ORGANIZATION AND ACCOUNTING POLICIES

6 Months Ended

Mar. 31, 2021

Organization, Consolidation and Presentation of Financial Statements [Abstract]

ORGANIZATION AND ACCOUNTING POLICIES

NOTE 1 – ORGANIZATION AND ACCOUNTING POLICIES

Monmouth Real Estate Investment Corporation, a Maryland corporation, together with its consolidated subsidiaries (we, our, us, the Company or MREIC), operates as a real estate investment trust (REIT) deriving its income primarily from real estate rental operations. We were founded in 1968 and are one of the oldest public equity REITs in the world. As of March 31, 2021, we owned 121 properties with total square footage of 24.6 million, as compared to 119 properties with total square footage of 23.4 million as of September 30, 2020. Our occupancy rate at the end of the quarter was 99.7% as compared to 99.4% as of September 30, 2020. Subsequent to quarter end, on April 15, 2021, we sold our 60,400 square foot building located in Carlstadt (New York, NY), NJ. As this property was one of our two joint venture holdings, we now have only one property that is not wholly-owned by MREIC (Somerset, NJ). Our properties are located in 31 states: Alabama, Arizona, Colorado, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Virginia, Washington and Wisconsin. As of the quarter ended March 31, 2021, our weighted average lease term was 7.4 years and our annualized average base rent per occupied square foot was $6.51. As of March 31, 2021, the weighted average building age, based on the square footage of our buildings, was 9.9 years.

The future effects of the evolving impact of the COVID-19 Pandemic are uncertain however, at this time COVID-19 has not had a material adverse effect on our financial condition. We invest in modern single-tenant, industrial buildings, leased primarily to investment-grade tenants or their subsidiaries on long-term net-leases. Our investments are exclusively situated in the continental United States, and are primarily located in strategic locations that are mission-critical to our tenants’ needs. In many cases our buildings are highly automated in order to better serve the omni-channel distribution networks that have become essential today. Approximately 83% of our revenue is derived from investment-grade tenants, or their subsidiaries as defined by S&P Global Ratings (www.standardandpoors.com) and by Moody’s (www.moodys.com). The references in this report to S&P Global Ratings and Moody’s are not intended to and do not include, or incorporate by reference into this report, the information of S&P Global Ratings or Moody’s on such websites.

For many years, ecommerce demand has increased, and it has now become an integral part of the retail landscape. The COVID-19 Pandemic has created an even greater move towards on-line shopping. As a result of state and local government-mandated shutdowns, public health guidance and changing consumer demand, ecommerce sales as a percentage of total retail sales has substantially increased during the past year. The COVID-19 Pandemic has also created a need for supply chain reconfiguration. It is estimated that ecommerce sales require three times the warehouse space relative to brick and mortar retail sales. Increased inventory stocking is currently taking place across many industries and it appears that this trend will continue in order to accommodate surges in demand.

Our portfolio of modern, net-leased industrial properties continues to provide shareholders with reliable and predictable income streams. Our resilient occupancy rates and rent collection results during these challenging times highlight the mission-critical nature of our assets and underscore the essential need for our tenants’ operations. Furthermore, because our weighted average lease term is 7.4 years and our weighted average fixed rate mortgage debt maturity is 11.3 years, we expect our cash flow to remain resilient over long periods of time. Our overall occupancy rate and our base rent collections have remained strong throughout the COVID-19 Pandemic. Our overall occupancy rate has been over 99% throughout the Pandemic and was 99.7% during the current quarter. Our base rent collections have averaged 99.9% throughout the COVID-19 Pandemic and we expect future months to be consistent with this trend.

On May 4, 2021, we announced that, following a comprehensive strategic alternatives process, we entered into a definitive merger agreement with Equity Commonwealth, a New York Stock Exchange traded real estate investment trust, by which Equity Commonwealth will acquire MREIC in an all-stock transaction. See Note 10-Subsequent Events.

Income Tax

We have elected to be taxed as a REIT under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the Code), and we intend to maintain our qualification as a REIT in the future. As a qualified REIT, with limited exceptions, we will not be taxed under Federal and certain state income tax laws at the corporate level on taxable income that we distribute to our shareholders. For special tax provisions applicable to REITs, refer to Sections 856-860 of the Code. We are subject to franchise taxes in several of the states in which we own properties.

In December 2017, as part of the Tax Cuts and Jobs Act of 2017 (the TCJA), Section 199A was added to the Code and became effective for tax years beginning after December 31, 2017 and before January 1, 2026. Under the TCJA, subject to certain income limitations, an individual taxpayer and estates and trusts may deduct 20% of the aggregate amount of qualified REIT dividends they receive from their taxable income. Qualified REIT dividends do not include any portion of a dividend received from a REIT that is classified as a capital gain dividend or non-qualified dividend income.

We follow the provisions of ASC Topic 740, Income Taxes, that, among other things, defines a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Based on our evaluation, we determined that we have no uncertain tax positions and no unrecognized tax benefits as of March 31, 2021. We record interest and penalties relating to unrecognized tax benefits, if any, as interest expense. As of March 31, 2021, the fiscal tax years 2017 through and including 2020 remain open to examination by the Internal Revenue Service. There are currently no federal tax examinations in progress.

The interim Consolidated Financial Statements furnished herein have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America (U.S. GAAP) applicable to interim financial information, the instructions to Form 10-Q, and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation, have been included. Operating results for the three and six months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2021. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020.

Use of Estimates

In preparing the financial statements in accordance with U.S. GAAP, we are required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods and related disclosure of contingent assets and liabilities. Actual results could differ from these estimates and assumptions.

Reclassification

Certain prior period amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the current period’s presentation.

Stock Compensation Plan

We account for awards of stock, stock options and restricted stock in accordance with ASC 718-10, “Compensation-Stock Compensation.” ASC 718-10 requires that compensation cost for all stock awards be calculated and amortized over the service period (generally equal to the vesting period). The compensation cost for stock option grants is determined using option pricing models, intended to estimate the fair value of the awards at the grant date less estimated forfeitures. The compensation expense for restricted stock is recognized based on the fair value of the restricted stock awards less estimated forfeitures. The fair value of stock awards and restricted stock awards is equal to the fair value of our stock on the grant date. The amortization of compensation costs for the awards of stock, stock option grants and restricted stock are included in General and Administrative Expenses in the accompanying Consolidated Statements of Income and amounted to $77,000 and $114,000 for the three months ended March 31, 2021 and 2020, respectively and amounted to $134,000 and $270,000 for the six months ended March 31, 2021 and 2020, respectively.

During the six months ended March 31, 2021 and 2020, the following stock options, which vest one year after grant date, were granted under our Stock Option Plan:

Date of Grant	Number of Employees	Number of Shares (in thousands)		Option Price		Expiration Date
01/13/21	1		65	$	16.46	01/13/29
01/13/20	1		65	$	14.55	01/13/28

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in the fiscal year indicated:

	Fiscal 2021			Fiscal 2020
Dividend yield		4.37	%		4.67	%
Expected volatility		20.17	%		18.40	%
Risk-free interest rate		0.80	%		1.76	%
Expected lives (years)		8			8
Estimated forfeitures		0			0

The weighted average fair value of options granted during the six months ended March 31, 2021 and 2020 was $1.49 and $1.24 per share subject to the option.

During the six months ended March 31, 2021 and 2020, no shares of restricted stock were granted. During the six months ended March 31, 2021, three participants exercised options to purchase 159,000 shares of common stock at a weighted average price of $12.37 per share for total proceeds of $2.0 million. During the six months ended March 31, 2020, two participants exercised options to purchase 95,000 shares of common stock at a weighted average price of $10.69 per share for total proceeds of $1.0 million. As of March 31, 2021, a total of 1.2 million shares were available for grant as stock, stock options, restricted stock, or other equity-based awards, plus any shares subject to outstanding options that expire or are forfeited without being exercised. As of March 31, 2021, there were outstanding options to purchase 856,000 shares with an aggregate intrinsic value of $3.5 million.

Lease Termination Income

Lease Termination Income is recognized in operating revenues when there is a signed termination agreement, all of the conditions of the agreement have been met, the tenant is no longer occupying the property and the termination consideration is probable of collection. Lease termination amounts are paid by tenants who want to terminate their lease obligations before the end of the contractual term of the lease by agreement with us.

Effective October 1, 2020, we entered into a lease termination agreement with RGH Enterprises, Inc. (Cardinal Health) for our 75,000 square foot facility located in Halfmoon (Albany), NY whereby we received a termination fee in the amount of $377,000 representing approximately 50% of the then remaining rent due under the lease, which was set to expire in 1.2 years on November 30, 2021. We simultaneously entered into a 10.4 year lease agreement with United Parcel Service, Inc. (UPS) which became effective November 1, 2020. The lease agreement with UPS provides for five months of free rent, after which, on April 1, 2021, initial annual rent of $510,000, representing $6.80 per square foot, will commence, with 2.0% annual increases thereafter, resulting in a straight-line annualized rent of $541,000, representing $7.21 per square foot over the life of the lease, which expires March 31, 2031. This compares to the former U.S GAAP straight-line rent of $574,000, representing $7.65 per square foot and former cash rent of $8.19 per square foot, resulting in a decrease of $33,000, representing a 5.8% decrease on a U.S GAAP straight-line basis and a decrease of 17.0% on a cash basis. The new 10.4 year lease agreement with UPS provides for an additional 9.3 years of lease term versus the old lease with Cardinal Health.

Only four of our 121 properties have leases that contain an early termination provision. These four properties contain 260,000 total rentable square feet, representing 1% of our total rentable square feet. Our leases with early termination provisions are our 36,000 square foot location in Urbandale (Des Moines), IA, our 39,000 square foot location in Rockford, IL, our 83,000 square foot location in Roanoke, VA and our 102,000 square foot location in O’Fallon (St. Louis), MO. Each lease termination provision contains certain requirements that must be met in order to exercise each termination provision. These requirements include: the date termination can be exercised, the time frame that notice must be given by the tenant to us and the termination fee that would be required to be paid by the tenant to us. The total potential termination fee to be paid to us from the four tenants with leases that have a termination provision amounts to $2.0 million.

Gains on Sale of Real Estate Investment

Gains on the sale of real estate investment is recognized when the profit on a given sale is determinable, and the seller is not obliged to perform significant activities after the sale to earn such profit.

Recent Accounting Pronouncements

In April 2020, FASB issued interpretive guidance relating to the accounting for lease concessions provided as a result of the COVID-19 Pandemic that allows entities to treat the concession as if it was a part of the existing contract instead of applying lease modification accounting. This guidance is only applicable to the COVID-19 Pandemic related lease concessions that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee. We have elected this option relating to qualifying rent deferral and rent abatement agreements. For qualifying lease modifications with rent deferrals, this results in no change to our revenue recognition but an increase in the lease receivable balance until the deferred rent has been repaid. For qualifying lease modifications that include rent abatement concessions, this results in a direct reduction of rental income in the current period. As of March 31, 2021, we have entered into rent deferral agreements related to the COVID-19 Pandemic representing approximately $438,000 of base rent otherwise owed during the months of April through October 2020 representing 31 basis points of our total annual base rent. As of the quarter end, we have collected 85% of this $438,000 deferred rent amount.

We do not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying Consolidated Financial Statements.

Segment Reporting & Financial Information

Our primary business is the ownership and management of real estate properties. We invest in well-located, modern, single-tenant, industrial buildings, leased primarily to investment-grade tenants or their subsidiaries on long-term net-leases. We review operating and financial information for each property on an individual basis and therefore, each property represents an individual operating segment. We evaluate financial performance using Net Operating Income (NOI) from property operations. NOI is a non-GAAP financial measure, which we define as recurring Rental and Reimbursement Revenue, less Real Estate Taxes and Operating Expenses, such as insurance, utilities and repairs and maintenance. We have aggregated the properties into one reportable segment as the properties share similar long-term economic characteristics and have other similarities, including the fact that they are operated as industrial properties subject to long-term net-leases primarily to investment-grade tenants or their subsidiaries.

Derivative Instruments and Hedging Activities

In the normal course of business, we are exposed to financial market risks, including interest rate risk on our variable rate debt. We attempt to limit these risks by following established risk management policies, procedures and strategies, including the use of derivative financial instruments. Our primary strategy in entering into derivative contracts is to minimize the variability that changes in interest rates could have on its future cash flows. We generally employ derivative instruments that effectively convert a portion of our variable rate debt to fixed rate debt. We do not enter into derivative instruments for speculative purposes. As further described in “Note 5 – Debt”, in November 2019 we entered into an interest rate swap agreement that has the effect of fixing the interest rate on our $75.0 million unsecured term loan (the “Term Loan”).

The interest rate for borrowings under the Term Loan will at our election, either i) bear interest at LIBOR plus 130 basis points to 200 basis points, depending on our leverage ratio, or ii) bear interest at BMO’s prime lending rate plus 30 basis points to 100 basis points, depending on our leverage ratio. The re-pricing and scheduled maturity dates, payment dates, index and the notional amounts of the interest rate swap agreement coincides with those of the underlying Term Loan. The interest rate swap agreement is net settled monthly. The Company has designated this derivative as a cash flow hedge and has recorded the fair value on the balance sheet in accordance with ASC 815, Derivatives and Hedging (See Note 7 for information on the determination of fair value). The effective portion of the gain or loss on this hedge will be reported as a component of Accumulated Other Comprehensive Loss on our Consolidated Balance Sheets. To the extent that the hedging relationship is not effective or does not qualify as a cash flow hedge, the ineffective portion is recorded in interest expense. Hedges that received designated hedge accounting treatment are evaluated for effectiveness at the time that they are designated as well as through the hedging period. As of March 31, 2021, the Company has determined that this interest rate swap agreement is highly effective as a cash flow hedge. As a result, the fair value of this derivative of $2.6 million and $4.4 million as of March 31, 2021 and September 30, 2020, respectively, was recorded as a component of Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets, with the corresponding liability included in Other Liabilities. The change in the fair value of the interest rate swap agreement is reflected in the Consolidated Statement of Comprehensive Income and amounted to $1.4 million and $1.8 million for the three and six months ended March 31, 2021.