortgage notes assumed totaled $2.3 million and $6.7 million during the three and nine months ended September 30, 2012, respectively, and $2.2 million and $6.5 million for the three and nine months ended September 30, 2011, respectively. In addition, related to our unconsolidated joint ventures, amortization of deferred financing costs and amortization of fair value adjustments of mortgage notes assumed totaled $8,000 and $26,000 for the three and nine months ended September 30, 2012, respectively, and $55,000 and $197,000 for the three and nine months ended September 30, 2011, respectively, which is included in equity in income of unconsolidated joint ventures and other income on the condensed consolidated unaudited statements of operations.
Distributions
Our board of directors authorized a daily distribution, based on 366 days in the calendar year, of $0.001707848 per share (which equates to 6.25% on an annualized basis calculated at the current rate, assuming a $10.00 per share purchase price, and an annualized return of approximately 6.68%, based on the most recent estimate of the value of our shares of $9.35 per share) for stockholders of record as of the close of business on each day of the period, commencing on January 1, 2012 and ending on December 31, 2012.








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During the nine months ended September 30, 2012 and 2011, we paid distributions of $98.7 million and $98.3 million, respectively, including $43.2 million and $44.9 million, respectively, through the issuance of shares pursuant to our DRIP Offering. Our distributions for the nine months ended September 30, 2012 were funded by net cash provided by operating activities of $86.0 million, or 87%, a portion of the net proceeds in excess of our investment from our prior year sale of marketable securities of $10.0 million, or 10%, and distributions received in excess of income from our unconsolidated joint venture and cash received from mortgage notes receivable and real estate assets under direct financing leases of $2.7 million, or 3%. Our distributions for the nine months ended September 30, 2011 were funded by net cash provided by operating activities of $87.5 million, or 89%, proceeds from the DRIP Offering of $2.7 million, or 3%, distributions received in excess of income from our unconsolidated joint ventures of $2.0 million, or 2%, and net proceeds in excess of our investment from the sale of marketable securities of $6.1 million, or 6%. Net cash provided by operating activities for the nine months ended September 30, 2011, reflects a reduction for real estate acquisition related expenses incurred and expensed of $2.7 million in accordance with GAAP. We treat our real estate acquisition expenses as funded by proceeds from the offering of our shares, including proceeds from the DRIP Offering. Therefore, for consistency, proceeds from the issuance of common stock for the nine months ended September 30, 2011 have been reported as a source of distributions to the extent that acquisition expenses have reduced net cash flows from operating activities.
Share Redemptions
Our share redemption program provides that we will redeem shares of our common stock from requesting stockholders, subject to the terms and conditions of the share redemption program. On November 10, 2009, our board of directors voted to temporarily suspend our share redemption program other than for requests made upon the death of a stockholder. Effective August 1, 2010, our board of directors reinstated our share redemption program and adopted several amendments to the program. In particular, during any calendar year, we will not redeem in excess of 3% of the weighted average number of shares outstanding during the prior calendar year and the cash available for redemption is limited to the proceeds from the sale of shares pursuant to our DRIP Offering. In addition, we will redeem shares on a quarterly basis, at the rate of approximately one-fourth of 3% of the weighted average number of shares outstanding during the prior calendar year (including shares requested for redemption upon the death of a stockholder). Funding for redemptions for each quarter will be limited to the net proceeds we receive from the sale of shares, during such quarter, from our DRIP Offering.
Pursuant to the share redemption program, as amended, the redemption price per share is dependent on the length of time the shares are held and the most recently disclosed Estimated Share Value. As of September 30, 2012, the Estimated Share Value was $9.35 per share, as determined by the board of directors on July 27, 2011. During the three months ended September 30, 2012, we received valid redemption requests pursuant to the share redemption program, as amended, relating to approximately 5.1 million shares, including those requests unfulfilled and resubmitted from a previous period, and requests relating to approximately 1.5 million shares were redeemed for $14.2 million at an average price of $9.33 per share subsequent to September 30, 2012. The remaining redemption requests relating to approximately 3.6 million shares went unfulfilled, including those requests unfulfilled and resubmitted from a previous period. During the nine months ended September 30, 2012, we received valid redemption requests pursuant to the share redemption program, as amended, relating to approximately 15.2 million shares, including those requests unfulfilled and resubmitted from a previous period, and requests relating to approximately 4.6 million shares were redeemed for $43.2 million at an average price of $9.31 per share. The remaining redemption requests relating to approximately 10.6 million shares went unfulfilled, including those requests unfulfilled and resubmitted from a previous period. Requests for redemptions that are not fulfilled in a period may be resubmitted by stockholders in a subsequent period. Unfulfilled requests for redemptions are not carried over automatically to subsequent redemption periods. A valid redemption request is one that complies with the applicable requirements and guidelines of our share redemption program, as amended, and set forth in our Current Report on Form 8-K filed on November 18, 2011. We have funded and intend to continue funding share redemptions with proceeds from our DRIP Offering.
Liquidity and Capital Resources
General
Our principal demands for funds are for the payment of principal and interest on our outstanding indebtedness, operating and property maintenance expenses and distributions to and redemptions by our stockholders. We may also acquire additional real estate and real estate related investments. Generally, cash needs for payments of interest, operating and property maintenance expenses and distributions to stockholders will be generated from cash flows from operations from our real estate assets. The sources of our operating cash flows are primarily driven by the rental income received from leased properties, interest income earned on mortgage notes receivable and interest income on our cash balances. We expect to utilize the available cash from issuance of shares under the DRIP Offering, available borrowings on our Credit Facility and potential additional financings and refinancings to repay our outstanding indebtedness and complete possible future property acquisitions.

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As of September 30, 2012, we had cash and cash equivalents of $47.9 million and available borrowings of $43.4 million under our Credit Facility. Additionally, as of September 30, 2012, we had unencumbered properties with a gross book value of $767.9 million, including $635.8 million of assets that are part of the Credit Facility’s unencumbered borrowing base (the “Borrowing Base Assets”), which may be used as collateral to secure additional financing in future periods or as additional collateral to facilitate the refinancing of current mortgage debt as it becomes due, subject to certain covenants and leverage and borrowing base restrictions related to our Credit Facility; however, the use of any Borrowing Base Assets as collateral would reduce the available borrowings under our Credit Facility.
Short-term Liquidity and Capital Resources
On a short-term basis, our principal demands for funds will be for operating expenses, distributions and redemptions to stockholders and interest and principal on current and any future debt financings. We expect to meet our short-term liquidity requirements through available cash, cash provided by property operations, the issuance of new mortgage notes on unencumbered assets and borrowings from our Credit Facility. As of September 30, 2012, we had no debt amounts maturing within the next 12 months and we had available borrowings on our Credit Facility of $43.4 million. We believe that the resources stated above will be sufficient to satisfy our operating requirements for the foreseeable future, and we do not anticipate a need to raise funds from sources other than those described above within the next 12 months.
Long-term Liquidity and Capital Resources
We expect to meet our long-term liquidity requirements through proceeds from secured or unsecured financings from banks and other lenders, borrowing on our Credit Facility, available cash from issuance of shares under the DRIP Offering, the selective and strategic sale of properties and net cash flows from operations. We expect that our primary uses of capital will be for property and other asset acquisitions and the payment of tenant improvements, operating expenses, including debt service payments on any outstanding indebtedness, and distributions and redemptions to our stockholders.
We expect that substantially all cash flows from operations will be used to pay distributions to our stockholders after certain capital expenditures, including tenant improvements and leasing commissions, are paid; however, we may use other sources to fund distributions as necessary, including the proceeds from the DRIP Offering, borrowing on the Credit Facility and/or borrowings in anticipation of future cash flow. To the extent that cash flows from operations are lower due to lower than expected returns on the properties or we elect to retain cash flows from operations to make additional real estate investments or reduce our outstanding debt, distributions paid to our stockholders may be lower.
We expect that substantially all net cash resulting from the DRIP Offering or debt financing will be used to fund acquisitions, for certain capital expenditures identified at acquisition, for repayments of outstanding debt, or for any distributions to stockholders in excess of cash flows from operations and redemption of shares from our stockholders.
As of September 30, 2012, we had issued approximately 229.7 million shares of our common stock in the Offerings resulting in gross proceeds of $2.3 billion. As of September 30, 2012, we had redeemed a total of approximately 19.6 million shares of common stock for a cost of $178.0 million. Redemption requests relating to approximately 10.6 million shares that were received during the nine months ended September 30, 2012 went unfulfilled.
As of September 30, 2012, we had $1.8 billion of debt outstanding, consisting of (1) $1.5 billion of Fixed Rate Debt, which includes $77.7 million of variable rate debt swapped to fixed rates, (2) $4.3 million of Variable Rate Debt and (3) $306.1 million outstanding under the Credit Facility, which includes $111.1 million swapped to a fixed rate. The Fixed Rate Debt has annual interest rates ranging from 3.15% to 7.22%, with a weighted average annual interest rate of 5.69%, and various maturity dates ranging from September, 2014 through August, 2031. The Variable Rate Debt has an annual interest rate of LIBOR plus 275 basis points, and matures in September, 2014. As of September 30, 2012, the weighted average interest rate in effect for Revolving Loans under the Credit Facility was 3.72% and the Term Loan was fixed at a rate of 4.94% per annum based on our overall leverage levels. Additionally, the ratio of debt to gross real estate and related assets net of gross intangible lease liabilities, as of September 30, 2012, was 51% and the weighted average years to maturity was 4.0 years. Our contractual obligations as of September 30, 2012 were as follows (in thousands):
 

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Payments due by period (1) (2)
 
 
Total
 
Less Than 1
Year
 
1-3 Years
 
3-5 Years
 
More Than 5
Years
Principal payments — fixed rate debt (3)
 
$
1,461,176

 
$
5,119

 
$
176,253

 
$
973,969

 
$
305,835

Interest payments — fixed rate debt (4)
 
373,437

 
84,051

 
163,611

 
102,668

 
23,107

Principal payments — variable rate debt
 
4,250

 
—

 
4,250

 
—

 
—

Interest payments — variable rate debt (5)
 
258

 
128

 
130

 
—

 
—

Principal payments — credit facility
 
306,111

 
—

 
306,111

 
—

 
—

Interest payments — credit facility (4) (6)
 
15,577

 
12,834

 
2,743

 
—

 
—

Total
 
$
2,160,809

 
$
102,132

 
$
653,098

 
$
1,076,637

 
$
328,942

 
 
 
 
 
 
 
 
 
 
 
 
(1)
The table above does not include amounts due to our advisor or its affiliates pursuant to our advisory agreement because such amounts are not fixed and determinable.
(2)
Principal paydown amounts are included in payments due by period.
(3)
Principal payment amounts reflect actual payments based on face amount of notes payable. As of September 30, 2012, the fair value adjustment, net of amortization, of mortgage notes assumed was $8.9 million.
(4)
As of September 30, 2012, we had $188.8 million of Variable Rate Debt and Credit Facility borrowings fixed through the use of interest rate swaps. We used the fixed rates under the swap agreement to calculate the debt payment obligations in future periods.
(5)
A rate of 2.98% was used to calculate the variable debt payment obligations in future periods. This was the rate effective as of September 30, 2012.
(6)
Payment obligations for the Term Loan and Revolving Loans outstanding under the Credit Facility calculated based on interest rates of 4.94% and 3.72%, respectively, in effect as of September 30, 2012.
Our charter prohibits us from incurring debt that would cause our borrowings to exceed the greater of 60% of our gross assets, valued at the greater of the aggregate cost (before depreciation and other non-cash reserves) or fair value of all assets owned by us, unless approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report.
Cash Flow Analysis
Operating Activities. Net cash provided by operating activities decreased $1.5 million, or 2%, to $86.0 million for the nine months ended September 30, 2012, compared to $87.5 million for the nine months ended September 30, 2011. The decrease was primarily due to a net change in our working capital accounts of $6.3 million, offset by an increase in net income before non-cash adjustments for depreciation, amortization, impairments and gains on sale of marketable securities and unconsolidated joint ventures of $4.7 million for the nine months ended September 30, 2012 compared to September 30, 2011. See “— Results of Operations” for a more complete discussion of the factors impacting our operating performance.
Investing Activities. Net cash provided by investing activities increased $23.9 million to $17.6 million for the nine months ended September 30, 2012, compared to net cash used in investing activities of $6.2 million for the nine months ended September 30, 2011. The increase was primarily a result of less cash used for the investment in real estate and related assets of as we made no real estate acquisitions during the nine months ended September 30, 2012, compared to the acquisition of 26 properties for a total purchase price of $90.1 million during the nine months ended September 30, 2011. Additionally, we received $21.2 million in proceeds from the sale of our interest in an unconsolidated joint venture during the nine months ended September 30, 2012 compared to proceeds of $19.1 million from the sale of our interest in an unconsolidated joint venture during the nine months ended September 30, 2011. These amounts were partially offset by a decrease in proceeds from sale of marketable securities of $82.1 million, as no sales occurred during the nine months ended September 30, 2012.
Financing Activities. Net cash used in financing activities increased $36.4 million, or 50%, to $108.9 million for the nine months ended September 30, 2012 compared to $72.4 million for the nine months ended September 30, 2011. During the nine months ended September 30, 2012, our loan activity resulted in net repayments of $6.4 million and during the nine months ended September 30, 2011 our loan activity resulted in net borrowings of $21.5 million, combining for an increase in cash used for mortgage notes payable, the Credit Facility and our Repurchase Agreement of $27.9 million. Additionally, the increase in net cash used in financing activities was due to an increase in cash used for the redemptions of common stock of $4.9 million and an increase in distributions to investors of $2.2 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

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Election as a REIT
We are taxed as a REIT under the Internal Revenue Code of 1986, as amended. To maintain our qualification as a REIT, we must continue to meet certain requirements relating to our organization, sources of income, nature of assets, distributions of income to our stockholders and recordkeeping. As a REIT, we generally are not subject to federal income tax on taxable income that we distribute to our stockholders so long as we distribute at least 90% of our annual taxable income (computed without regard to the dividends paid deduction and excluding net capital gains).
If we fail to maintain our qualification as a REIT for any reason in a taxable year and applicable relief provisions do not apply, we will be subject to tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct distributions paid to our stockholders in any year in which we fail to maintain our qualification as a REIT. We also will be disqualified for the four taxable years following the year during which qualification was lost unless we are entitled to relief under specific statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we are organized and operate in such a manner as to maintain our qualification as a REIT for federal income tax purposes. No provision for federal income taxes has been made in our accompanying condensed consolidated unaudited financial statements. We are subject to certain state and local taxes related to the operations of properties in certain locations, which have been provided for in our accompanying condensed consolidated unaudited financial statements.
Critical Accounting Policies and Estimates
Our accounting policies have been established to conform to GAAP. The preparation of financial statements in conformity with GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. We consider our critical accounting policies to be the following:
•
Investment in and Valuation of Real Estate and Related Assets;
•
Allocation of Purchase Price of Real Estate and Related Assets;
•
Investment in Direct Financing Leases;
•
Investment in Mortgage Notes Receivable;
•
Investment in Marketable Securities;
•
Investment in Unconsolidated Joint Venture;
•
Revenue Recognition;
•
Income Taxes; and
•
Derivative Instruments and Hedging Activities.
A complete description of such policies and our considerations is contained in our Annual Report on Form 10-K for the year ended December 31, 2011, and our critical accounting policies have not changed during the nine months ended September 30, 2012. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2011, and related notes thereto.
Commitments and Contingencies
We may be subject to certain commitments and contingencies with regard to certain transactions. Refer to Note 11 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further explanations.
Related-Party Transactions and Agreements
We have entered into agreements with Cole Advisors II and its affiliates, whereby we have paid, and may continue to pay, certain fees to, or reimburse certain expenses of, Cole Advisors II or its affiliates such as acquisition and advisory fees and expenses, financing coordination fees, organization and offering costs, sales commissions, dealer manager fees, asset and property management fees and expenses, leasing fees, real estate commissions and reimbursement of certain operating costs. See Note 12 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for a further explanation of the various related-party transactions, agreements and fees.


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Table of Contents

Subsequent Events
Certain events occurred subsequent to September 30, 2012 through the filing date of this Quarterly Report on Form 10-Q. Refer to Note 15 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further explanation. Such events are:
•
Issuance of shares of common stock in the DRIP Offering;
•
Redemption of shares of common stock; and
•
Line of credit.
New Accounting Pronouncements
Refer to Note 2 to our condensed consolidated unaudited financial statements included in this Quarterly Report on Form 10-Q for further explanation. There have been no accounting pronouncements issued, but not yet applied by us, that will significantly impact our financial statements.
Off Balance Sheet Arrangements
As of September 30, 2012 and December 31, 2011, we had no material off-balance sheet arrangements that had or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity or capital resources.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
We have obtained variable rate debt financing to fund certain property acquisitions, and therefore we are exposed to changes in LIBOR and a bank’s prime rate. Our objectives in managing interest rate risks will be to limit the impact of interest rate changes on operations and cash flows, and to lower overall borrowing costs. To achieve these objectives we will borrow primarily at interest rates with the lowest margins available and, in some cases, with the ability to convert variable interest rates to fixed rates. We have entered, and may to continue to enter, into derivative financial instruments, such as interest rate swaps and caps in order to mitigate our interest rate risk on a given variable rate financial instrument. We have not entered, and do not intend to enter, into derivative or interest rate transactions for speculative purposes. We may also enter into rate lock arrangements to lock interest rates on future borrowings. We may be exposed to credit and market risks including, but not limited to, the failure of any counterparty to perform under the terms of the derivative contract or the adverse effect on the value of the financial instrument resulting from a change in interest rates.
As of September 30, 2012, $199.3 million of the $1.8 billion outstanding on notes payable and the Credit Facility was subject to variable interest rates. Revolving Loans under the Credit Facility bore interest at a weighted average rate of 3.72%. The remaining variable rate debt bore interest at the one-month LIBOR plus 275 basis points. As of September 30, 2012, an increase of 50 basis points in interest rates would result in a change in interest expense of $1.0 million per year, assuming all of our derivatives remain effective hedges.
As of September 30, 2012, we had four interest rate swap agreements outstanding, which mature on various dates from November 2013 through March 2016, with an aggregate notional amount under the swap agreements of $188.8 million and an aggregate net fair value of $(2.6) million. The fair value of these interest rate swap agreements is dependent upon existing market interest rates and swap spreads. As of September 30, 2012, an increase of 50 basis points in interest rates would result in an increase to the fair value of these interest rate swaps of $1.5 million. These interest rate swaps were designated as hedging instruments.
We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.

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Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As required by Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we, under the supervision and with the participation of our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of September 30, 2012, were effective to ensure that information required to be disclosed by us in this Quarterly Report on Form 10-Q is recorded, processed, summarized and reported within the time periods specified by the rules and forms promulgated under the Exchange Act, and is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Control Over Financial Reporting
No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d -15(f) of the Exchange Act) in connection with the foregoing evaluations that occurred during the three months ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II
OTHER INFORMATION
Item 1.
Legal Proceedings
In the ordinary course of business we may become subject to litigation or claims. We are not aware of any material pending legal proceedings, other than ordinary routine litigation incidental to our business, to which we are a party or to which our properties are the subject.
Item 1A.
Risk Factors
There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2011.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
As of September 30, 2012, we had accepted subscriptions for 229.7 million shares (including shares sold pursuant to our DRIP Offering and net of redemptions) of common stock in the Offerings, resulting in gross proceeds of $2.3 billion, out of which we paid $171.8 million in selling commissions and dealer manager fees, $70.4 million in acquisition fees, $24.4 million in finance coordination fees, and $16.3 million in organization and offering costs to our advisor or its affiliates. We paid no selling commissions, dealer manager fees, acquisition fees or organization and offering costs to Cole Capital during the three months ended September 30, 2012.
Total net offering proceeds from the Offerings are $2.0 billion as of September 30, 2012. With the net offering proceeds and indebtedness, we acquired $3.5 billion in real estate and related assets net of gross intangible lease liabilities. As of November 9, 2012, we had sold an aggregate of approximately 230.7 million shares in our Offerings for gross offering proceeds of $2.3 billion (including shares sold pursuant to our DRIP Offering). We did not sell any unregistered equity securities during the three months ended September 30, 2012.
Our board of directors has adopted a share redemption program that enables our stockholders who hold their shares for more than one year to sell their shares to us in limited circumstances. Under the terms of the share redemption program, during any calendar year, we will redeem shares on a quarterly basis, at the rate of approximately one-fourth of 3% of the weighted average number of shares outstanding during the prior calendar year (including shares requested for redemption upon the death of a stockholder). Funding for redemptions for each quarter are limited to the net proceeds we receive from the sale of shares, in that quarter, under our DRIP Offering. These limits might prevent us from accommodating all redemption requests made in any fiscal quarter or in any twelve month period. Our board of directors also reserves the right, in its sole discretion at any time, and from time to time, to reject any request for redemption for any reason.
The provisions of the share redemption program in no way limit our ability to repurchase shares from stockholders by any other legally available means for any reason that our board of directors, in its discretion, deems to be in our best interest. During the three months ended September 30, 2012, we redeemed shares as follows:


 
Total Number
of Shares
Redeemed
 
Average Price
Paid per Share
 
Total Number of Shares
Purchased as Part
of Publicly Announced
Plans or Programs
 
Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
July 2012
 
—

 
$
—

 
—

 
(1)
August 2012
 
1,538,322

 
$
9.32

 
1,538,322

 
(1)
September 2012
 
1,751

 
$
9.31

 
1,751

 
(1)
Total
 
1,540,073

 
 
 
1,540,073

 
(1)
 
 
 
 
 
 
 
 
 
 
(1)
A description of the maximum number of shares that may be purchased under our redemption program is included in the narrative preceding this table.

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Item 3.
Defaults Upon Senior Securities
No events occurred during the three months ended September 30, 2012 that would require a response to this item.
Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
No events occurred during the three months ended September 30, 2012 that would require a response to this item.
Item 6.
Exhibits
The exhibits listed on the Exhibit Index (following the signatures section of this Quarterly Report on Form 10-Q) are included herewith, or incorporated herein by reference.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Cole Credit Property Trust II, Inc.
(Registrant)
 
 
 
 
By:
 
/s/ Gavin B. Brandon
 
Name: Gavin B. Brandon
 
Title:   Vice President of Accounting
           (Principal Accounting Officer)
Date: November 9, 2012


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EXHIBIT INDEX
The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2012 (and are numbered in accordance with Item 601 of Regulation S-K).
 
Exhibit No.
 
Description
3.1
 
Fifth Articles of Amendment and Restatement, as corrected (Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K (File No. 333-121094), filed on March 23, 2006).
 
 
 
3.2
 
Amended and Restated Bylaws (Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K (File No. 333-121094), filed on September 6, 2005).
 
 
 
3.3
 
Articles of Amendment to Fifth Articles of Amendment and Restatement (Incorporated by reference to Exhibit 3.3 to the Company’s Form S-11 (File No. 333-138444), filed on November 6, 2006).
 
 
 
31.1*
 
Certification of the Principal Executive Officer of the Company pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2*
 
Certification of the Principal Financial Officer of the Company pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1**
 
Certification of the Principal Executive Officer and Principal Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS***
 
XBRL Instance Document.
 
 
 
101.SCH***
 
XBRL Taxonomy Extension Schema Document.
 
 
 
101.CAL***
 
XBRL Taxonomy Extension Calculation Linkbase Document.
 
 
 
101.DEF***
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
 
 
101.LAB***
 
XBRL Taxonomy Extension Label Linkbase Document.
 
 
 
101.PRE***
 
XBRL Taxonomy Extension Presentation Linkbase Document.

*
Filed herewith.
**
In accordance with Item 601(b) (32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
***
XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.


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