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, 2017. The Company expects that changes in classifications between levels will be infrequent.

Items Measured at Fair Value on a Recurring Basis

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis, based on market rates of the Company’s positions and other observable interest rates as discussed in Note 6 – Investment Securities, at Fair Value and Note 11 – Derivatives and Hedging Activities, as of September 30, 2017 and December 31, 2016, 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, 2017
Assets:
CMBS	$	—	$	—		$	41,677	$	41,677
Derivative assets	—		351			—		351
Total assets	$	—	$	351		$	41,677	$	42,028

	Level 1		Level 2			Level 3		Balance as of December 31, 2016
Assets:
CMBS	$	—	$	—		$	47,215	$	47,215
Derivative assets	—		199			—		199
Total assets	$	—	$	199		$	47,215	$	47,414
Liabilities:
Derivative liabilities	$	—	$	(3,547	)	$	—	$	(3,547	)

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 that the prices are representative of fair value through its 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 risks are included in the consideration and selection of discount rates or market yields: risk of default, rating of the investment and comparable company investments.

Derivative Assets and Liabilities – The Company’s derivative financial instruments relate to interest rate swaps, discussed in Note 11 – Derivatives and Hedging Activities. 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, 2017, 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, 2017 and 2016 (in thousands):



	CMBS
Balance as of December 31, 2016	$	47,215
Total gains and losses
Unrealized loss included in other comprehensive income, net	(547		)
Purchases, issuance, settlements
Return of principal received	(4,077		)
Amortization included in net income, net	(914		)
Ending Balance, September 30, 2017	$	41,677



	CMBS
Balance as of December 31, 2015	$	53,304
Total gains and losses
Unrealized loss included in other comprehensive loss, net	(1,599		)
Purchases, issuance, settlements
Return of principal received	(3,786		)
Accretion included in net loss, net	179
Ending Balance, September 30, 2016	$	48,098

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, 2017		Fair Value at September 30, 2017		Carrying Amount at December 31, 2016		Fair Value at December 31, 2016
Assets:
Mortgage notes receivable	3	$	20,510	$	28,539	$	22,764	$	30,460

Liabilities⁽¹⁾:
Mortgage notes payable and other debt, net	2	$	2,129,461	$	2,186,955	$	2,687,739	$	2,713,155
Corporate bonds, net	2	2,848,591		2,944,615		2,248,063		2,273,850
Convertible debt, net	2	990,922		1,021,580		987,106		1,004,733
Credit facility	2	—		—		500,000		500,000
Total liabilities		$	5,968,974	$	6,153,150	$	6,422,908	$	6,491,738

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(1)	Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.

Mortgage notes receivable – 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.

Debt – The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of observable market interest rates. Corporate bonds and convertible debt are valued using quoted market prices in active markets with limited trading volume when available.

Items Measured at Fair Value on a Non-Recurring Basis

Certain financial and nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.

Real Estate Assets

As discussed in Note 5 – Real Estate Investments, during the nine months ended September 30, 2017, net real estate assets and an investment in a property subject to a direct financing lease representing 53 properties were deemed to be impaired and their carrying values were reduced to their estimated fair value of $57.0 million, resulting in impairment charges of $30.9 million. During the nine months ended September 30, 2016, net real estate assets related to 139 properties were deemed to be impaired and their carrying values totaling $655.1 million were reduced to their estimated fair values of $478.9 million, resulting in impairment charges of $176.2 million. The Company estimates fair values using Level 3 inputs and using a combined income and market approach, specifically using discounted cash flow analysis and recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and to make certain key assumptions, including, but not limited to, the following: (1) capitalization rate; (2) discount rates; (3) number of years property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental income and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants. For the Company’s impairment tests for the real estate assets during the nine months ended September 30, 2017, the Company used a range of discount rates from 7.4% to 7.8% with a weighted-average rate of 7.5% and capitalization rates from 6.9% to 10.0% with a weighted-average rate of 8.2%.

The following table presents the impairment charges by asset class recorded during the nine months ended September 30, 2017 (dollar amounts in thousands):



	Nine Months Ended September 30, 2017
Properties impaired ⁽¹⁾	53

Asset classes impaired:
Investment in real estate assets, net	$	30,327
Investment in direct financing leases, net	553
Below-market lease liabilities, net	(23		)
Total impairment loss	$	30,857

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(1)	Six of these properties were disposed of during the nine months ended September 30, 2017.