News Column

COLE REAL ESTATE INCOME STRATEGY (DAILY NAV), INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 12, 2014

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated unaudited financial statements, the notes thereto and the other unaudited financial data included in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements and the notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013. The terms "we," "us," "our" and the "Company" refer to Cole Real Estate Income Strategy (Daily NAV), Inc. and unless otherwise defined herein, capitalized terms used herein shall have the same meanings as set forth in our condensed consolidated unaudited financial statements and the notes thereto. Forward-Looking Statements Certain statements contained in this Quarterly Report on Form 10-Q of Cole Real Estate Income Strategy (Daily NAV), Inc., other than historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We intend for all such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act, as applicable by law. Such statements include, in particular, statements about our plans, strategies and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as "may," "will," "would," "could," "should," "expect," "intend," "anticipate," "estimate," "believe," "continue" or other similar words. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to: changes in economic conditions generally and the real estate and securities markets specifically;



the effect of financial leverage, including changes in interest rates,

availability of credit, loss of flexibility due to negative and

affirmative covenants, refinancing risk at maturity and generally the

increased risk of loss if our investments fail to perform as expected;

our ability to raise a substantial amount of capital in the near term;

our ability to access sources of liquidity when we have the need to fund

redemptions of common stock in excess of the proceeds from the sales of shares of our common stock in our continuous offering and the consequential risk that we may not have the resources to satisfy redemption requests;



our ability to effectively deploy the proceeds raised in our public offering;

legislative or regulatory changes (including changes to the laws governing

the taxation of REITs); and

changes to GAAP.

Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. We caution readers not to place undue reliance on forward-looking statements, which reflect our management's view only as of the date this Quarterly Report on Form 10-Q is filed with the SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q. Additionally, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. The forward-looking statements should be read in light of the risk factors identified in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2013. 21



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Overview

We were formed on July 27, 2010 to acquire and operate a diversified portfolio of (1) necessity retail, office and industrial properties that are leased to creditworthy tenants under long-term net leases, and are strategically located throughout the United States and U.S. protectorates, (2) notes receivable secured by commercial real estate, including the origination of loans, and (3) cash, cash equivalents, other short-term investments and traded real estate securities. We commenced our principal operations on December 7, 2011, when we issued the initial $10.0 million in shares of our common stock in the Offering and acquired our first real estate property. We have no paid employees and are externally advised and managed by Cole Advisors, our advisor. We elected to be taxed, and currently qualify, as a REIT for federal income tax purposes. On February 7, 2014, ARCP acquired Cole, which, prior to its acquisition, indirectly owned and/or controlled our external advisor, Cole Advisors, our dealer manager, CCC, our property manager, CREI Advisors, and our sponsor, Cole Capital. As a result of ARCP's acquisition of Cole, ARCP indirectly owns and/or controls Cole Advisors, CCC, CREI Advisors and Cole Capital. As of June 30, 2014, we owned 53 properties located in 24 states, comprised of approximately 1.1 million rentable square feet of commercial space, including the square footage of buildings which are on land subject to ground leases. Our operating results and cash flows are primarily influenced by rental income from our commercial properties, interest expense on our property indebtedness and acquisition and operating expenses. Rental and other property income accounted for 93% and 92%, respectively, of our total revenue for the three and six months ended June 30, 2014, and 97% and 95%, respectively, of our total revenue for the three and six months ended June 30, 2013. As 99.9% of our rentable square feet was under lease as of June 30, 2014 with a weighted average remaining lease term of 12.4 years, we believe our exposure to changes in commercial rental rates on our portfolio is substantially mitigated, except for vacancies caused by tenant bankruptcies or other factors. Cole Advisors regularly monitors the creditworthiness of our tenants by reviewing the tenant's financial results, credit rating agency reports, when available, on the tenant or guarantor, the operating history of the property with such tenant, the tenant's market share and track record within its industry segment the general health and outlook of the tenant's industry segment, and other information for changes and possible trends. If our advisor identifies significant changes or trends that may adversely affect the creditworthiness of a tenant, it will gather a more in-depth knowledge of the tenant's financial condition and, if necessary, attempt to mitigate the tenant credit risk by evaluating the possible sale of the property or identifying a possible replacement tenant should the current tenant fail to perform on the lease. As of June 30, 2014, the debt leverage ratio of our consolidated real estate assets, which is the ratio of debt to total gross real estate and related assets, net of gross intangible lease liabilities, was 37%, and all of our debt was subject to variable interest rates. As we acquire additional commercial real estate, we will be subject to changes in real estate prices and changes in interest rates on any current variable rate debt, refinancings or new indebtedness used to acquire the properties. We may manage our risk of changes in real estate prices on future property acquisitions, when applicable, by entering into purchase agreements and loan commitments simultaneously, or through loan assumption, so that our operating yield is determinable at the time we enter into a purchase agreement, by contracting with developers for future delivery of properties or by entering into sale-leaseback transactions. We manage our interest rate risk by monitoring the interest rate environment in connection with our future property acquisitions, when applicable, or upcoming debt maturities to determine the appropriate financing or refinancing terms, which may include fixed rate loans, variable rate loans or interest rate hedges. If we are unable to acquire suitable properties or obtain suitable financing terms for future acquisitions or refinancing, our results of operations may be adversely affected. 22



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Results of Operations Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate investments. The following table shows the property statistics of our consolidated real estate assets as of June 30, 2014 and 2013: As of June 30, 2014 2013 Number of properties 53 20



Approximate rentable square feet (in thousands) (1) 1,056 309 Percentage of rentable square feet leased

99.9 % 100 % (1) Includes square feet of the buildings on land that are subject to ground leases. The following table summarizes our consolidated real estate investment activity during the three and six months ended June 30, 2014 and 2013: Three Months Ended June 30, Six Months Ended June 30, 2014 2013 2014 2013 Properties acquired 13 7 21 10 Approximate purchase price of acquired properties (in millions) $ 35.5 $ 17.2 $ 49.5 $ 21.3 Approximate rentable square feet (in thousands) 281 60 336 84 As shown in the tables above, we owned 53 commercial properties as of June 30, 2014, compared to 20 commercial properties as of June 30, 2013. Accordingly, our results of operations for the three and six months ended June 30, 2014, compared to the three and six months ended June 30, 2013, reflect significant increases in most categories. Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013 Revenue. Revenue increased $1.7 million to $2.7 million for the three months ended June 30, 2014, compared to $994,000 for the three months ended June 30, 2013. Of this amount, rental and other property income increased $1.5 million to $2.5 million for the three months ended June 30, 2014, compared to $962,000 for the three months ended June 30, 2013. The increase was primarily due to the acquisition of 33 properties subsequent to June 30, 2013. We also recorded tenant reimbursement income of $188,000 related to certain operating expenses paid by us subject to reimbursement by tenants during the three months ended June 30, 2014, compared to $31,000 during the three months ended June 30, 2013. General and Administrative Expenses. General and administrative expenses remained relatively constant, decreasing $2,000 to $304,000 for the three months ended June 30, 2014, compared to $306,000 for the three months ended June 30, 2013. The decrease was primarily due to the expense cap on general and administrative expenses for the three months ended June 30, 2014 as discussed in Note 8 to the condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. There was no such cap during the three months ended June 30, 2013. The primary general and administrative expense items are professional fees, board of directors costs, state franchise and income taxes, escrow and trustee fees, fees for unused amounts on the Line of Credit, and other licenses and fees. During the three months ended June 30, 2014, we incurred $146,000 of Excess G&A which will be reimbursed by our advisor. Property Operating Expenses. Property operating expenses increased $160,000 to $217,000 for the three months ended June 30, 2014, compared to $57,000 for the three months ended June 30, 2013. The increase was primarily due to the acquisition activity subsequent to June 30, 2013. The primary property operating expense items are property taxes, repairs and maintenance and property insurance. Advisory Expenses. Advisory expenses increased $120,000 to $198,000 for the three months ended June 30, 2014, compared to $78,000 for the three months ended June 30, 2013, as we recorded advisory fees earned by our advisor pursuant to our advisory agreement. The increase in advisory fees was primarily due to an increase in our NAV resulting from the issuance of common stock subsequent to June 30, 2013. 23



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Acquisition Related Expenses. Acquisition related expenses increased $188,000 to $385,000 for the three months ended June 30, 2014, compared to $197,000 for the three months ended June 30, 2013. The increase was primarily due to acquisition related reimbursements and expenses incurred in connection with the purchase of 13 commercial properties for an aggregate purchase price of $35.5 million during the three months ended June 30, 2014, compared to acquisition related expenses incurred in connection with the purchase of seven commercial properties for an aggregate purchase price of $17.2 million during the three months ended June 30, 2013. Depreciation and Amortization Expenses. Depreciation and amortization expenses increased $645,000 to $926,000 for the three months ended June 30, 2014, compared to $281,000 for the three months ended June 30, 2013. The increase was primarily related to depreciation and amortization on 33 properties acquired subsequent to June 30, 2013. Interest and Other Expense, Net. Interest and other expense, net increased $372,000 to $544,000 for the three months ended June 30, 2014, compared to $172,000 for the three months ended June 30, 2013, primarily due to an increase of $33.8 million in our outstanding debt balance for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. This increase was also due to an increase in amortization related to $804,000 of deferred financing costs incurred subsequent to June 30, 2013. Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013 Revenue. Revenue increased $3.2 million to $5.0 million for the six months ended June 30, 2014, compared to $1.8 million for the six months ended June 30, 2013. Of this amount, rental and other property income increased $3.0 million to $4.7 million for the six months ended June 30, 2014, compared to $1.7 million for the six months ended June 30, 2013. The increase was primarily due to the acquisition of 33 properties subsequent to June 30, 2013. We also recorded tenant reimbursement income of $377,000 related to certain operating expenses paid by us subject to reimbursement by tenants during the six months ended June 30, 2014, compared to $79,000 during the six months ended June 30, 2013. General and Administrative Expenses. General and administrative expenses decreased $22,000 to $540,000 for the six months ended June 30, 2014, compared to $562,000 for the six months ended June 30, 2013. The decrease was primarily due to the expense cap on general and administrative expenses for the six months ended June 30, 2014 as discussed in Note 8 to the condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q. There was no such cap during the six months ended June 30, 2013. The primary general and administrative expense items are professional fees, board of directors costs, state franchise and income taxes, escrow and trustee fees, fees for unused amounts on the Line of Credit, and other licenses and fees. During the six months ended June 30, 2014, we incurred $240,000 of Excess G&A, of which $146,000 had not been reimbursed and was due to the Company as of June 30, 2014. Property Operating Expenses. Property operating expenses increased $333,000 to $439,000 for the six months ended June 30, 2014, compared to $106,000 for the six months ended June 30, 2013. The increase was primarily due to the acquisition activity subsequent to June 30, 2013. The primary property operating expense items are property taxes, repairs and maintenance and property insurance. Advisory Expenses. Advisory expenses increased $246,000 to $372,000 for the six months ended June 30, 2014, compared to $126,000 for the six months ended June 30, 2013, as we recorded advisory fees earned by our advisor pursuant to our advisory agreement. The increase in advisory fees was primarily due to an increase in our NAV resulting from the issuance of common stock subsequent to June 30, 2013. Acquisition Related Expenses. Acquisition related expenses increased $319,000 to $583,000 for the six months ended June 30, 2014, compared to $264,000 for the six months ended June 30, 2013. The increase was primarily due to acquisition related reimbursements and expenses incurred in connection with the purchase of 21 commercial properties for an aggregate purchase price of $49.5 million during the six months ended June 30, 2014, compared to acquisition related expenses incurred in connection with the purchase of ten commercial properties for an aggregate purchase price of $21.3 million during the six months ended June 30, 2013. Depreciation and Amortization Expenses. Depreciation and amortization expenses increased $1.2 million to $1.7 million for the six months ended June 30, 2014, compared to $483,000 for the six months ended June 30, 2013. The increase was primarily related to depreciation and amortization on 33 properties acquired subsequent to June 30, 2013. 24



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Interest and Other Expense, Net. Interest and other expense, net increased $649,000 to $1.0 million for the six months ended June 30, 2014, compared to $352,000 for the six months ended June 30, 2013, primarily due to an increase of $31.9 million in our average outstanding debt balance for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. This increase was also due to an increase in amortization related to $804,000 of deferred financing costs incurred subsequent to June 30, 2013. Distributions Our board of directors authorized a daily distribution, based on 365 days in the calendar year, of $0.002563727 per share for stockholders of record as of the close of business on each day of the period commencing on January 1, 2014 and ending on March 31, 2014. In addition, our board of directors authorized a daily distribution of $0.002678083 per share for stockholders of record as of the close of business on each day of the period commencing on April 1, 2014 and ending on September 30, 2014. The daily distribution amount for each class of outstanding common stock will be adjusted based on the relative NAV of the various classes each day so that, from day to day, distributions constitute a uniform percentage of the NAV per share of all classes. As a result, from day to day, the per share daily distribution for each outstanding class of common stock may be higher or lower than the daily distribution amount authorized by our board of directors based on the relative NAV of each class of common stock on that day. During the six months ended June 30, 2014 and 2013, we paid distributions of $2.2 million and $645,000, respectively, including $863,000 and $122,000, respectively, through the issuance of shares pursuant to the DRIP. Our distributions for the six months ended June 30, 2014 were fully funded by cash flows from operations. Our distributions for the six months ended June 30, 2013 were funded by cash flows from operations, including cash flow in excess of distributions from the prior year, of $317,000, or 49%, and offering proceeds of $328,000, or 51%. Net cash provided by operating activities for the six months ended June 30, 2014 and 2013 reflect a reduction for real estate acquisition related expenses. We treat our real estate acquisition expenses as funded by proceeds from the Offering of our shares. Therefore, for consistency, proceeds from the issuance of common stock may be reported as a source of distributions to the extent that acquisition expenses have reduced net cash flows from operating activities in the current and prior periods. Share Redemptions We have adopted a share redemption plan to provide limited liquidity whereby, on a daily basis, stockholders may request that we redeem all or any portion of their shares. Our share redemption plan provides that, on each business day, stockholders may request that we redeem all or any portion of their shares, subject to a minimum redemption amount and certain short-term trading fees. The redemption price per share for each class on any business day will be our NAV per share for such class for that day, calculated by the independent fund accountant in accordance with our valuation policies. Our share redemption plan includes certain redemption limits, including a quarterly limit and, in some cases, a stockholder by stockholder limit. During the six months ended June 30, 2014, we received redemption requests for, and redeemed approximately 102,000 W Shares of our common stock for $1.7 million. We intend to fund share redemptions with available cash, proceeds from our liquid investments and proceeds from sales of additional shares. We may, after taking the interests of our Company as a whole and the interests of our remaining stockholders into consideration, use proceeds from any available sources at our disposal to satisfy redemption requests, including, but not limited to, proceeds from sales of additional shares, excess cash flow from operations, sales of our liquid investments, incurrence of indebtedness and, if necessary, proceeds from the disposition of real estate properties or real estate-related assets. In an effort to have adequate cash available to support our share redemption plan, Cole Advisors may determine to reserve borrowing capacity under the Line of Credit. Cole Advisors could then elect to borrow against the Line of Credit in part to redeem shares presented for redemption during periods when we do not have sufficient proceeds from the sale of shares in the Offering to fund all redemption requests. 25



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Liquidity and Capital Resources General Our principal demands for funds will be for real estate and real estate related investments, for the payment of acquisition related expenses, operating expenses, distributions and redemptions to stockholders and principal and interest on any current and any future indebtedness. Generally, cash needs for items other than acquisitions and acquisition related expenses will be generated from operations of our current and future investments. We expect to meet cash needs for acquisitions from the net proceeds of the Offering and from debt financings. The sources of our operating cash flows will primarily be driven by the rental income received from current and future leased properties. We expect to continue to raise capital through the Offering and to utilize such funds and future proceeds from secured or unsecured financing to complete future property acquisitions. Our investment guidelines provide that we will target the following aggregate allocation to relatively liquid investments, such as U.S. government securities, agency securities, corporate debt, publicly traded debt and equity real estate-related securities, cash, cash equivalents and other short-term investments and, in Cole Advisors' discretion, a line of credit (collectively, the "Liquid Assets"): (1) 10% of our NAV up to $1.0 billion; and (2) 5% of our NAV in excess of $1.0 billion. To the extent that Cole Advisors elects to maintain borrowing capacity under a line of credit, the amount available under the line of credit will be included in calculating the Liquid Assets under these guidelines. These are guidelines, and our stockholders should not expect that we will, at all times, hold liquid assets at or above the target levels or that all liquid assets will be available to satisfy redemption requests as we receive them. We anticipate that both our overall allocation to liquid assets as a percentage of our NAV and our allocation to different types of liquid assets will vary. In making these determinations, our advisor will consider our receipt of proceeds from sales of additional shares, our cash flow from operations, available borrowing capacity under a line of credit, if any, or from additional mortgages on our real estate, our receipt of proceeds from sales of assets and the anticipated use of cash to fund redemptions, as well as the availability and pricing of different investments. The amount of the Liquid Assets is determined by our advisor, in its sole discretion, but is subject to review by our independent directors on a quarterly basis. Short-term Liquidity and Capital Resources On a short-term basis, our principal demands for funds will be for operating expenses, distributions and redemptions to stockholders and interest on the Line of Credit. We expect to meet our short-term liquidity requirements through available cash, cash provided by property operations, proceeds from the Offering and borrowings from the Line of Credit. As of June 30, 2014, the Borrowing Base under the Line of Credit was $75.0 million and we had $17.6 million available for borrowing. As of August 8, 2014, we had $51.5 million outstanding under the Line of Credit and $23.5 million available for borrowing. The Line of Credit has a scheduled maturity date of December 8, 2014; however, we may elect to extend the maturity date for a period of 12 months upon the satisfaction of certain conditions in the Credit Agreement. As a result, we believe that the resources stated above will be sufficient to satisfy our short-term operating requirements, and we do not anticipate a need to raise funds from sources other than those described above within the next 12 months. Long-term Liquidity and Capital Resources On a long-term basis, our principal demands for funds will be for property and other asset acquisitions and the payment of tenant improvements, operating expenses, including debt service payments on any outstanding indebtedness, and distributions and redemptions to our stockholders. We expect to meet our long-term liquidity requirements through proceeds from the Offering, secured or unsecured financings from banks and other lenders, any available capacity on the Line of Credit by the addition of properties to the Borrowing Base, proceeds from the sale of marketable securities and net cash flows provided by operations. As of June 30, 2014, we had received and accepted subscriptions for approximately 6.3 million shares of common stock for gross proceeds of $103.8 million. As of June 30, 2014, we had redeemed approximately 140,000 W Shares of common stock for $2.4 million. No valid redemption requests received during the six months ended June 30, 2014 went unfulfilled. 26



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As of June 30, 2014, we had $57.4 million of debt outstanding on the Line of Credit and $17.6 million of available borrowings based on the then-current Borrowing Base. See Note 6 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for certain terms of the Line of Credit. Our contractual obligations as of June 30, 2014 were as follows (in thousands): Payments due by period (1) Less Than 1 More Than Total Year 1-3 Years 3-5 Years 5 Years Principal payments - line of credit (2) $ 57,400$ 57,400 $ - $ - $ - Interest payments - line of credit (3) 703 703 - - - Total $ 58,103$ 58,103 $ - $ - $ -



(1) The table does not include amounts due to our advisor or its affiliates

pursuant to our advisory agreement because such amounts are not fixed and

determinable. (2) Does not include the impact of any extension. We may elect to extend the maturity of the Line of Credit for a period of 12 months upon the satisfaction of certain conditions in the Credit Agreement.



(3) Payment obligations for the amount outstanding under the Line of Credit

were calculated based on an interest rate of 2.74% in effect as of

June 30, 2014.

Our charter prohibits us from incurring debt that would cause our borrowings to exceed 75% of our gross assets, valued at the aggregate cost (before depreciation and other non-cash reserves), unless approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report. Our board of directors has adopted a policy to further limit our borrowings to 60% of the greater of cost (before depreciation or other non-cash reserves) or fair market value of our gross assets, unless the excess borrowing is approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report. During the initial period of the Offering, our board of directors, including a majority of our independent directors, approved borrowings exceeding this limit because we were and are in the process of raising sufficient equity capital to acquire our portfolio. After we have acquired a substantial portfolio, our advisor will target a leverage of 50% of the greater of cost (before deducting depreciation or other non-cash reserves) or fair market value of our gross assets. As of June 30, 2014, our ratio of debt to total gross real estate assets, net of gross intangible lease liabilities, was 37%. Cash Flow Analysis Operating Activities. Net cash provided by operating activities was $2.4 million for the six months ended June 30, 2014, compared to $220,000 for the six months ended June 30, 2013. The increase was primarily due to an increase in net income before non-cash adjustments for depreciation, amortization of intangibles, amortization of deferred financing costs and amortization of discounts on marketable securities of $2.0 million, combined with an increase in our working capital balances of $162,000. See "- Results of Operations" for a more complete discussion of the factors impacting our operating performance. Investing Activities. Net cash used in investing activities increased $27.5 million to $49.5 million for the six months ended June 30, 2014, compared to $22.0 million for the six months ended June 30, 2013. The increase was primarily due to the acquisition of 21 commercial properties during six months ended June 30, 2014, compared to the acquisition of ten commercial properties during the six months ended June 30, 2013. Financing Activities. Net cash provided by financing activities increased $20.9 million to $44.6 million for the six months ended June 30, 2014, compared to $23.7 million for the six months ended June 30, 2013. The increase was primarily due to an increase in net borrowings on the Line of Credit of $17.4 million and an increase in net proceeds from the issuance of common stock of $6.8 million. This increase was partially offset by an increase in redemptions of common stock of $1.5 million and an increase in distributions paid to investors of $806,000. 27



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Election as a REIT From the date of our formation and until the day following the date on which we issued shares to stockholders other than our initial stockholder, we were a qualified subchapter S subsidiary of our initial stockholder, and therefore were disregarded as an entity separate from our initial stockholder for U.S. federal income tax purposes. We have elected to be taxed, and currently qualify, as a REIT under the Internal Revenue Code of 1986, as amended. To maintain our qualification as a REIT, we must continue to meet certain requirements relating to our organization, sources of income, nature of assets, distributions of income to our stockholders and recordkeeping. As a REIT, we generally are not subject to federal income tax on taxable income that we distribute to our stockholders so long as we distribute at least 90% of our annual taxable income (determined without regard to the deduction for dividends paid and excluding certain non-cash items and net capital gains). If we fail to maintain our qualification as a REIT for any reason in a taxable year and applicable relief provisions do not apply, we will be subject to tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct distributions paid to our stockholders in any year in which we fail to maintain our qualification as a REIT. We also will be disqualified for the four taxable years following the year during which qualification was lost unless we are entitled to relief under specific statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to stockholders. However, we believe that we are organized and operate in such a manner as to maintain our qualification as a REIT for federal income tax purposes. No provision for federal income taxes has been made in our accompanying condensed consolidated unaudited financial statements. We are subject to certain state and local taxes related to the operations of properties in certain locations, which, if applicable, have been provided for in our accompanying condensed consolidated unaudited financial statements. Critical Accounting Policies and Estimates Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If management's judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. We consider our critical accounting policies to be the following: Investment in and Valuation of Real Estate and Related Assets;



Allocation of Purchase Price of Real Estate and Related Assets;

Revenue Recognition; and Income Taxes. A complete description of such policies and our considerations is contained in our Annual Report on Form 10-K for the year ended December 31, 2013 and our critical accounting policies have not changed during the six months ended June 30, 2014. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2013, and related notes thereto. Commitments and Contingencies We may be subject to certain commitments and contingencies with regard to certain transactions. Refer to Note 7 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further explanations. Related-Party Transactions and Agreements We have entered into agreements with Cole Advisors and its affiliates whereby we agree to pay certain fees to, or reimburse certain expenses paid by, Cole Advisors or its affiliates, primarily advisory and performance fees and expenses, organization and offering costs, selling commissions, dealer manager fees and expenses, distribution fees and reimbursement of certain acquisition and operating costs. See Note 8 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for a discussion of the various related-party transactions, agreements and fees. 28



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Subsequent Events Certain events occurred subsequent to June 30, 2014 through the filing date of this Quarterly Report on Form 10-Q. Refer to Note 10 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further explanation. Recent Accounting Pronouncements Refer to Note 2 to our condensed consolidated unaudited financial statements in this Quarterly Report on Form 10-Q for further explanation. There have been no accounting pronouncements issued, but not yet applied by us, that will significantly impact our financial statements. Off-Balance Sheet Arrangements As of June 30, 2014 and December 31, 2013, we had no material off-balance sheet arrangements that had or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity or capital resources. Item 3. Quantitative and Qualitative Disclosures About Market Risk In connection with the acquisition of our properties, we have obtained variable rate debt financing, and are therefore exposed to changes in LIBOR. As of June 30, 2014, we had $57.4 million of variable rate debt outstanding on the Line of Credit, and a change of 50 basis points in interest rates would result in a change in interest expense of $287,000 per annum. In the future, our objectives in managing interest rate risks will be to limit the impact of interest rate changes on operations and cash flows, and to lower overall borrowing costs. To achieve these objectives, we expect to borrow primarily at interest rates with the lowest margins available and, in some cases, with the ability to convert variable rates to fixed rates. In addition, we expect that we may enter into derivative financial instruments such as interest rate swaps, interest rate caps and rate lock arrangements in order to mitigate our interest rate risk. To the extent we enter into such arrangements, we will be exposed to credit and market risks including, but not limited to, the failure of any counterparty to perform under the terms of the derivative contract or the adverse effect on the value of the financial instrument resulting from a change in interest rates. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, we, under the supervision and with the participation of our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of June 30, 2014, were effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified by the rules and forms promulgated under the Exchange Act and is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosures. Changes in Internal Control Over Financial Reporting No change occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended June 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 29



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