Quarterly report pursuant to Section 13 or 15(d)

Orion Office REIT, Fair Value Measures

v3.22.2.2
Orion Office REIT, Fair Value Measures
 9 Months Ended
Sep. 30, 2022
Fair Value Disclosures [Abstract]  
Fair Value Measures
Note 5 – Fair Value Measures
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 as of September 30, 2022 and December 31, 2021, 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, 2022
Assets:
Derivative assets $ —  $ 7,057  $ —  $ 7,057 
Level 1 Level 2 Level 3
Balance as of December 31, 2021
Assets:
Derivative assets $ —  $ 299  $ —  $ 299 
Derivative Assets – The Company’s derivative financial instruments relate to interest rate swap agreements entered into in order to hedge interest rate volatility with respect to the Company’s borrowings under the Term Loan Facility (as defined in Note 6 - Debt, Net). 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 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, 2022 and December 31, 2021, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Items Measured at Fair Value on a Non-Recurring Basis
Certain financial and nonfinancial assets and liabilities are measured at fair value on a non-recurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
Real Estate and Other Investments – The Company performs quarterly impairment review procedures for real estate investments, leasehold improvements and property and equipment, right of use assets and its investment in the unconsolidated entity, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of such assets may not be recoverable.
As part of the Company’s impairment review procedures, net real estate assets representing ten properties were deemed to be impaired resulting in impairment charges of $54.2 million during the nine months ended September 30, 2022, that relate to adjustments to expected sales prices for certain non-core assets which have been identified by management for potential sale or management determined would not be re-leased by the existing tenant.
There were no impairment charges recorded during the nine months ended September 30, 2021.The following table summarizes our provisions for impairment during the periods indicated below (dollars in thousands):
Nine Months Ended September 30,
2022
Number of properties 10 
Carrying value of impaired properties $ 98,633 
Provisions for impairment (54,161)
Estimated fair value $ 44,472 
The Company estimates fair values using Level 2 and Level 3 inputs and uses a combined income and market approach, specifically using discounted cash flow analysis and/or recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and make certain key assumptions, including the following: (1) capitalization rate; (2) discount rates; (3) number of years the property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental revenue 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, 2022, the fair value measurement for eight impaired properties was determined by applying an estimated sales price based on market data and two impaired properties by applying a discount rate of 8.5% and capitalization rate of 8.0%. During the nine months ended September 30, 2022, impairment charges of $44.0 million were recorded for held and used properties, $1.6 million for held for sale properties, and $8.6 million for disposed properties.
The following table presents certain of the Company’s assets measured at fair value on a non-recurring basis as of September 30, 2022, aggregated by the level in the fair value hierarchy within which those assets fall (in thousands):
Level 1
Level 2(1)
Level 3(1)
Balance as of September 30, 2022
Assets of properties held and used $ —  $ 1,000  $ 22,339  $ 23,339 
Assets of properties held for sale(2)
—  4,782  —  4,782 
$ —  $ 5,782  $ 22,339  $ 28,121 
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(1)The fair value of the level 2 category was derived using negotiated sales prices and the fair value of the level 3 category was derived using discounted cash flow analysis and management estimates of selling prices.
(2)An additional property is included in real estate assets held for sale, net on the balance sheets at a carrying value of $1.6 million.
Real Estate and Other Investments – Separation Fair Value Assessment – Following the Mergers, Realty Income performed a purchase price allocation assessing the value of the assets acquired and liabilities assumed at the date of acquisition of VEREIT. The assessment of fair value is preliminary and is based on information that was available to Realty Income management at the time the consolidated and combined statements were prepared. Measurement period adjustments, if any, will be recorded in the period in which they are determined, as if they had been completed at the acquisition date. The finalization of Realty Income’s purchase accounting assessment could result in changes in the valuation of real estate assets and liabilities up to one year after the date of the Mergers, and these changes could be material.
Fair Value of Financial Instruments
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, accounts receivable, and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature. The fair values of the Company’s financial instruments are reported below (dollar amounts in thousands):
Level
Carrying Amount at September 30, 2022
Fair Value at September 30, 2022
Carrying Amount at December 31, 2021
Fair Value at December 31, 2021
Liabilities (1):
Bridge facility 2 —  —  $ 355,000  $ 355,000 
Mortgages payable 2 355,000  334,473  —  — 
Credit facility term loan 2 175,000  175,000  175,000  175,000 
Credit facility revolver 2 31,000  31,000  90,000  90,000 
Total $ 561,000  $ 540,473  $ 620,000  $ 620,000 
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(1)Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.
Debt – The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of credit spreads and observable market interest rates, representing level 2 on the fair value hierarchy.