Fair Value of Financial Instruments

The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. The guidance defines three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.

Level 3 – Unobservable inputs that reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.

The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects that changes in classifications between levels will be infrequent.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2014 and 2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

During the year ended December 31, 2014, real estate assets with a carrying amount of $199.5 million related to 16 properties were deemed to be impaired and their carrying amounts were reduced to their estimated fair values, resulting in impairment charges of $100.5 million. During the year ended December 31, 2013, real estate assets with a carrying amount of $4.5 million related to two properties were deemed to be impaired, resulting in impairment charges of $3.3 million. Impairment charges for the years ended 2014 and 2013 are included in impairments on the consolidated statements of operations.

The Company’s estimated fair values of its real estate assets were primarily based upon an income approach utilizing a present value technique to discount the expected cash flows using market participant assumptions for market rent and terminal values, which are considered to be Level 3 inputs, or based upon recent comparable sales transactions, which are considered to be Level 2 inputs. The aggregate fair value of impaired real estate assets for the year ended December 31, 2014 and December 31, 2013 was $99.0 million and $1.2 million, respectively.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and December 31, 2013, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):



	Level 1		Level 2			Level 3			Balance as of December 31, 2014
Assets:
CMBS	$	—	$	—		$	58,646		$	58,646
Interest rate swap assets	—		5,509			—			5,509
Total assets	$	—	$	5,509		$	58,646		$	64,155
Liabilities:
Interest rate swap liabilities	$	—	$	(7,384	)	$	—		$	(7,384	)

	Level 1		Level 2			Level 3			Balance as of December 31, 2013
Assets:
Investments in real estate fund	$	—	$	1,484		$	—		$	1,484
CMBS	—		—			60,583			60,583
Interest rate swap assets	—		9,189			—			9,189
Total assets	$	—	$	10,673		$	60,583		$	71,256
Liabilities:
Interest rate swap liabilities	$	—	$	(1,719	)	$	—		$	(1,719	)
Series D Preferred Stock embedded derivative	—		—			(16,736		)	(16,736		)
Total liabilities	$	—	$	(1,719	)	$	(16,736	)	$	(18,455	)

CMBS – The fair values of the Company’s CMBS are valued using broker quotations, collateral values, subordination levels and liquidity of the individual securities.

Derivatives – The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.

Series D Preferred Stock embedded derivative – The valuation of this derivative instrument was determined using a binomial option pricing model. Key inputs in the model include the expected term, risk-free interest rate, volatility and dividend yield.

The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, due to affiliates and accounts payable approximate their carrying value on the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.

A review of the fair value hierarchy classification is conducted on a quarterly basis. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1 and Level 2 or Level 3 of the fair value hierarchy during the year ended December 31, 2014.

The following are reconciliations of the changes in instruments with Level 3 inputs in the fair value hierarchy for the years ended December 31, 2014 and 2013(in thousands):



	CMBS			Series D Preferred Stock Embedded Derivative			Contingent Consideration Arrangements			Total
Balance, December 31, 2012	$	—		$	—		$	—		$	—
Fair value at purchase/issuance	60,730			(18,692		)	—			42,038
Dispositions	(278		)	—			—			(278		)
Changes in fair value included in net loss	131			1,956			—			2,087
Balance, December 31, 2013	60,583			(16,736		)	—			43,847
Total gains and losses:
Unrealized gain included in other comprehensive income, net	8,731			—			—			8,731
Changes in fair value included in net loss	—			(13,594		)	3,292			(10,302		)
Purchases, issuances, settlements and amortization:
Fair value at purchase/issuance	151,197			—			(3,606		)	147,591
Dispositions	(158,637		)				—			(158,637		)
Principal payments received	(3,505		)	—			—			(3,505		)
Amortization included in net loss	277			—			—			277
Payment	—			—			314			314
Redemption of Series D	—			30,330			—			30,330
Balance, December 31, 2014	$	58,646		$	—		$	—		$	58,646

The fair values of the Company’s financial instruments that are not reported at fair value on the consolidated balance sheets are reported below (dollar amounts in thousands):



	Level	Carrying Amount at December 31, 2014		Fair Value at December 31, 2014		Carrying Amount at December 31, 2013		Fair Value at December 31, 2013
Assets:
Loans held for investment	3	$	42,106	$	42,645	$	26,279	$	26,435

Liabilities:
Mortgage notes payable, net	3	$	3,759,935	$	3,883,341	$	1,301,114	$	1,305,823
Corporate bonds, net	3	2,546,499		2,709,845		—		—
Convertible debt, net	3	977,521		1,088,069		972,490		976,629
Credit facilities	3	3,184,000		3,145,884		1,969,800		1,843,145
Other Debt	3	45,826		47,688		104,804		228,399
Total liabilities		$	10,513,781	$	10,874,827	$	4,348,208	$	4,353,996

Loans held for investment – The fair value of the Company’s fixed-rate loan portfolio is estimated with a discounted cash flow analysis, utilizing scheduled cash flows and discount rates estimated by management to approximate those that a willing buyer and seller might use.

Credit facilities – Management believes that the stated interest rates (which float based on short-term interest rates) approximate market rates. As such, the fair values of these obligations are estimated to be equal to the outstanding principal amounts.

Convertible notes, mortgage notes payable and secured term loan – The fair value of mortgages payable on real estate investments and the secured term loan is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of market interest rates.

Trust preferred notes – The fair value of the Company’s other long-term debt is estimated using a discounted cash flow analysis, based on management’s estimates of market interest rates.