Claros Mortgage Trust, Inc. (CMTG) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those in this discussion as a result of various factors, including those discussed in Part I. Item 1A, “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” in this Annual Report on Form 10-K.

Introduction

We are a CRE finance company focused primarily on originating senior and subordinate loans on transitional CRE assets located in major U.S. markets, including mortgage loans secured by a first priority or subordinate mortgage on transitional CRE assets, and subordinate loans including mezzanine loans secured by a pledge of equity ownership interests in the direct or indirect property owner rather than directly in the underlying commercial properties. These loans are subordinate to a mortgage loan but senior to the property owner’s equity ownership interests. Transitional CRE assets are properties that require repositioning, renovation, rehabilitation, leasing, development or redevelopment or other value-added elements in order to maximize value. We believe our Sponsor’s real estate development, ownership and operations experience, and infrastructure differentiates us in lending on these transitional CRE assets. Our objective is to be a premier provider of debt capital for transitional CRE assets and, in doing so, to generate attractive risk-adjusted returns for our stockholders over time, primarily through dividends. We strive to create a diversified investment portfolio of CRE loans that we generally intend to hold to maturity. We focus primarily on originating loans ranging from $50 million to $300 million on transitional CRE assets located in U.S. markets with attractive fundamental characteristics supported by macroeconomic tailwinds.

We were organized as a Maryland corporation on April 29, 2015 and commenced operations on August 25, 2015, and our common stock is traded on the New York Stock Exchange, or NYSE, under the symbol “CMTG.” We have elected and believe we have qualified to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2015. We are externally managed and advised by our Manager, an investment adviser registered with the Securities and Exchange Commission (“SEC”) pursuant to the Investment Advisers Act of 1940, as amended, (the “Advisers Act”). We operate our business in a manner that permits us to maintain our exclusion from registration under the Investment Company Act of 1940, as amended (the “1940 Act”).

I. Key Financial Measures and Indicators

As a CRE finance company, we believe the key financial measures and indicators for our business are net income (loss) per share, Distributable Earnings (Loss) per share, Distributable Earnings per share prior to realized gains and losses, which includes principal charge-offs, dividends declared per share, book value per share, adjusted book value per share, Net Debt-to-Equity Ratio and Total Leverage Ratio. During the year ended December 31, 2023, we had net income per share of $0.02, Distributable Earnings (Loss) per share of $0.28, and Distributable Earnings per share prior to realized gains and principal charge-offs of $1.31, and dividends declared per share of $1.24. As of December 31, 2023, our book value per share was $16.28, our adjusted book value per share was $17.03, our Net-Debt-to-Equity Ratio was 2.4x, and our Total Leverage Ratio was 2.8x. We use Net Debt-to-Equity Ratio and Total Leverage Ratio, financial measures which are not prepared in accordance with GAAP, to evaluate our financial leverage, which in the case of our Total Leverage Ratio, makes certain adjustments that we believe provide a more conservative measure of our financial condition.

Net Income Per Share and Dividends Declared Per Share

The following table sets forth the calculation of basic and diluted net income per share and dividends declared per share ($ in thousands, except share and per share data):

We intend to declare and pay regular quarterly dividends to our stockholders, although all future distributions will be declared and paid at the discretion of the Board of Directors and will depend upon cash generated by operating activities, our financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Code and such other factors as the Board of Directors deems relevant.

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Distributable Earnings (Loss)

Distributable Earnings (Loss) is a non-GAAP measure used to evaluate our performance excluding the effects of certain transactions, non-cash items and GAAP adjustments, as determined by our Manager. Distributable Earnings (Loss) is a non-GAAP measure, which we define as net income (loss) in accordance with GAAP, excluding (i) non-cash stock-based compensation expense, (ii) real estate depreciation and amortization, (iii) any unrealized gains or losses from mark-to-market valuation changes (other than permanent impairments) that are included in net income (loss) for the applicable period, (iv) one-time events pursuant to changes in GAAP and (v) certain non-cash items, which in the judgment of our Manager, should not be included in Distributable Earnings (Loss). Furthermore, the Company presents Distributable Earnings prior to realized gains and losses, which includes principal charge-offs, as the Company believes this more easily allows our Board, Manager, and investors to compare our operating performance to our peers, to assess our ability to declare and pay dividends, and to determine our compliance with certain financial covenants. Pursuant to the Management Agreement, we use Core Earnings, which is substantially the same as Distributable Earnings (Loss) excluding incentive fees, to determine the incentive fees we pay our Manager.

We believe that Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses provide meaningful information to consider in addition to our net income (loss) and cash flows from operating activities in accordance with GAAP. Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses do not represent net income (loss) or cash flows from operating activities in accordance with GAAP and should not be considered as an alternative to GAAP net income (loss), an indication of our cash flows from operating activities, a measure of our liquidity or an indication of funds available for our cash needs. In addition, our methodology for calculating these non-GAAP measures may differ from the methodologies employed by other companies to calculate the same or similar supplemental performance measures and, accordingly, our reported Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses may not be comparable to the Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses reported by other companies.

In order to maintain our status as a REIT, we are required to distribute at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, as dividends. Distributable Earnings (Loss), Distributable Earnings prior to realized gains and losses, and other similar measures, have historically been a useful indicator over time of a mortgage REIT’s ability to cover its dividends, and to mortgage REITs themselves in determining the amount of any dividends to declare. Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses are key factors, among others, considered by the Board in setting the dividend each quarter and as such we believe Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and losses are also useful to investors.

While Distributable Earnings (Loss) excludes the impact of our provision for or reversal of current expected credit loss reserve, principal charge-offs are recognized through Distributable Earnings (Loss) when deemed non-recoverable. Non-recoverability is determined (i) upon the resolution of a loan (i.e., when the loan is repaid, fully or partially, or when we acquire title in the case of foreclosure, deed-in-lieu of foreclosure, or assignment-in-lieu of foreclosure), or (ii) with respect to any amount due under any loan, when such amount is determined to be uncollectible.

In determining Distributable Earnings (Loss) per share and Distributable Earnings per share prior to realized gains and losses, the dilutive effect of unvested RSUs is considered. The weighted average diluted shares outstanding used for Distributable Earnings (Loss) has been adjusted from weighted average diluted shares under GAAP to include weighted average unvested RSUs.

The table below summarizes the reconciliation from weighted average diluted shares under GAAP to the weighted average diluted shares used for Distributable Earnings (Loss) for the years ended December 31, 2023 and 2022:

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The following table provides a reconciliation of net income attributable to common stock to Distributable Earnings (Loss) and Distributable Earnings prior to realized gains and principal charge-offs ($ in thousands, except share and per share data):

Book Value Per Share

We believe that presenting book value per share adjusted for the general current expected credit loss reserve and accumulated depreciation and amortization on our real estate owned and related lease intangibles is useful for investors as it enhances the comparability across the industry. We believe that our investors and lenders consider book value excluding these items as an important metric related to our overall capitalization.

The following table sets forth the calculation of our book value and our adjusted book value per share as of December 31, 2023 and 2022 ($ in thousands, except share and per share data):

(1)
Calculated as (i) total equity divided by (ii) number of shares of common stock outstanding and RSUs at period end.

II. Our Portfolio

The below table summarizes our loans receivable held-for-investment as of December 31, 2023 ($ in thousands):

(1)
Loan commitment represents principal outstanding plus remaining unfunded loan commitments.

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(2)
Net of specific CECL reserve of $72.6 million.

(3)
Weighted averages are based on unpaid principal balance.

(4)
Represents the weighted average annualized yield to initial maturity of each loan, inclusive of coupon, and fees received, based on the applicable floating benchmark rate/floors (if applicable), in place as of December 31, 2023. For loans placed on non-accrual, the annualized yield to initial maturity used in calculating the weighted average annualized yield to initial maturity is 0%.

(5)
Fully extended maturity assumes all extension options are exercised by the borrower upon satisfaction of the applicable conditions.

(6)
LTV represents “loan-to-value” or “loan-to-cost,” which is calculated as our total loan commitment from time to time, as if fully funded, plus any financings that are pari passu with or senior to our loan, divided by our estimate of either (1) the value of the underlying real estate, determined in accordance with our underwriting process (typically consistent with, if not less than, the value set forth in a third-party appraisal) or (2) the borrower’s projected, fully funded cost basis in the asset, in each case as we deem appropriate for the relevant loan and other loans with similar characteristics. Underwritten values and projected costs should not be assumed to reflect our judgment of current market values or project costs, which may have changed materially since the date of origination. LTV is updated only in connection with a partial loan paydown and/or release of collateral, material changes to expected project costs, the receipt of a new appraisal (typically in connection with financing or refinancing activity) or a change in our loan commitment. Totals represent weighted average based on loan commitment, including non-consolidated senior interests and pari passu interests. Loans with specific CECL reserves are reflected as 100% LTV.

Our loans receivable held-for-sale as of December 31, 2023 were comprised of the following loans ($ in thousands):

In January of 2024, we sold these three senior loans to an unaffiliated purchaser. The principal charge-off follows the recognition of an incremental specific CECL reserve in the same amount and is allocated and attributable to the construction status of one loan’s collateral asset and such loan’s $105.0 million of remaining unfunded commitments. As of September 30, 2023, the loans were ascribed loan risk ratings ranging from 2 to 3. As of December 31, 2023, we determined that these loans met the held-for-sale criteria and were not considered in determining our general CECL reserve.

Portfolio Activity and Overview

The following table summarizes changes in unpaid principal balance for our loans receivable held-for-investment ($ in thousands):

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The following table details our individual loan receivables held-for-investment based on unpaid principal balances as of December 31, 2023 ($ in thousands):

(1)
Loan commitment represents principal outstanding plus remaining unfunded loan commitments.

(2)
Net of specific CECL reserve of $72.6 million.

(3)
Fully extended maturity assumes all extension options are exercised by the borrower upon satisfaction of the applicable conditions.

(4)
Classification of property type and construction status reflect the state of collateral as of December 31, 2023.

(5)
Percent of total construction loans based on loan commitments as of December 31, 2023.

Real Estate Owned

On February 8, 2021, we acquired legal title to a portfolio of seven limited service hotels located in New York, NY through a foreclosure. Prior to the foreclosure, the hotel portfolio represented the collateral for a mezzanine loan held by us with an unpaid principal balance of $103.9 million and a securitized senior mortgage with an unpaid principal balance of $300.0 million held by third parties. Both loans were in default as a result of the borrower failing to pay debt service. Upon foreclosure, we assumed the securitized senior

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mortgage, which is non-recourse to us, and recorded a gain of $1.4 million based upon the hotel portfolio’s $414.0 million estimated fair value as determined by a third-party appraisal. As of December 31, 2023, the hotel portfolio appears as part of real estate owned, net on our consolidated balance sheet and is encumbered by a $290.0 million securitized senior mortgage, which is included as a liability on our consolidated balance sheet. On February 7, 2024, we modified this loan agreement to provide for, among other things, an extension of the contractual maturity date to November 9, 2024, a $10.0 million principal paydown, and partial recourse to us.

On June 30, 2023, we acquired legal title to a mixed-use property located in New York, NY and the equity interests therein through an assignment-in-lieu of foreclosure. The mixed-use property contains office, retail, and signage components. Prior to the assignment-in-lieu of foreclosure, the mixed-use property and a pledge of equity interests therein represented the collateral for a senior loan with an unpaid principal balance of $208.8 million, which was in default as a result of the borrower failing to pay debt service. As of December 31, 2023, the mixed-use property appears as part of real estate owned, net and related lease intangibles, net appear within other assets and other liabilities on our consolidated balance sheet and is unencumbered.

Refer to Note 5 to our consolidated financial statements for additional details.

Asset Management

Our Manager proactively manages the loans in our portfolio from closing to final repayment and our Sponsor has dedicated asset management employees to perform asset management services. Following the closing of an investment, the asset management team rigorously monitors the loan, with an emphasis on ongoing analyses of both quantitative and qualitative matters, including financial, legal, and market conditions. Through the final repayment of a loan, the asset management team maintains regular contact with borrowers, servicers and local market experts monitoring performance of the collateral, anticipating borrower, property and market issues, and enforcing our rights and remedies when appropriate.

Some of our borrowers may experience delays in the execution of their business plans or changes in market conditions which may impact the performance of the underlying collateral asset, borrower, or sponsor. As a transitional lender, we may from time to time execute loan modifications with borrowers when and if appropriate, which may include additional equity contributions from them, repurposing of reserves, pledge of additional collateral or other forms of credit support, provide additional guarantees, temporary deferrals of interest or principal, and/or partial deferral of coupon interest as payment-in-kind interest. To the extent warranted by ongoing conditions specific to our borrowers or overall market conditions, we may make additional modifications when and if appropriate, and depending on the business plans, financial condition, liquidity and results of operations of our borrowers, among other factors.

Our Manager evaluates the credit quality of each of our loans receivable on an individual basis and assigns a risk rating at least quarterly. We have developed a loan grading system for all of our outstanding loans receivable that are collateralized directly or indirectly by real estate. Grading criteria include, but are not limited to, as-is or as-stabilized debt yield, term of loan, property type, property or collateral location, loan type and other more subjective variables that include, but is not limited to, as-is or as-stabilized collateral value, market conditions, industry conditions and sponsor’s financial stability. While evaluating the credit quality of each loan within our portfolio, we assess these quantitative and qualitative factors as a whole and with no pre-prescribed weight on their impact to our determination of a loan’s risk rating. However, based upon the facts and circumstances for each loan and the overall market conditions, we may consider certain previously mentioned factors more or less relevant than others. We utilize the grading system to determine each loan’s risk of loss and to provide a determination as to whether an individual loan is impaired and whether a specific CECL reserve is necessary. Based on a 5-point scale, the loans are graded “1” through “5,” from less risk to greater risk, respectively. The weighted average risk rating of our total loan portfolio was 3.3 at December 31, 2023.

Current Expected Credit Losses

The current expected credit loss reserve required under GAAP reflects our current estimate of potential credit losses related to our loan commitments. See Note 2 to our consolidated financial statements for further detail of our current expected credit loss reserve methodology.

During the year ended December 31, 2023, we recorded a provision for current expected credit losses of $153.7 million, which consisted of a $159.6 million increase in our specific CECL reserve prior to principal charge-offs, and a reversal of $6.0 million of general CECL reserves. The reversal of general CECL reserves was primarily attributable to the seasoning of our portfolio and a reduction in the size of our loan portfolio subject to determination of the general CECL reserve, partially offset by deteriorating macroeconomic conditions. As of December 31, 2023, our total current expected credit loss reserve was $152.7 million. See discussion above regarding principal charge-offs related to loans classified as held-for-sale as of December 31, 2023.

During the year ended December 31, 2022, we recorded a provision for current expected credit losses of $84.4 million, which consisted of a $65.5 million increase in our specific CECL reserve prior to a principal charge-off, and an increase of $18.9 million in

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our general CECL reserve. The increase in the total current expected credit loss reserve was primarily attributable to additional specific CECL reserves, an increase in the size of the portfolio and deteriorating macroeconomic conditions. As of December 31, 2022, our total current expected credit loss reserve was $146.4 million.

Specific CECL Reserves

The following table presents a summary of our loans receivable held-for-investment with specific CECL reserves as of December 31, 2023 ($ in thousands):

During the three months ended September 30, 2023, we recorded a specific CECL reserve of $30.6 million in connection with a senior loan with a borrower that is experiencing financial difficulty and the loan is in maturity default. During the three months ended December 31, 2023, we recorded additional specific CECL reserves totaling $0.6 million as a result of protective advances made during the quarter, resulting in a total specific CECL reserve of $31.2 million. The loan is secured by land in Arlington, VA and as of December 31, 2023, has an unpaid principal balance and carrying value prior to any specific CECL reserve of $151.3 million and is in maturity default. Effective January 1, 2023, this loan was placed on non-accrual status.

During the three months ended September 30, 2023, we recorded a specific CECL reserve of $20.6 million in connection with a senior loan with a borrower that is experiencing financial difficulty. During the three months ended December 31, 2023, we reduced the specific CECL reserve based on changes to the collateral value, resulting in a total specific CECL reserve of $20.5 million. The loan is secured by an office building in San Francisco, CA and a pledge of equity interests therein. As of December 31, 2023, this loan has an unpaid principal balance and carrying value prior to any specific CECL reserve of $112.4 million and $112.2 million, respectively, and an initial maturity date of February 13, 2024. Effective September 1, 2023, this loan was placed on non-accrual status.

During the three months ended September 30, 2023, we recorded a specific CECL reserve of $19.8 million in connection with a senior loan with a borrower that is experiencing financial difficulty. During the three months ended December 31, 2023, we reduced the specific CECL reserve based on changes to the collateral value, resulting in a total specific CECL reserve of $20.0 million. The loan is secured by an office building in Atlanta, GA and a pledge of equity interests therein. As of December 31, 2023, this loan has an unpaid principal balance and carrying value prior to any specific CECL reserve of $71.5 million and $71.1 million, respectively, and an initial maturity date of August 27, 2024. Effective September 1, 2023, this loan was placed on non-accrual status.

During the three months ended June 30, 2023, we recorded a specific CECL reserve of $0.9 million in connection with a subordinate loan with a borrower that is experiencing financial difficulty and the loan is in maturity default. The loan is secured by the equity interests in a retail condo in Brooklyn, NY and, as of December 31, 2023, has an unpaid principal balance and carrying value prior to any specific CECL reserve of $0.9 million and is in maturity default. Effective June 30, 2023, the loan was placed on non-accrual status.

During the three months ended December 31, 2022, we recorded a specific CECL reserve of $18.3 million in connection with a senior loan with a borrower that was experiencing financial difficulty. The loan had a then unpaid principal balance of $138.8 million, a carrying value prior to any specific CECL reserve of $138.3 million and an initial maturity date of August 8, 2024. The loan, which was comprised of a portfolio of uncrossed loans, was collateralized by a portfolio of multifamily properties located in San Francisco, CA. During the three months ended June 30, 2023, we recorded an additional specific CECL reserve of $18.8 million due to a revised valuation of the collateral properties. During the three months ended September 30, 2023, we sold the loan and recorded a principal charge-off of $73.0 million following the recognition of an incremental specific CECL reserve of $35.9 million due to a further decline in the value of the collateral properties. Effective December 1, 2022 and through the date of the loan sale, the loan was placed on non-accrual status. Prior to the loan sale and while the loan was on non-accrual status during 2023, we received payments of $1.1 million which were treated as a reduction in our carrying value.

During the three months ended December 31, 2022, we recorded a specific CECL reserve of $42.0 million in connection with a senior loan with a borrower that was experiencing financial difficulty. The loan was secured by a mixed-use building in New York, NY and a pledge of equity interests therein with an unpaid principal balance and carrying value prior to any specific CECL reserve of $208.8 million and an initial maturity date of February 1, 2023. On June 30, 2023, we obtained legal title to the collateral through an

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assignment-in-lieu of foreclosure and during the three months ended June 30, 2023 we recorded an additional specific CECL reserve of $29.2 million prior to a principal charge-off of $71.2 million. See Note 5 - Real Estate Owned for further detail. Effective November 1, 2022 and through the date of the assignment-in-lieu of foreclosure, this loan was placed on non-accrual status. Prior to obtaining legal title to the collateral and while the loan was on non-accrual status during 2023, we recognized $8.3 million of interest income.

Fair market values used to determine specific CECL reserves are calculated using a discounted cash flow model, a sales comparison approach, or a market capitalization approach. Estimates of fair market values used to determine specific CECL reserves as of December 31, 2023 include assumptions of property specific cash flows over estimated holding periods, assumptions of property redevelopment costs, discount rates ranging from 7.5% to 9.5%, and market and terminal capitalization rates ranging from 6.0% to 8.3%. These assumptions are based upon the nature of the properties, recent sales and lease comparables, and anticipated real estate and capital market conditions.

Portfolio Financing

Our financing arrangements include repurchase arrangements, a term participation facility, asset-specific financings, debt related to real estate owned and secured term loan borrowings.

The following table summarizes our loans portfolio financing ($ in thousands):

(1)
Weighted average spread over the applicable benchmark rate is based on unpaid principal balance. One-month term Secured Overnight Financing Rate (“SOFR”) as of December 31, 2023 was 5.35%. Fixed rate loans are presented as a spread over the relevant floating benchmark rates.

Refer to Note 6 to our consolidated financial statements for additional details.

Repurchase Agreements and Term Participation Facility

We finance certain of our loans using repurchase agreements and a term participation facility. As of December 31, 2023, aggregate borrowings outstanding under our repurchase agreements and term participation facility totaled $4.3 billion, with a weighted average coupon of SOFR plus 2.76% per annum based on unpaid principal balance. As of December 31, 2023, outstanding borrowings under these facilities had a weighted average term to initial maturity and fully extended maturity of 1.2 years and 2.7 years, respectively, assuming all conditions to extend are met.

Each repurchase agreement contains “margin maintenance” provisions, which are designed to allow the counterparty to require the delivery of cash or other assets to de-lever financings on assets that are determined to have experienced a diminution in value. Since inception through December 31, 2023, we have not received any margin calls under any of our repurchase agreements. As of December 31, 2023, six of our loans were financed under the term participation facility.

Loan Participations Sold

We finance certain of our loans via the sale of a participation in such loans, and we present the loan participations sold as a liability on our consolidated balance sheet when such arrangements do not qualify as sales under GAAP. In instances where we have multiple loan participations with the same lender, the financings are generally not cross-collateralized. Each of our loan participations sold is generally term-matched to its underlying loan. As of December 31, 2023, two of our loans were financed with loan participations sold.

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Notes Payable

We finance certain of our loans via secured financings that are generally non-recourse and are term-matched to the underlying loan. We refer to such financings as notes payable and they are secured by the related loans receivable. As of December 31, 2023, five of our loans were financed with notes payable.

Secured Term Loan

We have a secured term loan which we originally entered into on August 9, 2019. Our secured term loan is presented net of any original issue discount and transaction expenses which are deferred and recognized as interest expense over the life of the loan using the effective interest method. The secured term loan matures on August 9, 2026 and as of December 31, 2023 has an unpaid principal balance of $725.5 million and a carrying value of $712.6 million. During the year ended December 31, 2023, we purchased and retired $22.0 million of principal of our secured term loan for a price of $19.3 million, recognizing a $2.2 million gain on extinguishment of debt, inclusive of $0.5 million of unamortized deferred financing costs.

Debt Related to Real Estate Owned

On February 8, 2021 in connection with a foreclosure of a hotel portfolio we assumed a securitized senior mortgage, which is non-recourse to us, with a then unpaid principal balance of $300.0 million. On June 2, 2021, the terms of the securitized senior mortgage were modified to include an extension of the maturity date to February 9, 2024 and a principal repayment of $10.0 million. As of December 31, 2023, our debt related to real estate owned has an unpaid principal balance of $290.0 million, a carrying value of $289.9 million and a stated rate of one-month SOFR plus 2.83%, subject to a one-month SOFR floor of 0.75%. See Derivatives below for further detail of our interest rate cap. On February 7, 2024, we modified this loan agreement to provide for, among other things, an extension of the contractual maturity date to November 9, 2024, a $10.0 million principal paydown, and partial recourse to us. Concurrent with this modification, we purchased an interest rate cap for $0.5 million which provides for a strike rate of 5.00% through the extended contractual maturity date.

Derivatives

As part of the agreement to amend the terms of our debt related to real estate owned on June 2, 2021, we acquired an interest rate cap with a notional amount of $290.0 million, a strike rate of 3.00%, and a maturity date of February 15, 2024 for $275,000. The fair value of the interest rate cap is $0.9 million at December 31, 2023.

The interest rate cap effectively limits the maximum interest rate of our debt related to real estate owned to 5.83%. Changes in the fair value of our interest rate cap are recorded as an unrealized gain or loss on interest rate cap on our consolidated statements of operations and the fair value is recorded in other assets on our consolidated balance sheets. Proceeds received from our counterparty related to the interest rate cap are recorded as proceeds from interest rate cap on our consolidated statements of operations. During the years ended December 31, 2023 and 2022, we recognized approximately $6.1 million and $0.5 million, respectively, as proceeds from interest rate cap.

On February 7, 2024, we modified our debt related to real estate owned and concurrently purchased an interest rate cap for $0.5 million which provides for a strike rate of 5.00% through the extended contractual maturity date.

Short-Term Funding Facility

On June 29, 2022, we entered into a full recourse revolving credit facility with $150.0 million in capacity. The facility generally provides interim financing for eligible loans for up to 180 days at an initial advance rate between 55% and 75%, which begins to decline after the 90th day. The facility matures on June 29, 2025 and we incur interest at a rate of SOFR, plus a 0.10% credit spread adjustment, plus a spread of 2.25%. With the consent of our lenders, and subject to certain conditions, the commitment of the facility may be increased up to $500.0 million. As of December 31, 2023 and 2022, we had no outstanding balance on the facility.

Financial Covenants

Our financing agreements generally contain certain financial covenants. For example, our ratio of earnings before interest, taxes, depreciation, and amortization (“EBITDA”), to interest charges, as defined in the agreements, shall be not less than either 1.3 to 1.0 or 1.5 to 1.0. Further, (i) our tangible net worth, as defined in the agreements, shall not be less than $2.06 billion as of each measurement date plus 75% of proceeds from future equity issuances; (ii) cash liquidity shall not be less than the greater of (x) $50 million or (y) 5% of our recourse indebtedness; and (iii) our indebtedness shall not exceed 77.8% of our total assets. As of December 31, 2023 and December 31, 2022, we are in compliance with all covenants under our financing agreements. The requirements set forth in (i) through (iii) above are based upon the most restrictive financial covenants in place as of the reporting date. For the quarters ended December 31, 2023 and March 31, 2024, we modified certain of our EBITDA to interest charges covenants to provide for a minimum ratio of 1.3 to

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1.0 for such covenants which previously required a minimum ratio of 1.4 to 1.0. Future compliance with our financial covenants is dependent upon the results of our operating activities, our financial condition, and the overall market conditions in which we and our borrowers operate. As market conditions evolve, we may work with our counterparties to request modifications of financial covenants as needed.

Non-Consolidated Senior Interests Sold and Non-Consolidated Senior Interests Held by Third Parties

In certain instances, we use structural leverage through the non-recourse syndication of a match-term senior loan interest to a third party which qualifies for sale accounting under GAAP, or through the acquisition of a subordinate loan for which a non-recourse senior interest is retained by a third party. In such instances, the senior loan is not included on our consolidated balance sheet.

The following table summarizes our non-consolidated senior interests and related retained subordinate interests as of December 31, 2023 ($ in thousands):

(1)
Non-consolidated senior interests are indexed to SOFR, which was 5.35% at December 31, 2023.

(2)
Weighted average is based on unpaid principal balance.

(3)
Term to fully extended maturity is determined based on the maximum maturity of each of the corresponding loans, assuming all extension options are exercised by the borrower; provided, however, that our loans may be repaid prior to such date.

Floating and Fixed Rate Portfolio

Our business model seeks to minimize our exposure to changing interest rates by originating floating rate loans and financing them with floating rate liabilities. Further, we seek to match the benchmark index in the floating rate loans we originate with the benchmark index used in the related floating rate financings. Generally, we use SOFR as the benchmark index in both our floating rate loans and floating rate financings. As of December 31, 2023, 98.0% of our loans based on unpaid principal balance were floating rate and indexed to SOFR. The majority of our floating rate loans were financed with floating rate liabilities indexed to SOFR, which resulted in approximately $1.2 billion of net floating rate exposure.

The following table details our net floating rate exposure as of December 31, 2023 ($ in thousands):

(1)
Our floating rate loans and related liabilities are all indexed to SOFR, which as of December 31, 2023 was 5.35%. Includes $341.8 million of net floating rate exposure related to loans on non-accrual status.

As of December 31, 2023, we have an interest rate cap on our debt related to real estate owned with a notional amount of $290.0 million, a strike rate of 3.00%, and a maturity date of February 15, 2024. The interest rate cap effectively limits the maximum interest rate of our debt related to real estate owned to 5.83%. On February 7, 2024, we modified our debt related to real estate owned and concurrently purchased an interest rate cap for $0.5 million which provides for a strike rate of 5.00% through the extended contractual maturity date. We have not employed other interest rate derivatives (interest rate swaps, caps, collars or floors) to hedge our asset or liability portfolio, but we may do so in the future.

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Results of Operations – Years Ended December 31, 2023 and 2022:

Operating Results

The following table sets forth information regarding our consolidated results of operations for the years ended December 31, 2023 and 2022 ($ in thousands, except per share data):

Comparison of the Years Ended December 31, 2023 and 2022

Revenue

Total net revenue increased $19.3 million during the year ended December 31, 2023, as compared to December 31, 2022. The increase is primarily due to an increase in revenue from real estate owned of $15.7 million due to higher overall average occupancy, ADR, and RevPAR levels at the hotel portfolio compared to the year ended December 31, 2022 and revenue generated from the mixed-use property we acquired legal title to on June 30, 2023. The increase was also due to an increase in net interest income of $3.6 million for the comparative period, which was driven by an increase in interest income of $227.2 million, primarily as a result of reference rate increases and an increased average loans receivable balance, partially offset by a greater portion of the loan portfolio being on non-accrual during the year ended December 31, 2023, and further offset by an increase in interest expense of $223.6 million as a result of increased borrowing levels and reference rate increases.

Expenses

Expenses are primarily comprised of base management fees payable to our Manager, incentive fees payable to our Manager, general and administrative expenses, stock-based compensation expense, operating expenses from real estate owned, interest expense from debt related to real estate owned, and depreciation and amortization on real estate owned. Expenses increased by $25.5 million during the year ended December 31, 2023 as compared to the year ended December 31, 2022, primarily due to:

(i)
an increase in interest expense on debt related to real estate owned of $9.5 million primarily as a result of reference rate increases over the comparative period;

(ii)
an increase in stock-based compensation of $9.1 million during the comparative period, due to restricted stock units

granted in June 2022 being outstanding for the full period in 2023 and additional awards granted in 2023;

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(iii)
an increase in operating expenses from real estate owned of $7.5 million during the comparative period, due to increased

variable operating expenses in connection with higher occupancy levels at the hotel portfolio during the comparative

period and expenses incurred at the mixed-use property we acquired legal title to on June 30, 2023;

(iv)
an increase in incentive fees of $1.6 million as a result of core earnings over the trailing four quarters being in excess of a

7% hurdle as of March 31, 2023;

(v)
partially offset by a decrease in general and administrative expenses of $2.1 million primarily as a result of decreases in

non-recurring charges as well as certain corporate overhead items incurred compared to the comparative period;

(vi)
further offset by a decrease in management fees of $1.3 million as a result of lower stockholders’ equity over the

comparative period due to shares repurchased in 2022 and principal charge-offs taken.

Gain on Sale of Loan

During the year ended December 31, 2023, we realized a gain on the sale of a loan of $0.6 million. During the year ended December 31, 2022, we realized a gain on the sale of a loan of $30.1 million.

Proceeds from Interest Rate Cap

Proceeds from interest rate cap were $5.6 million higher during the comparative period due to SOFR exceeding our interest rate

cap’s 3% strike rate during 2023.

Unrealized (Loss) Gain on Interest Rate Cap

During the year ended December 31, 2023, we recognized a $5.2 million unrealized loss on interest rate cap, compared to a $6.0 million unrealized gain on interest rate cap during the year ended December 31, 2022. The fair value of the interest rate cap increases as interest rates increase, decreases as the interest rate cap approaches maturity, and further fluctuates following shifts in the forward curve.

Gain on Foreclosure of Real Estate Owned

During the year ended December 31, 2023, we recorded an out-of-period adjustment of $4.2 million, representing an over accrual of accounts payable assumed upon foreclosure of our hotel portfolio in 2021 and, accordingly, we recorded an adjustment on our consolidated statement of operations during the year ended December 31, 2023 to correct the prior period understatement of the gain on foreclosure. During the year ended 2022, there was no such adjustment.

Income from Equity Method Investment

During the year ended December 31, 2023, we recognized income from equity method investment of $0.6 million compared to $2.5 million recognized during the year ended December 31, 2022 as a result of a decline in income earned by our investee, driven primarily by the loans held by the equity method investee being placed on non-accrual status effective April 1, 2023.

Gain on Extinguishment of Debt

During the year ended December 31, 2023, we recognized a gain on extinguishment of debt of $2.2 million, inclusive of $0.5 million of unamortized deferred financing costs, as a result of the retirement of $22.0 million of principal of our secured term loan for a price of $19.3 million. During the year ended 2022, there was no such activity.

Provision for Current Expected Credit Loss Reserve

During the year ended December 31, 2023, we recorded a provision for current expected credit losses of $153.7 million, primarily attributable to a $159.6 million increase in our specific CECL reserves prior to principal charge-offs, and a $6.0 million reversal of our general CECL reserves attributable to seasoning of and a reduction in the size of our loan portfolio, offset by deteriorating macroeconomic conditions. During the year ended December 31, 2022, we recorded a provision for current expected credit losses of $84.4 million, primarily attributable to a $65.5 million increase in our specific CECL reserves prior to principal charge-offs, and a $18.9 million increase in our general CECL reserves attributable to an increase in the size of our portfolio and deteriorating macroeconomic conditions.

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See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Year Ended December 31, 2022 and 2021” in our Form 10-K, which is accessible on the SEC’s website at www.sec.gov, for a comparison of year ended December 2022 and 2021.

Liquidity and Capital Resources

Capitalization

We have capitalized our business to date primarily through the issuance of shares of our common stock and borrowings under our secured financings and our secured term loan. As of December 31, 2023, we had 138,745,357 shares of our common stock outstanding, representing $2.3 billion of equity, and also had $5.7 billion of outstanding borrowings under our secured financings, our secured term loan, and our debt related to real estate owned. As of December 31, 2023, our secured financings consisted of six repurchase agreements with capacity of $5.1 billion and an outstanding balance of $3.8 billion, a term participation facility with capacity of $654.4 million and an outstanding balance of $465.4 million, seven asset-specific financings with capacity of $540.5 million and an outstanding balance of $407.5 million and a short-term funding facility with capacity of $150.0 million and no outstanding balance. As of December 31, 2023, our secured term loan had an outstanding balance of $725.5 million and our debt related to real estate owned had an outstanding balance of $290.0 million.

Net Debt-to-Equity Ratio and Total Leverage Ratio

Net Debt-to-Equity Ratio and Total Leverage Ratio are non-GAAP measures that we use to evaluate our financial leverage, which in the case of our Total Leverage Ratio, makes certain adjustments that we believe provide a more conservative measure of our financial condition.

Net Debt-to-Equity Ratio is calculated as the ratio of asset-specific debt (repurchase agreements, term participation facility, loan participations sold, net, notes payable, net, and debt related to real estate owned, net) and secured term loan, less cash and cash equivalents to total equity.

Total Leverage Ratio is similar to Net Debt-to-Equity Ratio; however, it includes non-consolidated senior interests sold and non-consolidated senior interests held by third parties. Non-consolidated senior interests sold and non-consolidated senior interests held by third parties, as applicable, are secured by the same collateral as our loan and are structurally senior in repayment priority relative to our loan. We believe the inclusion of non-consolidated senior interests sold and non-consolidated senior interests held by third parties provides a meaningful measure of our financial leverage.

The following table presents our Net Debt-to-Equity Ratios and Total Leverage Ratios as of December 31, 2023 and 2022 ($ in thousands):

Sources of Liquidity

Our primary sources of liquidity include cash and cash equivalents, interest income from our loans, loan repayments, available borrowings under our repurchase agreements based on existing collateral, identified borrowing capacity related to our notes payable and loan participations sold based on existing collateral, proceeds from the issuance of incremental secured term loan or other corporate debt issuances, and proceeds from the issuance of our common stock. As circumstances warrant, we and our subsidiaries may also issue common equity, preferred equity and/or debt, incur other debt, including term loans, or explore sales of certain of our loan receivables

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or real estate owned properties from time to time on an opportunistic basis, dependent upon market conditions and available pricing. The following table sets forth, as of December 31, 2023 and 2022, our sources of available liquidity ($ in thousands):

(1)
Represents loan principal payments held in lockboxes or by our third-party loan servicer as of the balance sheet date which were remitted to us during the subsequent remittance cycle, net of the related secured debt balance.

(2)
Amounts based on existing collateral.

In January of 2024, we sold three senior loans to an unaffiliated purchaser resulting in additional available liquidity of $77.0 million after repayment of associated financings and transaction costs.

As of December 31, 2023 and February 16, 2024, we have $432.7 million unpaid principal balance of unencumbered loans receivable held-for-investment, respectively. As of December 31, 2023 and February 16, 2024, we have unencumbered mixed-use real estate owned and net lease intangible assets with a carrying value of $147.1 million and $146.8 million, respectively. Our ability to finance certain of these unencumbered loans, or our real estate owned asset is subject to one or more counterparties' willingness to finance such loans.

To facilitate future offerings of equity, debt and other securities, we have in place an effective shelf registration statement (the “Shelf”) with the SEC. The amount of securities to be issued pursuant to this Shelf was not specified when it was filed and there is no specific dollar limit on the amount of securities we may issue. The securities covered by this Shelf include: (i) common stock, (ii) preferred stock, (iii) debt securities, (iv) depositary shares, (v) warrants, (vi) purchase contracts, and (vii) units. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering material, at the time of any offering.

Liquidity Needs

In addition to our loan origination and acquisition activity, our primary liquidity needs include future fundings to our borrowers on our unfunded loan commitments, interest and principal payments on outstanding borrowings under our financings, operating expenses, and dividend payments to our stockholders necessary to satisfy REIT dividend requirements. Additionally, certain financial covenants in our financing agreements require us to maintain minimum levels of liquidity. We currently maintain, and seek to maintain, cash and liquidity to comply with minimum liquidity requirements under our financings, and we also maintain and seek to maintain excess cash and liquidity to, if necessary, de-lever certain of our secured financings, including our repurchase agreements. During 2023 and in cooperation with our various financing counterparties, we proactively de-levered specific assets and may continue to do so on an as-needed basis.

As of December 31, 2023, we had aggregate unfunded loan commitments of $1.1 billion which is comprised of funding for capital expenditures and construction, leasing costs, and interest and carry costs. The timing of these fundings will vary depending on the progress of capital projects, leasing, and cash flows at the properties securing our loans. Therefore, the exact timing and amounts of such future loan fundings are uncertain and will depend on the current and future performance of the underlying collateral assets. We expect to fund our loan commitments over the remaining maximum term of the related loans, which have a weighted average future funding period of 3.0 years.

We may from time to time use capital to retire, redeem, or repurchase our equity or debt securities, term loans or other debt instruments through open market purchases, privately negotiated transactions or otherwise. The execution of such repurchases, redemptions or retirements, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and/or other factors.

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Contractual Obligations and Commitments

Our contractual obligations and commitments as of December 31, 2023 were as follows ($ in thousands):

(1)
The estimated allocation of our unfunded loan commitments is based on the earlier of our expected funding date and the commitment expiration date. As of December 31, 2023, we have $670.8 million of expected or in-place financings to fund our remaining commitments, excluding $48.1 million of approved and undrawn credit capacity based on existing collateral. Amounts exclude unfunded loan commitments for loans receivable classified as held-for-sale as of December 31, 2023.

(2)
The allocation of our secured financings and secured term loan is based on the earlier of the fully extended maturity date (assuming conditions to extend are met) of each individual borrowing or the maximum maturity date under the respective agreement, and assumes five loans with aggregate borrowings outstanding of $250.7 million that are in maturity default have a contractual obligation to pay in less than one year.

(3)
Assumes two loans with aggregate borrowings outstanding of $184.2 million classified as held-for-sale as of December 31, 2023 have a contractual obligation to pay in less than one year, as the loans were subsequently sold in January of 2024 and the associated borrowings were repaid in full.

(4)
Amounts include the related future interest payment obligations, which are estimated by assuming the amounts outstanding under our secured financing agreements and SOFR in effect as of December 31, 2023 will remain constant into the future. This is only an estimate, as actual amounts borrowed and rates will vary over time. Our floating rate loans and related liabilities are indexed to SOFR. Totals exclude non-consolidated senior interests.

We are required to pay our Manager, in cash, a base management fee and incentive fees (to the extent earned) on a quarterly basis in arrears. The tables above do not include the amounts payable to our Manager under the Management Agreement as they are not fixed and determinable.

Loan Maturities

The following table summarizes the future scheduled repayments of principal for loans receivable held-for-investment as of December 31, 2023 ($ in thousands):

(1)
Excludes $261.8 million in unpaid principal balance of loans that are in maturity default with no available extension options.

Cash Flows

The following table provides a breakdown of the net change in our cash and cash equivalents and restricted cash for the years ended December 31, 2023 and 2022 ($ in thousands):

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We experienced a net decrease in cash and cash equivalents and restricted cash of $133.3 million during the year ended December 31, 2023, compared to a net increase of $14.0 million during the year ended December 31, 2022.

During the year ended December 31, 2023, we made initial fundings of $101.1 million of new loans and $668.7 million of advances on existing loans and made repayments on financings arrangements of $1.0 billion. We received $1.0 billion of proceeds from borrowings under our financing arrangements, received $550.1 million from loan repayments and received $186.7 million of loan sale proceeds.

Income Taxes

We have elected and believe we have qualified to be taxed as a REIT for U.S. federal income tax purposes, commencing with our initial taxable year ended December 31, 2015. We generally must distribute annually at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain, to maintain our REIT status. To the extent that we satisfy this distribution requirement, but distribute less than 100% of our REIT taxable income, we will be subject to U.S. federal income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay (or are treated as paying) out to our stockholders in a calendar year is less than a minimum amount specified under U.S. federal tax laws. Our real estate owned hotel portfolio is held in a TRS. Our TRS is not consolidated for U.S. federal income tax purposes and is taxed separately as a corporation. For financial reporting purposes, a provision or benefit for current and deferred taxes is established for the portion of earnings or expense recognized by us with respect to our TRS.

Our qualification as a REIT also depends on our ability to meet various other requirements imposed by the Internal Revenue Code, which relate to organizational structure, diversity of stock ownership and certain restrictions with regard to the nature of our assets and the sources of our income. Even if we qualify as a REIT, we may be subject to certain U.S. federal income and excise taxes and state and local taxes on our income and assets. If we fail to maintain our qualification as a REIT for any taxable year, we may be subject to material penalties as well as federal, state and local income tax on our REIT taxable income at regular corporate rates and we would not be able to qualify as a REIT for the subsequent four full taxable years. As of December 31, 2023, we were in compliance with all REIT requirements.

The following table details the income tax treatment for our common stock dividends:

Refer to Note 13 to our consolidated financial statements for additional information about our income taxes.

Off-Balance Sheet Arrangements

As of December 31, 2023, we had no off-balance sheet arrangements aside from those discussed in Note 3 - Loan Portfolio, Note 4 - Equity Method Investment, and Note 14 - Commitments and Contingencies.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires our Manager to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We believe that all of the decisions and estimates are reasonable, based upon the information available to us. We believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements. The assumptions within our accounting policies may vary from quarter to quarter as our portfolio changes and market and economic conditions evolve.

Refer to Note 2 to our consolidated financial statements for a description of our significant accounting policies.

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Current Expected Credit Losses

The CECL reserve required under ASU 2016-13 “Financial Instruments – Credit Losses – Measurement of Credit Losses on Financial Instruments (Topic 326)” (“ASU 2016-13”), reflects our current estimate of potential credit losses related to our loan portfolio. Changes to the CECL reserve are recognized through a provision for or reversal of current expected credit loss reserve on our consolidated statements of operations. ASU 2016-13 specifies the reserve should be based on relevant information about past events, including historical loss experience, current loan portfolio, market conditions and reasonable and supportable macroeconomic forecasts for the duration of each loan.

For our loan portfolio, we perform a quantitative assessment of the impact of CECL using the Weighted Average Remaining Maturity, or WARM, method. The application of the WARM method to estimate a general CECL reserve requires judgment, including the appropriate historical loan loss reference data, the expected timing and amount of future loan fundings and repayments, the current credit quality of our portfolio, and our expectations of performance and market conditions over the relevant time period.

The WARM method requires us to reference historical loan loss data from a comparable data set and apply such loss rate to each of our loans over their expected remaining term, taking into consideration expected economic conditions over the forecasted timeframe. Our general CECL reserve reflects our forecast of the current and future macroeconomic conditions that may impact the performance of the commercial real estate assets securing our loans and the borrower’s ultimate ability to repay. These estimates include unemployment rates, price indices for commercial properties, and market liquidity, all of which may influence the likelihood and magnitude of potential credit losses for our loans during their anticipated term. Additionally, further adjustments may be made based upon loan positions senior to ours, the risk rating of a loan, whether a loan is a construction loan, or the economic conditions specific to the property type of a loan’s underlying collateral.

To estimate an annual historical loss rate, we obtained historical loss rate data for loans most comparable to our loan portfolio from a commercial mortgage-backed securities database licensed by a third party, Trepp, LLC, which contains historical loss data from January 1, 1999 through December 31, 2023. We believe this CMBS data is the most relevant, available, and comparable dataset to our portfolio.

When evaluating the current and future macroeconomic environment, we consider the aforementioned macroeconomic factors. Historical data for each metric is compared to historical commercial real estate credit losses in order to determine the relationship between the two variables. We use projections of each macroeconomic factor, obtained from a third party, to approximate the impact the macroeconomic outlook may have on our loss rate. Selections of these economic forecasts require judgment about future events that, while based on the information available to us as of the balance sheet date, are ultimately subjective and uncertain, and the actual economic conditions could vary significantly from the estimates we made. Following a reasonable and supportable forecast period, we use a straight-line method of reverting to the historical loss rate. Additionally, we assess the obligation to extend credit through our unfunded loan commitments over each loan’s contractual period, adjusted for projected fundings from interest reserves, if applicable, which is considered in the estimate of the general CECL reserve. For both the funded and unfunded portions of our loans, we consider our internal risk rating of each loan as the primary credit quality indicator underlying our assessment.

In certain circumstances we may determine that a loan is no longer suited for the WARM method due to its unique risk characteristics or where we have deemed the borrower/sponsor to be experiencing financial difficulty and the repayment of the loan’s principal is collateral-dependent. We may instead elect to employ different methods to estimate credit losses that also conform to ASU 2016-13 and related guidance. For such loan we would separately measure the specific reserve for each loan by using the estimated fair value of the loan’s collateral. If the estimated fair value of the loan's collateral is less than the carrying value of the loan, an asset-specific reserve is created as a component of our overall current expected credit loss reserve. Specific reserves are equal to the excess of a loan’s carrying value to the estimated fair value of the collateral, less estimated costs to sell, if recovery of our investment is expected from the sale of the collateral and such costs will reduce amounts recoverable by us.

We evaluate the credit quality of each of our loans receivable on an individual basis and assigns a risk rating at least quarterly. We have developed a loan grading system for all of our outstanding loans receivable that are collateralized directly or indirectly by real estate. Grading criteria include, but are not limited to, as-is or as-stabilized debt yield, term of loan, property type, property or collateral location, loan type and other more subjective variables that include, but is not limited to, as-is or as-stabilized collateral value, market conditions, industry conditions and sponsor’s financial stability. While evaluating the credit quality of each loan within our portfolio, we assess these quantitative and qualitative factors as a whole and with no pre-prescribed weight on their impact to our determination of a loan’s risk rating. However, based upon the facts and circumstances for each loan and the overall market conditions, we may consider certain previously mentioned factors more or less relevant than others. We utilize the grading system to determine each loan’s risk of loss and to provide a determination as to whether an individual loan is impaired and whether a specific CECL reserve is necessary.

Significant judgment is required in determining impairment and in estimating the resulting credit loss reserve, and actual losses, if any, could materially differ from those estimates.

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Real Estate Owned

We may assume legal title and/or physical possession of the underlying collateral property of a defaulted loan through foreclosure, a deed-in-lieu of foreclosure, or an assignment-in-lieu of foreclosure.

We account for acquisitions of real estate, including foreclosures, deed-in-lieu of foreclosures, or assignment-in-lieu of foreclosures, in accordance with ASC 805, Business Combinations, which first requires that we determine if the real estate investment is the acquisition of an asset or a business combination. Under this model, we identify and determine the estimated fair value of any assets acquired and liabilities assumed. This generally results in the allocation of the purchase price to the assets acquired and liabilities assumed based on the relative estimated fair values of each respective asset and liability. Debt related to real estate owned is non-recourse to us and is initially recorded at its estimated fair value at the time of foreclosure, deed-in-lieu of foreclosure, or assignment-in-lieu of foreclosure.

Assets acquired and liabilities assumed generally include land, building, building improvements, tenant improvements, furniture, fixtures and equipment, mortgages payable, and identified intangible assets and liabilities, which generally consist of above or below market lease values, in-place lease values, and other lease-related values. In estimating fair values for allocating the purchase price of our real estate owned, we may utilize various methods, including a market approach, which considers recent sales of similar properties, adjusted for differences in location and state of the physical asset, or a replacement cost approach, which considers the composition of physical assets acquired, adjusted based on industry standard information and the remaining useful life of the acquired property. In estimating fair values of intangible assets acquired or liabilities assumed, we consider the estimated cost of leasing our real estate owned assuming the property was vacant, the value of the current lease agreements relative to market-rate leases, and the estimation of total lease-up time including lost rents.

Real estate assets are evaluated for indicators of impairment on a quarterly basis. Factors that we may consider in our impairment analysis include, among others: (1) significant underperformance relative to historical or anticipated operating results; (2) significant negative industry or economic trends; (3) costs necessary to extend the life or improve the real estate asset; (4) significant increase in competition; and (5) ability to hold and dispose of the real estate asset in the ordinary course of business. A real estate asset is considered impaired when the sum of estimated future undiscounted cash flows expected to be generated by the real estate asset over the estimated remaining holding period is less than the carrying amount of such real estate asset. Cash flows include operating cash flows and anticipated capital proceeds generated by the sale of the real estate asset. If the sum of such estimated undiscounted cash flows is less than the carrying amount of the real estate asset, an impairment charge is recorded equal to the excess of the carrying value of the real estate asset over its estimated fair value. When determining the estimated fair value of a real estate asset, we make certain assumptions including consideration of projected operating cash flows, comparable selling prices and projected cash flows from the eventual disposition of the real estate asset based upon our estimate of a capitalization rate and discount rate. There were no impairments of our real estate assets through December 31, 2023.