Fair Value Measures

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. U.S. GAAP 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 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. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the nine months ended September 30, 2015. The Company expects that changes in classifications between levels will be infrequent.

The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying amounts of its real estate 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 or tenants, such as a history of late payments, rental concessions and other factors, as well as significant decreases in a property’s revenues due to lease terminations, vacancies, co-tenancy clauses, or reduced lease rates. When impairment indicators are identified, 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 assets to their respective fair values and recognize an impairment loss. During the three months ended September 30, 2015, no impairment indicators were identified through the procedures noted above.

During the second quarter of 2015, the Company identified certain properties with a more likely than not probability of being disposed of within the next 12 to 24 months, in addition to the properties identified through the quarterly review procedures noted above. The Company considered the likely disposition to be an impairment indicator for these properties. As such, the Company reviewed estimated selling prices for these assets based on a number of factors including, but not limited to, existing leases in place, comparable lease rates and sales prices, third party opinions of value, comparable capitalization rates and estimated disposal costs. Of the properties reviewed, 161 properties were noted to have an estimated sales price, less disposal costs, that was less than the carrying amount of each respective property. As such, the Company reduced the carrying amounts of each asset to their respective fair values and recognized an impairment loss for such reductions. During the nine months ended September 30, 2015 and 2014, real estate assets with carrying values totaling $319.3 million and $8.2 million, respectively, were deemed to be impaired and their carrying values were reduced to their estimated fair values of $234.0 million and $4.3 million, resulting in impairment charges of $85.3 million and $3.9 million, respectively.

The following table presents the impairment charges by asset class recorded during the nine months ended September 30, 2015 and 2014 (dollar amounts in thousands):



	Nine Months Ended September 30,
	2015			2014
Properties impaired	188			9

Asset classes impaired:
Investment in real estate assets, net	$	82,654		$	3,855
Investment in direct financing leases, net	3,417			—
Below-market lease liabilities, net	(730		)	—
Total impairment loss	$	85,341		$	3,855

The Company’s estimated fair values of its real estate assets were primarily based upon recent comparable sales transactions, which are considered to be Level 2 inputs, or 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.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, 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 September 30, 2015
Assets:
CMBS	$	—	$	—		$	54,455	$	54,455
Total assets	$	—	$	—		$	54,455	$	54,455
Liabilities:
Interest rate swap liabilities	$	—	$	(15,350	)	$	—	$	(15,350	)

	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	)

CMBS – The Company’s CMBS are carried at fair value and are valued using Level 3 inputs. The Company used estimated non-binding quoted market prices from the trading desks of financial institutions that are dealers in such securities for similar CMBS tranches that actively participate in the CMBS market. Broker quotes are only indicative of fair value and may not necessarily represent what the Company would receive in an actual trade for the applicable instrument. Management determines the prices are representative of fair value through their knowledge of and experience in the market. The significant unobservable input used in valuing the CMBS is the discount rate or market yield used to discount the estimated future cash flows expected to be received from the underlying investment, which include both future principal and interest payments. Significant increases or decreases in the discount rate or market yield would result in a decrease or increase in the fair value measurement. The following risk factors are included in the consideration and selection of discount rates or market yields: risk of default, rating of the investment and comparable company investments.

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.

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 September 30, 2015, 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.

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 in the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.

The following are reconciliations of the changes in assets and (liabilities) with Level 3 inputs in the fair value hierarchy for the nine months ended September 30, 2015 and 2014 (in thousands):



	CMBS
Beginning balance, December 31, 2014	$	58,646
Total gains and losses:
Unrealized loss included in other comprehensive income, net	(232		)
Purchases, issuances, settlements and amortization:
Principal payments received	(4,055		)
Amortization included in net income	96
Ending balance, September 30, 2015	$	54,455



	CMBS			Series D Preferred Stock Embedded Derivative			Contingent Consideration Arrangements			Total
Beginning balance, December 31, 2013	$	60,583		$	(16,736	)	$	—		$	43,847
Total gains and losses:
Unrealized gain included in other comprehensive income, net	9,456			—			—			9,456
Changes in fair value included in net loss	—			(13,574		)	(990		)	(14,564		)
Purchases, issuances, settlements and amortization:
Fair value at purchase/issuance	151,197			—			(3,606		)	147,591
Sale of CMBS acquired in the Cole Merger	(151,248		)	—			—			(151,248		)
Reclassification of previous unrealized gains on investment securities into net loss-CMBS	(7,417		)	—			—			(7,417		)
Return of principal received	(3,678		)	—			—			(3,678		)
Amortization included in net loss	184			—			—			184
Reclassification of contingent consideration to held for sale	—			—			4,596			4,596
Redemption of Series D	—			30,310			—			30,310
Ending balance, September 30, 2014	$	59,077		$	—		$	—		$	59,077

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



	Level	Carrying Amount at September 30, 2015		Fair Value at September 30, 2015		Carrying Amount at December 31, 2014		Fair Value at December 31, 2014
Assets:
Loans held for investment	3	$	40,002	$	48,330	$	42,106	$	42,645

Liabilities:
Mortgage notes payable and other debt, net ⁽¹⁾	3	$	3,210,413	$	3,476,992	$	3,805,761	$	3,931,029
Corporate bonds, net	3	2,547,059		2,588,214		2,546,499		2,709,845
Convertible debt, net	3	981,031		1,020,495		977,521		1,088,069
Credit facilities	3	2,110,000		2,114,292		3,184,000		3,145,884
Total liabilities		$	8,848,503	$	9,199,993	$	10,513,781	$	10,874,827

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(1) Includes mortgage notes secured by properties held for sale as of September 30, 2015.

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 market interest rates.

Mortgage notes payable and other debt and credit facilities – The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of market interest rates.

Convertible debt and corporate bonds – The fair value is estimated based on current pricing marks received from an independent third party.