filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this report entitled “Forward-Looking Statements.” Certain risk factors may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the sections in this report entitled “Risk Factors” and “Forward-Looking Statements.”
Occupancy percentages included in the following discussion, for some of our properties, are calculated based on factors in addition to contractually leased square feet, including available power, required support space and common area.
Overview
Our Company. Digital Realty Trust, Inc. completed its initial public offering of common stock, or our IPO, on November 3, 2004. We believe that we have operated in a manner that has enabled us to qualify, and have elected to be treated, as a REIT under Sections 856 through 860 of the Code. Our Company was formed on March 9, 2004. During the period from our formation until we commenced operations in connection with the completion of our IPO, we did not have any corporate activity other than the issuance of shares of Digital Realty Trust, Inc. common stock in connection with the initial capitalization of the Company. Our Operating Partnership was formed on July 21, 2004.
On December 20, 2018, the Operating Partnership and Stellar Participações Ltda., a Brazilian subsidiary of the Operating Partnership (“Acquisition Sub”), completed the acquisition of Ascenty, a leading data center provider in Brazil, for cash and equity consideration of approximately $2.0 billion. We refer to this transaction as the Ascenty Acquisition.
On September 14, 2017, we completed the acquisition of DuPont Fabros Technology, Inc., in an all-stock merger, which we refer to as the DFT Merger, for equity consideration of approximately $6.2 billion. We believe this transaction expanded our reach with a complementary footprint in top U.S. metropolitan areas while enhancing our ability to meet the growing demand for hyper-scale and public cloud solutions and solidifying our blue-chip customer base. As part of the DFT Merger, we acquired 15 data centers, 14 of which are located in the United States and one is located in Canada.
Business and strategy. Our primary business objectives are to maximize: (i) sustainable long-term growth in earnings and funds from operations per share and unit, (ii) cash flow and returns to our stockholders and our operating partnership’s unitholders through the payment of distributions and (iii) return on invested capital. We expect to accomplish our objectives by achieving superior risk-adjusted returns, prudently allocating capital, diversifying our product offerings, accelerating our global reach and scale and driving revenue growth and operating efficiencies. We plan to focus on our core business of investing in and developing and operating data centers. A significant component of our current and future internal growth is anticipated through the development of our existing space held for development, acquisition of land for future development and acquisition of new properties. We target high-quality, strategically located properties containing the physical and connectivity infrastructure that supports the applications and operations of data center and technology industry customers and properties that may be developed for such use. Most of our data center properties contain fully redundant electrical supply systems, multiple power feeds, above-standard cooling systems, raised floor areas, extensive in-building communications cabling and high-level security systems. We focus exclusively on owning, acquiring, developing and operating data centers because we believe that the growth in data center demand and the technology-related real estate industry generally will continue to outpace the overall economy.
As of December 31, 2018, our portfolio included 214 data centers, including 18 data centers held as investments in unconsolidated joint ventures, with approximately 34.5 million rentable square feet including approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development. The 18 data centers held as investments in unconsolidated joint ventures have an aggregate of approximately 2.5 million rentable square feet. The 26 parcels of developable land we own comprised approximately 959 acres. At December 31, 2018, excluding non-managed joint ventures, approximately 2.8 million square feet was under construction for Turn-Key Flex®, colocation and Powered Base Building® products, all of which are expected to be income producing on or after completion, in five U.S. metropolitan areas, four European metropolitan areas, one Australian metropolitan area, one Canadian metropolitan area and one Asian metropolitan area, consisting of approximately 1.7 million square feet of base building construction and 1.1 million square feet of data center construction.
We have developed detailed, standardized procedures for evaluating new real estate investments to ensure that they meet our financial, technical and other criteria. We expect to continue to acquire additional assets as part of our growth strategy. We intend to aggressively manage and lease our assets to increase their cash flow. We may continue to build out our development portfolio when justified by anticipated demand and returns.
We may acquire properties subject to existing mortgage financing and other indebtedness or we may incur new indebtedness in connection with acquiring or refinancing these properties. Debt service on such indebtedness will have a priority over any cash dividends with respect to Digital Realty Trust, Inc.’s common stock and preferred stock. We are committed to maintaining a conservative capital structure. We target a debt-to-Adjusted EBITDA ratio at or less than 5.5x, fixed charge coverage of greater than three times, and floating rate debt at less than 20% of total outstanding debt. In addition, we strive to maintain a well-laddered debt maturity schedule, and we seek to maximize the menu of our available sources of capital, while minimizing the cost.
Revenue base. As of December 31, 2018, we operated 214 data centers through our Operating Partnership, including 18 data centers held as investments in unconsolidated joint ventures, and developable land. These data centers are mainly located throughout North America, with 38 located in Europe, 16 in Latin America, seven in Asia and five properties in Australia.
The following table presents an overview of our portfolio of data centers, including the 18 data centers held as investments in unconsolidated joint ventures, and developable land, based on information as of December 31, 2018.
| Metropolitan Area | Data Center Buildings | Net Rentable Square Feet (1) | Space Under Active Development (2) | Space Held for Development (3) | |||||||||
| North America | |||||||||||||
| Northern Virginia | 30 | 5,718,180 | 1,425,029 | 84,852 | |||||||||
| Chicago | 10 | 2,963,850 | 459,250 | 152,362 | |||||||||
| New York | 12 | 1,980,040 | — | 240,157 | |||||||||
| Silicon Valley | 19 | 2,251,021 | — | — | |||||||||
| Dallas | 21 | 3,435,188 | 132,310 | 81,206 | |||||||||
| Phoenix | 4 | 990,385 | — | 108,926 | |||||||||
| San Francisco | 4 | 834,540 | 13,753 | — | |||||||||
| Atlanta | 5 | 775,606 | — | 313,581 | |||||||||
| Los Angeles | 4 | 806,934 | 11,545 | — | |||||||||
| Boston | 5 | 534,249 | — | 50,649 | |||||||||
| Houston | 6 | 392,816 | — | 13,969 | |||||||||
| Toronto, Canada (4) | 3 | 326,591 | 60,506 | 511,969 | |||||||||
| Denver | 2 | 371,500 | — | — | |||||||||
| Austin | 1 | 85,688 | — | — | |||||||||
| Miami | 2 | 226,314 | — | — | |||||||||
| Portland | 1 | 48,574 | — | — | |||||||||
| Minneapolis/St. Paul | 1 | 328,765 | — | — | |||||||||
| Charlotte | 3 | 95,499 | — | — | |||||||||
| Seattle | 1 | 40,564 | — | 75,382 | |||||||||
| North America Total / Weighted Average | 134 | 22,206,304 | 2,102,393 | 1,633,053 | |||||||||
| Europe | |||||||||||||
| London, United Kingdom (5) | 16 | 1,430,107 | 92,560 | 104,606 | |||||||||
| Amsterdam, Netherlands (6) | 9 | 474,303 | 91,859 | 68,185 | |||||||||
| Dublin, Ireland (6) | 5 | 330,180 | 26,646 | — |
| Metropolitan Area | Data Center Buildings | Net Rentable Square Feet (1) | Space Under Active Development (2) | Space Held for Development (3) | |||||||||
| Frankfurt, Germany (6) | 3 | 83,981 | 157,056 | — | |||||||||
| Paris, France (6) | 3 | 185,994 | — | — | |||||||||
| Manchester, England (5) | 1 | 38,016 | — | — | |||||||||
| Geneva, Switzerland (6) | 1 | 59,190 | — | — | |||||||||
| Europe Total / Weighted Average | 38 | 2,601,771 | 368,121 | 172,791 | |||||||||
| Asia Pacific | |||||||||||||
| Singapore (7) | 2 | 540,638 | — | — | |||||||||
| Melbourne, Australia (8) | 2 | 146,570 | — | — | |||||||||
| Sydney, Australia (8) | 3 | 196,665 | 117,692 | — | |||||||||
| Osaka, Japan (9) | 1 | — | 239,999 | — | |||||||||
| Asia Pacific Total / Weighted Average | 8 | 883,873 | 357,691 | — | |||||||||
| Ascenty Acquisition (10) | 16 | 473,251 | 522,643 | 243,160 | |||||||||
| Non-Data Center Properties | — | 516,107 | — | — | |||||||||
| Managed Unconsolidated Joint Ventures | |||||||||||||
| Northern Virginia | 4 | 546,572 | — | — | |||||||||
| Hong Kong (11) | 1 | 114,883 | — | 71,417 | |||||||||
| Silicon Valley | 4 | 326,305 | — | — | |||||||||
| Dallas | 3 | 319,876 | — | — | |||||||||
| New York | 1 | 108,336 | — | — | |||||||||
| 13 | 1,479,594 | — | 7,795 | ||||||||||
| Non-Managed Unconsolidated Joint Ventures | |||||||||||||
| Seattle | 2 | 451,369 | — | — | |||||||||
| Tokyo (9) | 2 | 430,277 | — | — | |||||||||
| Osaka (9) | 1 | 92,087 | — | — | |||||||||
| 5 | 973,733 | — | — | ||||||||||
| Total | 214 | 29,134,633 | 3,350,848 | 2,056,799 |
| (1) | Current net rentable square feet as of December 31, 2018, which represents the current square feet under lease as specified in the applicable lease agreements plus management’s estimate of space available for lease based on engineering drawings. Includes customers’ proportional share of common areas and excludes space under active development and space held for development. |
| (2) | Space under active development includes current base building and data center projects in progress. |
| (3) | Space held for development includes space held for future data center development, and excludes space under active development. |
| (4) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.73 to 1.00 CAD. |
| (5) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $1.27 to £1.00. |
| (6) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $1.14 to €1.00. |
| (7) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.73 to 1.00 SGD. |
| (8) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.70 to 1.00 AUD. |
| (9) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.01 to 1.00 JPY. |
| (10) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.26 to 1.00 BRL. |
| (11) | Rental amounts were calculated based on the exchange rate in effect on December 31, 2018 of $0.13 to 1.00 HKD. |
As of December 31, 2018, our portfolio, including the 18 data centers held as investments in unconsolidated joint ventures, were approximately 89.0% leased excluding approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development. Due to the capital-intensive and long-term nature of the operations being supported, our lease terms are generally longer than standard commercial leases. As of December 31, 2018, our average remaining lease term is approximately five years. Our scheduled lease expirations through December 31, 2020 are 22.1% of rentable square feet excluding month-to-month leases, space under active development and space held for development as of December 31, 2018.
Factors Which May Influence Future Results of Operations
Global market and economic conditions. General economic conditions and the cost and availability of capital may be adversely affected in some or all of the metropolitan areas in which we own properties and conduct our operations. In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum. The terms of any withdrawal are subject to ongoing negotiations. Nevertheless, the referendum has created significant uncertainty about the future relationship between the United Kingdom and the European Union, and has given rise to calls for the governments of other European Union member states to consider withdrawal. Instability in the U.S., European, Asia Pacific and other international financial markets and economies may adversely affect our ability, and the ability of our customers, to replace or renew maturing liabilities on a timely basis, access the capital markets to meet liquidity and capital expenditure requirements and may result in adverse effects on our, and our customers’, financial condition and results of operations.
In addition, our access to funds under our global revolving credit facility depends on the ability of the lenders that are parties to such facilities to meet their funding commitments to us. We cannot assure you that long-term disruptions in the global economy and the return of tighter credit conditions among, and potential failures or nationalizations of, third party financial institutions as a result of such disruptions will not have an adverse effect on our lenders. If our lenders are not able to meet their funding commitments to us, our business, results of operations, cash flows and financial condition could be adversely affected.
If we do not have sufficient cash flow to continue operating our business and are unable to borrow additional funds, access our existing lines of credit or raise equity or debt capital, we may need to source alternative ways to increase our liquidity. Such alternatives may include, without limitation, curtailing development activity, disposing of one or more of our properties possibly on disadvantageous terms or entering into or renewing leases on less favorable terms than we otherwise would.
Foreign currency exchange risk. For the years ended December 31, 2018 and 2017, we had foreign operations in the United Kingdom, Ireland, France, the Netherlands, Germany, Switzerland, Canada, Singapore, Australia, Japan and Hong Kong as well as Brazil in the year ended December 31, 2018, and, as such, are subject to risk from the effects of exchange rate movements of foreign currencies, which may affect future costs and cash flows. Our foreign operations are conducted in the British pound sterling, Euro, Canadian dollar, Singapore dollar, Australian dollar, Brazilian real, Japanese Yen and the Hong Kong dollar. Our primary currency exposures are to the British pound sterling, the Euro and the Singapore dollar. The possible exit of the United Kingdom (or any other country) from the European Union, or prolonged periods of uncertainty relating to any of these possibilities, could result in increased foreign currency exchange volatility. We attempt to mitigate a portion of the risk of currency fluctuation by financing our investments in the local currency denominations, although there can be no assurance that this will be effective. As a result, changes in the relation of any such foreign currency to U.S. dollars may affect our revenues, operating margins and distributions and may also affect the book value of our assets, the book value of our debt and the amount of stockholders’ equity.
Rental income. The amount of rental income generated by the data centers in our portfolio depends on several factors, including our ability to maintain or improve the occupancy rates of currently leased space and to lease currently available space and space available from lease terminations. Excluding approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development as of December 31, 2018, the occupancy rate of our portfolio, including the 18 data centers held as investments in unconsolidated joint ventures, was approximately 89.0% of our net rentable square feet.
As of December 31, 2018, we had over 2,300 tenants in our data center portfolio, including the 13 data centers held in our managed portfolio of unconsolidated joint ventures. As of December 31, 2018, approximately 88% of our leases (on a rentable square footage basis) contained base rent escalations that were either fixed (generally ranging from 2% to 4%) or indexed based
on a consumer price index or other similar inflation related index. We cannot assure you that these escalations will cover any increases in our costs or will otherwise keep rental rates at or above market rates.
The amount of rental income we generate also depends on maintaining or increasing rental rates at our properties, which in turn depends on several factors, including supply and demand and market rates for data center space. Included in our approximately 26.7 million net rentable square feet, excluding space under active development and space held for development and 18 data centers held as investments in unconsolidated joint ventures, at December 31, 2018 is approximately 1.1 million square feet of data center space with extensive installed tenant improvements available for lease. Our Turn-Key Flex® product is an effective solution for customers who prefer to utilize a partner with the expertise or capital budget to provide extensive data center infrastructure and security. Our expertise in data center construction and operations enables us to lease space to these customers at a premium over other uses. In addition, as of December 31, 2018, we had approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development, or approximately 14% of the total rentable space in our portfolio, including the 18 data centers held as investments in unconsolidated joint ventures. Our ability to grow earnings depends in part on our ability to develop space and lease development space at favorable rates, which we may not be able to obtain. Development space requires significant capital investment in order to develop data center facilities that are ready for use and, in addition, we may require additional time or encounter delays in securing tenants for development space. We may purchase additional vacant properties and properties with vacant development space in the future. We will require additional capital to finance our development activities, which may not be available or may not be available on terms acceptable to us, including as a result of the conditions described above under “Global market and economic conditions.”
In addition, the timing between when we sign a new lease with a customer and when that lease commences and we begin to generate rental income may be significant and may not be easily predictable. Certain leases may provide for staggered commencement dates for additional space, the timing of which may be delayed significantly.
Economic downturns, including as a result of the conditions described above under “Global market and economic conditions,” or regional downturns affecting our metropolitan areas or downturns in the data center industry that impair our ability to lease or renew or re-lease space, or otherwise reduce returns on our investments or the ability of our customers to fulfill their lease commitments, as in the case of tenant bankruptcies, could adversely affect our ability to maintain or increase rental rates at our properties.
Scheduled lease expirations. Our ability to re-lease expiring space at rental rates equal to or in excess of current rental rates will impact our results of operations. In addition to approximately 3.1 million square feet of available space in our portfolio, which excludes approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development as of December 31, 2018 and the five data centers held as investments in our non-managed unconsolidated joint ventures, leases representing approximately 13.0% and 9.1% of the net rentable square footage of our portfolio are scheduled to expire during the years ending December 31, 2019 and 2020, respectively.
During the year ended December 31, 2018, we signed new leases totaling approximately 1.9 million square feet of space and renewal leases totaling approximately 2.0 million square feet of space. The following table summarizes our leasing activity in the year ended December 31, 2018:
| Rentable Square Feet (1) | Expiring Rates (2) | New Rates (2) | Rental Rate Changes | TI’s/Lease Commissions Per Square Foot | Weighted Average Lease Terms (years) | |||||||||||||||
| Leasing Activity (3)(4) | ||||||||||||||||||||
| Renewals Signed | ||||||||||||||||||||
| Turn-Key Flex ® | 907,572 | $ | 159.17 | $ | 170.69 | 7.2 | % | $ | 4.73 | 5.7 | ||||||||||
| Powered Base Building ® | 266,824 | $ | 42.06 | $ | 52.68 | 25.2 | % | $ | 6.73 | 4.8 | ||||||||||
| Colocation | 614,808 | $ | 255.95 | $ | 256.82 | 0.3 | % | $ | 0.06 | 1.8 | ||||||||||
| Non-technical | 250,503 | $ | 14.48 | $ | 16.68 | 15.2 | % | $ | 2.77 | 6.0 | ||||||||||
| New Leases Signed (5) | ||||||||||||||||||||
| Turn-Key Flex ® | 1,402,579 | — | $ | 137.55 | — | $ | 28.49 | 8.3 | ||||||||||||
| Powered Base Building ® | 290,989 | — | $ | 32.66 | — | $ | 13.82 | 11.6 | ||||||||||||
| Colocation | 143,483 | — | $ | 237.82 | — | $ | 24.55 | 2.3 | ||||||||||||
| Non-technical | 110,780 | — | $ | 20.39 | — | $ | 14.14 | 9.6 | ||||||||||||
| Leasing Activity Summary | ||||||||||||||||||||
| Turn-Key Flex ® | 2,310,151 | — | $ | 150.57 | — | — | ||||||||||||||
| Powered Base Building ® | 557,813 | — | $ | 42.24 | — | — | ||||||||||||||
| Colocation | 758,291 | — | $ | 253.22 | — | — | ||||||||||||||
| Non-technical | 361,283 | — | $ | 17.82 | — | — | ||||||||||||||
| Total Renewals | 2,039,707 | |||||||||||||||||||
| Total New | 1,947,831 |
| (1) | For some of our properties, we calculate square footage based on factors in addition to contractually leased square feet, including power, required support space and common area. |
| (2) | Rental rates represent annual estimated cash rent per rentable square foot adjusted for straight-line rents in accordance with GAAP. GAAP rental rates are inclusive of tenant concessions, if any. |
| (3) | Excludes short-term leases. |
| (4) | Commencement dates for the leases signed range from 2018 to 2019. |
| (5) | Includes leases signed for new and re-leased space. |
Our ability to re-lease or renew expiring space at rental rates equal to or in excess of current rental rates will impact our results of operations. We continue to see strong demand in most of our key metropolitan areas for data center space and, subject to the supply of available data center space in these metropolitan areas, expect the rental rates we are likely to achieve on re-leased or renewed data center space leases for 2018 expirations on an average aggregate basis will generally be higher than the rates currently being paid for the same space on a GAAP basis and down high single digits on a cash basis. For the year ended December 31, 2018, rents on renewed space increased by an average of 7.2% on a GAAP basis on our Turn-Key Flex® space compared to the expiring rents and increased by an average of 25.2% on a GAAP basis on our Powered Base Building® space compared to the expiring rents. Our past performance may not be indicative of future results, and we cannot assure you that leases will be renewed or that our data centers will be re-leased at all or at rental rates equal to or above the current average rental rates. Further, re-leased/renewed rental rates in a particular metropolitan area may not be consistent with rental rates across our portfolio as a whole and may fluctuate from one period to another due to a number of factors, including local real estate conditions, local supply and demand for data center space, competition from other data center developers or operators, the condition of the property and whether the property, or space within the property, has been developed.
Geographic concentration. We depend on the market for data centers in specific geographic regions and significant changes in these regional metropolitan areas can impact our future results. As of December 31, 2018, our portfolio, including the 18 data centers held as investments in unconsolidated joint ventures, was geographically concentrated in the following metropolitan areas:
| Metropolitan Area | Percentage of December 31, 2018 total annualized rent (1) | |
| Northern Virginia | 23.2 | % |
| Chicago | 11.8 | % |
| Silicon Valley | 9.0 | % |
| New York | 8.4 | % |
| London, United Kingdom | 8.4 | % |
| Dallas | 7.7 | % |
| Singapore | 3.6 | % |
| Phoenix | 3.6 | % |
| San Francisco | 2.6 | % |
| Sao Paulo, Brazil | 2.6 | % |
| Seattle | 2.3 | % |
| Atlanta | 2.1 | % |
| Amsterdam, Netherlands | 1.9 | % |
| Other | 12.8 | % |
| Total | 100.0 | % |
| (1) | Annualized rent is monthly contractual rent (defined as cash base rent before abatements) under existing leases as of December 31, 2018 multiplied by 12. The aggregate amount of abatements for the year ended December 31, 2018 was approximately $47.4 million. |
Operating expenses. Our operating expenses generally consist of utilities, property and ad valorem taxes, property management fees, insurance and site maintenance costs, as well as rental expenses on our ground and building leases. In particular, our buildings require significant power to support the data center operations contained in them. Many of our leases contain provisions under which the tenants reimburse us for all or a portion of property operating expenses and real estate taxes incurred by us. However, in some cases we are not entitled to reimbursement of property operating expenses, other than utility expense, and real estate taxes under our leases for Turn-Key Flex® facilities. We also incur general and administrative expenses, including expenses relating to our asset management function, as well as significant legal, accounting and other expenses related to corporate governance, Securities Exchange Commission, or the SEC, reporting and compliance with the various provisions of the Sarbanes-Oxley Act. Increases or decreases in such operating expenses will impact our overall performance. We expect to incur additional operating expenses as we continue to expand.
Climate change legislation. In June 2009, the U.S. House of Representatives approved comprehensive clean energy and climate change legislation intended to cut greenhouse gas, or GHG, emissions, via a cap-and-trade program. The U.S. Senate did not subsequently pass similar legislation. Significant opposition to federal climate change legislation exists.
In the absence of comprehensive federal climate change legislation, over the past several years, regulatory agencies, primarily the U.S. Environmental Protection Agency, or EPA, and states took the lead in regulating GHG emissions in the U.S. Under the Obama administration, the EPA moved aggressively to regulate GHG emissions from automobiles and large stationary sources, including electricity producers, using its own authority under the Clean Air Act. The Trump administration has moved to eliminate or modify certain of the EPA’s GHG emissions regulations and refocus the EPA’s mission away from such regulation.
The EPA made an endangerment finding in 2009 that allows it to create regulations imposing emissions reporting, permitting, control technology installation, and monitoring requirements applicable to certain emitters of GHGs, including facilities that provide electricity to our data centers, although the materiality of the impacts will not be fully known until all regulations are finalized and legal challenges are resolved. Under the Obama administration, the EPA finalized rules imposing
permitting and control technology requirements upon certain newly-constructed or modified facilities which emit GHGs under the Clean Air Act New Source Review Prevention of Significant Deterioration, or NSR PSD, and Title V permitting programs. As a result, newly-issued NSR PSD and Title V permits for new or modified electricity generating units (EGUs) and other facilities may need to address GHG emissions, including by requiring the installation of “Best Available Control Technology.” The EPA implemented in December 2015 the “Clean Power Plan” regulating carbon dioxide (CO2) emissions from new and existing coal-fired and natural gas EGUs. Existing EGUs are subject to statewide CO2 emissions reduction targets, an effort designed to achieve a thirty-two percent reduction in nationwide existing EGU CO2 emissions by 2030 (in comparison to 2005 levels). The Clean Power Plan would subject new, modified, and reconstructed EGUs to “New Source Performance Standards” that include both technological requirements and numeric emission limits. However, twenty-four states and a number of industry groups challenged the Clean Power Plan in federal court, and in February 2016 the U.S. Supreme Court issued a stay of the Clean Power Plan until the legal challenges have been decided. In March 2017, President Trump ordered the EPA to review and if appropriate revise or rescind the Clean Power Plan, and the EPA proposed to repeal the Clean Power Plan in October 2017. In August 2018, the EPA proposed the “Affordable Clean Energy Rule” to replace the Clean Power Plan. Separately, the EPA’s GHG “reporting rule” requires that certain emitters, including electricity generators, monitor and report GHG emissions. The Trump administration may seek to revise or reverse these regulations.
As a result, states may drive near-term regulation to reduce GHG emissions in the United States. At the state level, California implemented a GHG cap-and-trade program that began imposing compliance obligations on industrial sectors, including electricity generators and importers, in January 2013. In September 2016, California adopted legislation calling for a further reduction in GHG emissions to 40% below 1990 levels by 2030, and in July 2017, California extended its cap-and-trade program through 2030. In September 2018, California adopted legislation that will require all of the state’s electricity to come from carbon-free sources by 2045. As another example of state action, in January 2018, New Jersey announced that it would re-join nine other eastern states in the Regional Greenhouse Gas Initiative (RGGI), a market-based program aimed at reducing GHG emissions from power plants. Several other states have announced that they are actively pursuing new GHG reduction programs.
Outside the United States, the European Union, or EU (including the United Kingdom), has been operating since 2005 under a cap-and-trade program, which directly affects the largest emitters of GHGs, including electricity producers from whom we purchase power, and the EU has taken a number of other climate change-related initiatives, including a directive targeted at improving energy efficiency (which introduces energy efficiency auditing requirements). The Paris Agreement, which was adopted by the United States and 194 other countries and looks to prevent global average temperatures from increasing by more than 2 degrees Celsius above preindustrial levels officially went into force on November 4, 2016. President Trump announced in June 2017 that he will initiate the process to withdraw the United States from the Paris Agreement; however, a number of states have formed groups supporting the Paris Agreement and pledging to fulfill its goals at the state level. National legislation may also be implemented independently by members of the EU. For example, in the United Kingdom, the implementation of the CRC Energy Efficiency Scheme introduced a mandatory reporting and pricing scheme that is designed to incentivize energy efficiency and cut emissions by large energy users. It is not yet clear how Brexit will impact the United Kingdom’s (or the EU’s) approach to climate change regulation. In Canada, GHG cap and trade programs are in operation in Quebec and Nova Scotia. Climate change regulations are in various stages of implementation in other nations as well, including nations where we operate, such as Japan, Singapore, and Australia.
The cost of electric power comprises a significant component of our operating expenses. Any additional taxation or regulation of energy use, including as a result of (i) new legislation that Congress may pass, (ii) the regulations that the EPA has proposed or finalized, (iii) regulations under legislation that states have passed or may pass, or (iv) any further legislation or regulations in the EU or other regions where we operate could significantly increase our costs, and we may not be able to effectively pass all of these costs on to our customers. These matters could adversely impact our business, results of operations, or financial condition.
Interest rates. As of December 31, 2018, we had approximately $0.8 billion of variable rate debt subject to interest rate swap agreements, along with $1.4 billion, $435.9 million and $143.3 million of variable rate debt that was outstanding on the unswapped portions of the global revolving credit facilities and the unsecured term loans, along with floating rate notes due 2019, or the 2019 Notes, respectively. The availability of debt and equity capital may decrease or be on unfavorable terms as a result of the circumstances described above under “Global market and economic conditions” or other factors. The effects on commercial real estate mortgages, if available, include, but may not be limited to: higher loan spreads, tightened loan covenants, reduced loan-to-value ratios resulting in lower borrower proceeds and higher principal payments. Potential future increases in interest rates and credit spreads may increase our interest expense and fixed charges and negatively affect our financial condition and results of operations, potentially impacting our future access to the debt and equity capital markets. Increased interest rates may also increase the risk that the counterparties to our swap agreements will default on their obligations, which could further increase our interest expense. If we cannot obtain capital from third party sources, we may not
be able to acquire or develop properties when strategic opportunities exist, satisfy our debt service obligations or pay the cash dividends to Digital Realty Trust, Inc.’s stockholders necessary to maintain its qualification as a REIT.
Demand for data center space. Our portfolio consists primarily of data centers. A decrease in the demand for, or increase in supply of, data center space, Internet gateway facilities or other technology-related real estate would have a greater adverse effect on our business and financial condition than if we owned a portfolio with a more diversified customer base or less specialized use. We have invested in building out additional inventory primarily in what we anticipate will be our active major metropolitan areas prior to having executed leases with respect to this space. We believe that demand in key metropolitan areas such as Northern Virginia, Dallas, Singapore and London is largely in line with supply. We also continue to see strong demand in other key metropolitan areas across our portfolio. However, until this inventory is leased up, which will depend on a number of factors, including available data center space in these metropolitan areas, our return on invested capital is negatively impacted. Our development activities make us particularly susceptible to general economic slowdowns, including recessions and the other circumstances described above under “Global market and economic conditions,” as well as adverse developments in the corporate data center, Internet and data communications and broader technology industries. Any such slowdown or adverse development could lead to reduced corporate IT spending or reduced demand for data center space. Reduced demand could also result from business relocations, including to metropolitan areas that we do not currently serve. Changes in industry practice or in technology, such as virtualization technology, more efficient computing or networking devices, or devices that require higher power densities than today’s devices, could also reduce demand for the physical data center space we provide or make the tenant improvements in our facilities obsolete or in need of significant upgrades to remain viable. In addition, the development of new technologies, the adoption of new industry standards or other factors could render many of our customers’ current products and services obsolete or unmarketable and contribute to a downturn in their businesses, thereby increasing the likelihood that they default under their leases, become insolvent or file for bankruptcy. In addition, demand for data center space, or the rates at which we lease space, may be adversely impacted either across our portfolio or in specific metropolitan areas as a result of an increase in the number of competitors, or the amount of space being offered in our metropolitan areas and other metropolitan areas by our competitors.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses in the reporting period. Our actual results may differ from these estimates. We have provided a summary of our significant accounting policies in Item 8, Note 2 “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements. We describe below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and consolidated results of operations. Our management evaluates these estimates on an ongoing basis, based upon information currently available and on various assumptions management believes are reasonable as of the date on the front cover of this report.
Investments in Real Estate
Acquisition of real estate. The price that we pay to acquire a property is impacted by many factors including the condition of the property and improvements, the occupancy of the building, the term and rate of in-place leases, the creditworthiness of the customers, favorable or unfavorable financing, above- or below-market ground leases and numerous other factors.
Accordingly, we are required to make subjective assessments to allocate the purchase price paid to acquire investments in real estate among the identifiable assets including intangibles and liabilities assumed based on our estimate of the fair value of such assets and liabilities. This includes determining the value of the property and improvements, land, ground leases, if any, and tenant improvements. Additionally, we evaluate the value of in-place leases on occupancy and market rent, the value of the tenant relationships, the value (or negative value) of above (or below) market leases, any debt or deferred taxes assumed from the seller or loans made by the seller to us and any building leases assumed from the seller. Each of these estimates requires a great deal of judgment and some of the estimates involve complex calculations. These allocation assessments have a direct impact on our results of operations. For example, if we were to allocate more value to land, there would be no depreciation with respect to such amount. If we were to allocate more value to the property as opposed to allocating to the value of in-place tenant leases, this amount would be recognized as an expense over a much longer period of time. This potential effect occurs because the amounts allocated to property are depreciated over the estimated lives of the property whereas amounts allocated to in-place tenant leases are amortized over the estimated term (including renewal and extension assumptions) of the leases. Additionally, the amortization of the value (or negative value) assigned to above (or below) market rate leases is recorded as an adjustment to
rental revenue as compared to amortization of the value of in-place tenant leases and tenant relationships, which is included in depreciation and amortization in our consolidated income statements.
From time to time, we will receive offers from third parties to purchase our properties, either solicited or unsolicited. For those offers that we accept, the prospective buyers will usually require a due diligence period before consummation of the transactions. It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process. We classify real estate as “held for sale” when all criteria under the GAAP guidance have been met.
Asset impairment evaluation. We review each of our properties for indicators that its carrying amount may not be recoverable. Examples of such indicators may include a significant decrease in the market price of the property, a change in the expected holding period for the property, a significant adverse change in how the property is being used or expected to be used based on the underwriting at the time of acquisition, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of the property, or a history of operating or cash flow losses of the property. When such impairment indicators exist, we review an estimate of the future undiscounted net cash flows (excluding interest charges) expected to result from the real estate investment’s use and eventual disposition and compare that estimate to the carrying value of the property. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our future undiscounted net cash flow evaluation indicates that we are unable to recover the carrying value of a real estate investment, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. These losses have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. Since cash flows on properties considered to be long-lived assets to be held and used are considered on an undiscounted basis to determine whether the carrying value of a property is recoverable, our strategy of holding properties over the long-term directly decreases the likelihood of their carrying values not being recoverable and therefore requiring the recording of an impairment loss. If our strategy changes or market conditions otherwise dictate an earlier sale date, an impairment loss may be recognized and such loss could be material. If we determine that the asset fails the recoverability test, the affected assets must be reduced to their fair value.
We generally estimate the fair value of rental properties utilizing a discounted cash flow analysis that includes projections of future revenues, expenses and capital improvement costs that a market participant would use based on the highest and best use of the asset, which is similar to the income approach that is commonly utilized by appraisers. In certain cases, we may supplement this analysis by obtaining outside broker opinions of value.
Goodwill impairment evaluation. We perform an annual impairment test for goodwill and between annual tests, we evaluate goodwill for impairment whenever events or changes in circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying value. In our impairment tests of goodwill, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If based on this assessment, we determine that the fair value of the reporting unit is not less than its carrying value, then performing the additional two-step impairment test is unnecessary. If our qualitative assessment indicates that goodwill impairment is more likely than not, we perform a two-step impairment test. We test goodwill for impairment under the two-step impairment test by first comparing the book value of net assets including goodwill to the fair value of the reporting unit. If the fair value is determined to be less than the book value of the net assets, including goodwill, a second step is performed to compute the amount of impairment as the difference between the implied fair value of goodwill and its carrying value. We estimate the fair value of the reporting units using discounted cash flows. If the carrying value of goodwill exceeds its implied fair value, an impairment charge is recognized.
Revenue Recognition
The majority of our revenue is derived from lease arrangements, which we account for in accordance with “Leases (Topic 840)”. We account for the non-lease components within our lease arrangements, as well as other sources of revenue, in accordance with “Revenue from Contracts with Customers (Topic 606)”. Revenue recognized as a result of applying Topic 840 was 97% and Topic 606 was 3% of total operating revenue for the year ended December 31, 2018.
Our leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the terms of the leases, which may span multiple years. The excess of rents recognized over amounts contractually due pursuant to the underlying leases is included in deferred rent in the accompanying consolidated balance sheets and contractually due but unpaid rents are included in accounts and other receivables.
Tenant reimbursements for real estate taxes, common area maintenance, and other recoverable costs under our leases are recognized in the period that the expenses are incurred. Lease termination fees are recognized over the remaining term of the lease, effective as of the date the lease modification is finalized, assuming collection is not considered doubtful. As discussed above, we recognize amortization of the value of acquired above or below-market tenant leases as a reduction of rental revenue in the case of above-market leases or an increase to rental revenue in the case of below-market leases.
We must make subjective estimates as to when our revenue is earned and the collectability of our accounts receivable related to minimum rent, deferred rent, expense reimbursements, lease termination fees and other income. We specifically analyze accounts receivable and historical bad debts, customer concentrations, customer creditworthiness and current economic trends when evaluating the adequacy of the allowance for bad debts. These estimates have a direct impact on our net revenue because a higher bad debt allowance would result in lower net revenue, and recognizing rental revenue as earned in one period versus another would result in higher or lower net revenue for a particular period.
Recently Issued Accounting Pronouncements
Please refer to Item 8, Note 2(aa), “Recent Accounting Pronouncements” in the Notes to the Consolidated Financial Statements.
Results of Operations
The discussion below relates to our financial condition and results of operations for the years ended December 31, 2018, 2017 and 2016. A summary of our operating results from continuing operations for the years ended December 31, 2018, 2017 and 2016 was as follows (in thousands).
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Income Statement Data: | |||||||||||
| Total operating revenues | $ | 3,046,478 | $ | 2,457,928 | $ | 2,142,213 | |||||
| Total operating expenses | (2,496,691 | ) | (2,006,633 | ) | (1,644,927 | ) | |||||
| Operating income | 549,787 | 451,295 | 497,286 | ||||||||
| Other expenses, net | (208,672 | ) | (195,027 | ) | (65,434 | ) | |||||
| Net income | $ | 341,115 | $ | 256,268 | $ | 431,852 |
Our portfolio of properties has experienced consistent and significant growth since the first property acquisition in January 2002. As a result of this growth, our period-to-period comparison of our financial performance focuses on the impact on our revenues and expenses on a stabilized portfolio basis. Our stabilized portfolio includes properties owned as of December 31, 2016 with less than 5% of total rentable square feet under development and excludes properties that were undergoing, or were expected to undergo, development activities in 2017-2018 and properties sold or contributed to joint ventures. Our pre-stabilized pool includes the results of the operating properties acquired below, newly delivered properties that were previously under development and properties acquired as part of the DFT Merger in September 2017.
On December 20, 2018, our Brazilian subsidiary, Stellar Participações Ltda , completed the acquisition of Ascenty, a leading data center provider in Brazil. As part of the acquisition, we acquired 16 data centers, all located in Brazil. Due to the timing of the transaction, the acquisition of Ascenty did not have a substantial impact on our operating income in 2018.
In September 2017, as part of the DFT Merger, we acquired 15 data centers, 14 of which are located in the United States and one is located in Canada. In addition, we acquired the following real estate properties during the year ended December 31, 2018:
| Property Type | Amount (in millions)(2) | |||
| Land Parcels (1) | $ | 296.1 | ||
| Data Centers | 114.6 | |||
| $ | 410.7 |
| (1) | Represents currently vacant land which is not included in our operating property count. |
| (2) | Purchase price in U.S. dollars and excludes capitalized closing costs. |
2018 Dispositions
| Location | Metro Area | Date Sold | Gross Proceeds (in millions) | Gain (loss) on sale (in millions) | ||||||||
| 200 Quannapowitt Parkway | Boston | Jan 25, 2018 | $ | 15.0 | $ | (0.4 | ) | |||||
| 34551 Ardenwood Boulevard | Silicon Valley | Feb 9, 2018 | 73.3 | 25.3 | ||||||||
| 3065 Gold Camp Drive | Sacramento | Mar 14, 2018 | 14.2 | 5.4 | ||||||||
| 11085 Sun Center Drive | Sacramento | Mar 14, 2018 | 36.8 | 9.1 | ||||||||
| Austin Portfolio | Austin | Apr 19, 2018 | 47.6 | 12.0 | ||||||||
| 2010 East Centennial Circle | Phoenix | May 22, 2018 | 5.5 | (0.5 | ) | |||||||
| 1125 Energy Park Drive | Minneapolis | May 31, 2018 | 7.0 | 2.8 | ||||||||
| 360 Spear Street | San Francisco | Sep 21, 2018 | 92.3 | 26.7 | ||||||||
| $ | 291.7 | $ | 80.4 |
None of the Company's property sales to date represented a significant component or significant shift in strategy that would require discontinued operations presentation.
Comparison of the Year Ended December 31, 2018 to the Year Ended December 31, 2017 and Comparison of the Year Ended December 31, 2017 to the Year Ended December 31, 2016
Portfolio
As of December 31, 2018, our portfolio consisted of 214 data centers, including 18 data centers held as investments in unconsolidated joint ventures, with an aggregate of approximately 34.5 million rentable square feet, including 3.4 million square feet of space under active development and 2.1 million square feet of space held for development, compared to a portfolio consisting of 205 data centers, including seven held-for-sale data centers and 18 data centers held as investments in unconsolidated joint ventures, with an aggregate of approximately 32.1 million rentable square feet, including 2.7 million square feet of space under active development and 1.7 million square feet of space held for development as of December 31, 2017, and compared to a portfolio consisting of 187 data centers, including three held-for-sale data centers and 15 data centers held as investments in unconsolidated joint ventures, with an aggregate of 26.1 million rentable square feet, including 2.0 million square feet of space under active development and 1.1 million square feet of space held for development as of December 31, 2016.
Revenues
Total operating revenues for the years ended December 31, 2018, 2017 and 2016 were as follows (in thousands):
| Year Ended December 31, | Change | Percentage Change | |||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||||||
| Rental and other services | $ | 2,412,076 | $ | 2,010,301 | $ | 1,746,828 | $ | 401,775 | $ | 263,473 | 20.0 | % | 15.1 | % | |||||||||||
| Tenant reimbursements | 624,637 | 440,224 | 355,903 | 184,413 | 84,321 | 41.9 | % | 23.7 | % | ||||||||||||||||
| Fee income and other | 9,765 | 7,403 | 39,482 | 2,362 | (32,079 | ) | 31.9 | % | (81.2 | )% | |||||||||||||||
| Total operating revenues | $ | 3,046,478 | $ | 2,457,928 | $ | 2,142,213 | $ | 588,550 | $ | 347,481 | 23.9 | % | 14.7 | % |
The following tables show revenues for the years ended December 31, 2018, 2017 and 2016 for stabilized properties and pre-stabilized properties and other (all other properties) (in thousands). Revenue totals for pre-stabilized and other include results from properties that have not yet met the definition of stabilized and properties that are classified as held for sale or were sold during the period.
| Stabilized Year Ended December 31, | Pre-Stabilized and Other Year Ended December 31, | |||||||||||||||||||||||||
| 2018 | 2017 | Change | % Change | 2018 | 2017 | Change | ||||||||||||||||||||
| Rental and other services | $ | 1,397,953 | $ | 1,388,427 | $ | 9,526 | 0.7 | % | $ | 1,014,123 | $ | 621,874 | $ | 392,249 | ||||||||||||
| Tenant reimbursements | 254,725 | 254,876 | (151 | ) | (0.1 | )% | 369,912 | 185,348 | 184,564 | |||||||||||||||||
| Total operating revenues | $ | 1,652,678 | $ | 1,643,303 | $ | 9,375 | 0.6 | % | $ | 1,384,035 | $ | 807,222 | $ | 576,813 |
Stabilized rental and other services revenue increased $9.5 million, or 0.7%, for the year ended December 31, 2018 compared to the same period in 2017 primarily as a result of an increase in revenues from colocation services and new leasing at our properties during the year ended December 31, 2018, the largest of which was for space at 350 E. Cermak Road, 2121 South Price Road and 29A International Business Park, partially offset by expiring leases at certain properties in the stabilized portfolio. Stabilized tenant reimbursement revenue decreased $0.2 million, or 0.1%, for the year ended December 31, 2018 compared to the same period in 2017 primarily as a result of reimbursement credits and property tax refunds to tenants at properties in the stabilized portfolio offset by higher utility reimbursements driven by increased power consumption and new leasing.
Pre-stabilized and other revenue increases during the year ended December 31, 2018 compared to the same period in 2017 were primarily a result of the properties acquired in the DFT Merger, which contributed approximately $311.4 million and $164.0 million to the rental and other services revenue and tenant reimbursement increases, respectively. In addition, 505 North Railroad Avenue, which was acquired in December 2017, contributed $21.9 million and $5.1 million to the rental and other services revenue and tenant reimbursements increases, respectively, for the year ended December 31, 2018 compared to the same period in 2017. Also, there were contributions from new leases at our properties that were under development during
the year ended December 31, 2018, offset partially by a decrease in revenues as a result of properties sold during the year ended December 31, 2018.
| Stabilized Year Ended December 31, | Pre-Stabilized and Other Year Ended December 31, | |||||||||||||||||||||||||
| 2017 | 2016 | Change | % Change | 2017 | 2016 | Change | ||||||||||||||||||||
| Rental and other services | $ | 1,181,687 | $ | 1,154,380 | $ | 27,307 | 2.4 | % | $ | 828,614 | $ | 592,448 | $ | 236,166 | ||||||||||||
| Tenant reimbursements | 217,068 | 218,644 | (1,576 | ) | (0.7 | )% | 223,156 | 137,259 | 85,897 | |||||||||||||||||
| Total operating revenues | $ | 1,398,755 | $ | 1,373,024 | $ | 25,731 | 1.9 | % | $ | 1,051,770 | $ | 729,707 | $ | 322,063 |
Stabilized rental and other services revenues increased $27.3 million, or 2.4%, for the year ended December 31, 2017 compared to the same period in 2016 primarily as a result of new leasing at our properties during the year ended December 31, 2017, the largest of which was for space at 1-11 Templar Road, 1725 Comstock Street and 200 Paul Avenue along with an increase in revenues from colocation services, offset by expiring leases at certain properties in the stabilized portfolio. Stabilized tenant reimbursement revenue decreased $1.6 million, or 0.7%, for the year ended December 31, 2017 compared to the same period in 2016 primarily as a result of increased property tax reimbursements due to one-time reductions in 2016 at two properties in the stabilized portfolio as well as lower utility reimbursements due to decreased usage and vacancies at certain properties.
Pre-stabilized and other revenue increases during the year ended December 31, 2017 compared to the same period in 2016 were primarily a result of the properties acquired in the DFT Merger, which contributed approximately $115.4 million and $62.3 million to the rental revenue and tenant reimbursement increases, respectively. In addition, the European Portfolio Acquisition contributed approximately $44.9 million and $7.0 million to the rental revenue and interconnection revenue increases, respectively. The remainder of the increases was related to new leases at our properties during the year ended December 31, 2017, offset partially by a decrease in revenues as a result of properties sold during the year ended December 31, 2017.
Fee Income and Other
Occasionally, customers engage the Company for certain services. The nature of these services historically involves property management, construction management, and assistance with financing. The proper revenue recognition of these services can be different, depending on whether the arrangements are service revenue or contractor type revenue. Service revenues are typically recognized on an equal monthly basis based on the minimum fee to be earned. The monthly amounts could be adjusted depending on if certain performance milestones are met.
Fee income also includes management fees. These fees arise from contractual agreements with entities in which we have a noncontrolling interest. The management fees are recognized as earned under the respective agreements. Management and other fee income related to partially owned entities are recognized to the extent attributable to the unaffiliated interest.
During the year ended December 31, 2016, we recognized a non-cash gain on lease termination of approximately $29.2 million, as one of our customers, as part of a lease termination, conveyed substantially all of its colocation and turn-key improvements to the Company.
Operating Expenses and Interest Expense
Operating expenses and interest expense during the years ended December 31, 2018, 2017 and 2016 were as follows (in thousands):
| Year Ended December 31, | Change | Percentage Change | |||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | 2018 vs 2017 | 2017 vs 2016 | |||||||||||||||||||
| Rental property operating and maintenance | $ | 957,065 | $ | 759,616 | $ | 660,177 | $ | 197,449 | $ | 99,439 | 26.0 | % | 15.1 | % | |||||||||||
| Property taxes | 129,516 | 124,014 | 102,497 | 5,502 | 21,517 | 4.4 | % | 21.0 | % | ||||||||||||||||
| Insurance | 11,402 | 10,981 | 9,492 | 421 | 1,489 | 3.8 | % | 15.7 | % | ||||||||||||||||
| Depreciation and amortization | 1,186,896 | 842,464 | 699,324 | 344,432 | 143,140 | 40.9 | % | 20.5 | % | ||||||||||||||||
| General and administrative | 163,667 | 161,441 | 152,733 | 2,226 | 8,708 | 1.4 | % | 5.7 | % | ||||||||||||||||
| Transaction and integration expenses | 45,327 | 76,048 | 20,491 | (30,721 | ) | 55,557 | (40.4 | )% | 271.1 | % | |||||||||||||||
| Impairment of investments in real estate | — | 28,992 | — | (28,992 | ) | 28,992 | — | — | |||||||||||||||||
| Other | 2,818 | 3,077 | 213 | (259 | ) | 2,864 | (8.4 | )% | 1,344.6 | % | |||||||||||||||
| Total operating expenses | $ | 2,496,691 | $ | 2,006,633 | $ | 1,644,927 | $ | 490,058 | $ | 361,706 | 24.4 | % | 22.0 | % | |||||||||||
| Interest expense | $ | 321,529 | $ | 258,642 | $ | 236,480 | $ | 62,887 | $ | 22,162 | 24.3 | % | 9.4 | % |
The following tables show expenses for the years ended December 31, 2018, 2017 and 2016 for stabilized properties and pre-stabilized properties and other (all other properties) (in thousands). Expense totals for pre-stabilized and other include results from properties that have not yet met the definition of stabilized and properties that are classified as held for sale or were sold during the period.
| Stabilized Year Ended December 31, | Pre-Stabilized and Other Year Ended December 31, | |||||||||||||||||||||||||
| 2018 | 2017 | Change | % Change | 2018 | 2017 | Change | ||||||||||||||||||||
| Rental property operating and maintenance | $ | 505,127 | $ | 494,852 | $ | 10,275 | 2.1 | % | $ | 451,938 | $ | 264,764 | $ | 187,174 | ||||||||||||
| Property taxes | 73,349 | 78,059 | (4,710 | ) | (6.0 | )% | 56,167 | 45,955 | 10,212 | |||||||||||||||||
| Insurance | 7,925 | 8,164 | (239 | ) | (2.9 | )% | 3,477 | 2,817 | 660 |
Stabilized rental property operating and maintenance expenses increased by approximately $10.3 million, or 2.1%, for the year ended December 31, 2018 compared to the same period in 2017. The increase was primarily related to higher utility costs offset by reduced labor costs and cost containment measures across the portfolio.
Stabilized property taxes decreased by approximately $4.7 million, or 6.0%, for the year ended December 31, 2018 compared to the same period in 2017. The decrease was primarily due to a refund at one of our properties in our stabilized portfolio.
Pre-stabilized and other rental property operating and maintenance expenses increased by approximately $187.2 million for the year ended December 31, 2018 compared to the same period in 2017, primarily as a result of the properties acquired in the DFT Merger, which contributed approximately $138.7 million.
Pre-stabilized and other property tax expense increased approximately $10.2 million for the year ended December 31, 2018 compared to the same period in 2017, primarily as a result of the properties acquired in the DFT Merger, which contributed approximately $16.1 million offset partially by a decrease in property taxes as a result of properties sold during the year ended December 31, 2018 and a reduction in property tax liabilities at certain properties in our pre-stabilized and other portfolio.
| Stabilized Year Ended December 31, | Pre-Stabilized and Other Year Ended December 31, | |||||||||||||||||||||||||
| 2017 | 2016 | Change | % Change | 2017 | 2016 | Change | ||||||||||||||||||||
| Rental property operating and maintenance | $ | 409,614 | $ | 412,358 | $ | (2,744 | ) | (0.7 | )% | $ | 350,002 | $ | 247,819 | $ | 102,183 | |||||||||||
| Property taxes | 69,363 | 67,929 | 1,434 | 2.1 | % | 54,651 | 34,568 | 20,083 | ||||||||||||||||||
| Insurance | 7,663 | 7,165 | 498 | 7.0 | % | 3,318 | 2,327 | 991 |
Stabilized rental property operating and maintenance expenses decreased by approximately $2.7 million, or 0.7%, for the year ended December 31, 2017 compared to the same period in 2016 primarily as a result of reduced labor costs and cost containment measures across the portfolio.
Stabilized property taxes increased by approximately $1.4 million, or 2.1%, for the year ended December 31, 2017 compared to the same period in 2016, primarily as a result of increased assessed taxes at one of our properties in Illinois.
Pre-stabilized and other rental property operating and maintenance expenses increased by approximately $102.2 million for the year ended December 31, 2017 compared to the same period in 2016, primarily as a result of the properties acquired in the DFT Merger, which contributed approximately $51.2 million along with the European Portfolio Acquisition, which contributed approximately $20.4 million to the increase, and leasing of completed and delivered inventory.
Pre-stabilized and other property tax expense increased approximately $20.1 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to a tax refund received in 2016 at one property in Singapore related to a change in assessed value along with the properties acquired in the DFT Merger, which contributed approximately $5.3 million.
Depreciation and Amortization
Depreciation and amortization expense increased by approximately $344.4 million for the year ended December 31, 2018 compared to the same period in 2017, principally because of amortization of finite-lived intangibles associated with the DFT Merger, which contributed approximately $310.7 million to the increase.
Depreciation and amortization expense increased by approximately $143.1 million for the year ended December 31, 2017 compared to the same period in 2016, principally because of amortization of finite-lived intangibles associated with the DFT Merger, which contributed approximately $116.2 million to the increase along with the European Portfolio Acquisition, which contributed approximately $23.8 million, offset by an impairment charge on the Telx tradename of approximately $6.1 million recorded in the quarter ended June 30, 2016 along with fully depreciated building assets during the year ended December 31, 2017.
General and Administrative
General and administrative expenses increased by approximately $2.2 million for the year ended December 31, 2018 compared to the same period in 2017, primarily due to an increase in headcount from 2017 to 2018 to support the Company's continued growth.
General and administrative expenses increased by approximately $8.7 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to an increase in headcount from 2016 to 2017 to support the Company's continued growth.
Transactions and Integration Expense
Transactions and integration expense decreased by approximately $30.7 million for the year ended December 31, 2018 compared to the same period in 2017, principally due to expenses incurred for the DFT Merger, which was completed in September 2017 partially offset by costs incurred related to the Ascenty Acquisition.
Transactions and integration expense increased by approximately $55.6 million for the year ended December 31, 2017 compared to the same period in 2016, principally due to $43.0 million of transaction expenses for the year ended December 31, 2017 related to the DFT Merger along with integration expenses attributable to recently completed acquisitions.
Interest Expense
Interest expense increased by approximately $62.9 million for the year ended December 31, 2018 compared to the same period in 2017, primarily due to the issuance of the 2019 Notes in May 2017, the issuance of the 2.750% 2024 Notes and the 2029 Notes in July 2017, the issuance of the 2.750% 2023 Notes and the 2027 Notes in August 2017, the issuance of the 2028 Notes in June 2018 and the 2030 Notes in October 2018.
Interest expense increased by approximately $22.2 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the issuance of the 2019 Notes in May 2017, the issuance of the 2.750% notes due 2024 and the 3.300% notes due 2029 in July 2017 and the issuance of the 2.750% notes due 2023 and the 3.700% notes due 2027 in August 2017.
Impairment of Investments in Real Estate
We evaluated the carrying value of the properties identified as held for sale to ensure the carrying value was recoverable in light of a potentially shorter holding period. As a result of our evaluation, during the year ended December 31, 2017, we recognized $29.0 million of impairment charges on three properties located in the United States to reduce the carrying values to the estimated fair values less costs to sell. The fair values of the three properties were based on comparable sales price data. There were no impairment charges for the years ended December 31, 2018 and 2016.
Gain on Sale of Properties
During the year ended December 31, 2018, we recognized a gain on sale of properties of $80.4 million primarily related to the disposition of (i) 200 Quannapowitt Parkway, which sold for $15.0 million in January 2018, (ii) 34551 Ardenwood Boulevard, which sold for $73.3 million in February 2018, (iii) 3065 Gold Camp Drive, which sold for $14.2 million in March 2018, (iv) 11085 Sun Center Drive, which sold for $36.8 million in March 2018, (v) the Austin Portfolio, which sold for $47.6 million in April 2018, (vi) 2010 East Centennial Circle, which sold for $5.5 million in May 2018, (vii) 1125 Energy Park Drive, which sold for $7.0 million in May 2018 and (viii) 360 Spear Street, which sold for $92.3 million in September 2018.
During the year ended December 31, 2017, we recognized a gain on sale of properties of $40.4 million primarily related to the disposition of (i) 8025 North Interstate 35, which sold for $20.2 million in August 2017, (ii) 44874 Moran Road, which sold for $34.0 million in October 2017, and (iii) 1 Solutions Parkway, which sold for $37.1 million in November 2017.
During the year ended December 31, 2016, we recognized a gain on sale of properties of $169.9 million primarily related to the disposition of (i) 47700 Kato Road and 1055 Page Avenue, which sold for $37.5 million in January 2016, (ii) a four-property portfolio composed of 210 N. Tucker Boulevard, 900 Walnut Street, 251 Exchange Place and 1807 Michael Faraday Court, which sold for $114.5 million in the aggregate in July 2016, and (iii) 114 Ambroise Croizat, which sold for $212.0 million in August 2016.
Liquidity and Capital Resources of the Parent Company
In this “Liquidity and Capital Resources of the Parent Company” section and in the “Liquidity and Capital Resources of the Operating Partnership” section below, the term, our “Parent Company”, refers to Digital Realty Trust, Inc. on an unconsolidated basis, excluding our Operating Partnership.
Analysis of Liquidity and Capital Resources
Our Parent Company’s business is operated primarily through our Operating Partnership, of which our Parent Company is the sole general partner and which it consolidates for financial reporting purposes. Because our Parent Company operates on a consolidated basis with our Operating Partnership, the section entitled “Liquidity and Capital Resources of the Operating Partnership” should be read in conjunction with this section to understand the liquidity and capital resources of our Parent Company on a consolidated basis and how our Company is operated as a whole.
Our Parent Company issues public equity from time to time, but generally does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses in operating as a public company which are fully reimbursed by the Operating Partnership. Our Parent Company itself does not hold any indebtedness other than guarantees of the indebtedness of our Operating Partnership and certain of its subsidiaries, and its only material asset is its ownership of partnership interests of our
Operating Partnership. Therefore, the consolidated assets and liabilities and the consolidated revenues and expenses of our Parent Company and our Operating Partnership are the same on their respective financial statements, except for immaterial differences related to cash, other assets and accrued liabilities that arise from public company expenses paid by our Parent Company. However, all debt is held directly or indirectly at the Operating Partnership level. Our Parent Company’s principal funding requirement is the payment of dividends on its common and preferred stock. Our Parent Company’s principal source of funding for its dividend payments is distributions it receives from our Operating Partnership.
As the sole general partner of our Operating Partnership, our Parent Company has the full, exclusive and complete responsibility for our Operating Partnership’s day-to-day management and control. Our Parent Company causes our Operating Partnership to distribute such portion of its available cash as our Parent Company may in its discretion determine, in the manner provided in our Operating Partnership’s partnership agreement. Our Parent Company receives proceeds from its equity issuances from time to time, but is generally required by our Operating Partnership’s partnership agreement to contribute the proceeds from its equity issuances to our Operating Partnership in exchange for partnership units of our Operating Partnership.
Our Parent Company is a well-known seasoned issuer with an effective shelf registration statement filed on September 22, 2017, which allows our Parent Company to register an unspecified amount of various classes of equity securities. As circumstances warrant, our Parent Company may issue equity from time to time on an opportunistic basis, dependent upon market conditions and available pricing. Any proceeds from such equity issuances would generally be contributed to our Operating Partnership in exchange for additional equity interests in our Operating Partnership. Our Operating Partnership may use the proceeds to acquire additional properties, to fund development opportunities and for general working capital purposes, including potentially for the repurchase, redemption or retirement of outstanding debt or equity securities.
The liquidity of our Parent Company is dependent on our Operating Partnership’s ability to make sufficient distributions to our Parent Company. The primary cash requirement of our Parent Company is its payment of dividends to its stockholders. Our Parent Company also guarantees our Operating Partnership’s, as well as certain of its subsidiaries’ and affiliates’, unsecured debt. If our Operating Partnership or such subsidiaries fail to fulfill their debt requirements, which trigger Parent Company guarantee obligations, then our Parent Company will be required to fulfill its cash payment commitments under such guarantees. However, our Parent Company’s only material asset is its investment in our Operating Partnership.
We believe our Operating Partnership’s sources of working capital, specifically its cash flow from operations, and funds available under its global revolving credit facility are adequate for it to make its distribution payments to our Parent Company and, in turn, for our Parent Company to make its dividend payments to its stockholders. However, we cannot assure you that our Operating Partnership’s sources of capital will continue to be available at all or in amounts sufficient to meet its needs, including making distribution payments to our Parent Company. The lack of availability of capital could adversely affect our Operating Partnership’s ability to pay its distributions to our Parent Company, which would in turn, adversely affect our Parent Company’s ability to pay cash dividends to its stockholders.
Our Parent Company entered into equity distribution agreements in June 2011, which we refer to as the 2011 Equity Distribution Agreements, with each of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc. and Morgan Stanley & Co. LLC, or the Agents, under which it can issue and sell shares of its common stock having an aggregate offering price of up to $400.0 million from time to time through, at its discretion, any of the Agents as its sales agents. The sales of common stock made under the 2011 Equity Distribution Agreements will be made in “at the market” offerings as defined in Rule 415 of the Securities Act. Cumulatively through December 31, 2018, our Parent Company had generated net proceeds of approximately $342.7 million from the issuance of approximately 5.7 million common shares under the 2011 Equity Distribution Agreements at an average price of $60.35 per share after payment of approximately $3.5 million of commissions to the sales agents and before offering expenses. No sales were made under the program during the years ended December 31, 2018, 2017 and 2016. As of December 31, 2018, shares of common stock having an aggregate offering price of $53.8 million remained available for offer and sale under the program. The 2011 Equity Distribution Agreements were terminated in connection with the entry into the 2019 Equity Distribution Agreements (defined and discussed below) on January 4, 2019.
On January 4, 2019, our Parent Company entered into equity distribution agreements, which we refer to as the 2019 Equity Distribution Agreements, with each of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Barclays Capital Inc., BTIG, LLC, Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., J.P. Morgan Securities LLC, Mizuho Securities USA LLC, Morgan Stanley & Co. LLC, MUFG Securities Americas Inc., PNC Capital Markets LLC, Raymond James & Associates, Inc., RBC Capital Markets, LLC, Scotia Capital (USA) Inc., SMBC Nikko Securities America, Inc., SunTrust Robinson Humphrey, Inc., TD Securities (USA) LLC, and Wells Fargo Securities, LLC, or the Agents, under which it could issue and sell shares of its common stock having an aggregate offering price of up to $1.0 billion from time to time through, at its discretion, any of the Agents as its sales agents or as principals. Sales may also be made on a forward basis pursuant to separate forward sale
agreements. The sales of common stock made under the 2019 Equity Distribution Agreements will be made in “at the market” offerings as defined in Rule 415 of the Securities Act. To date, no sales have been made under the program.
On September 27, 2018, our Parent Company completed an underwritten public offering of 9,775,000 shares of its common stock (including 1,275,000 shares from the exercise in full of the underwriters' option to purchase additional shares), all of which were offered in connection with forward sale agreements it entered into with certain financial institutions acting as forward purchasers. The forward purchasers borrowed and sold an aggregate of 9,775,000 shares of our Parent Company’s common stock in the public offering. We did not receive any proceeds from the sale of our common stock by the forward purchasers in the public offering. We expect to receive net proceeds of approximately $1.1 billion (net of fees and estimated expenses) upon full physical settlement of the forward sale agreements, which is anticipated to be no later than September 27, 2019.
Ascenty Acquisition Financing
On December 20, 2018, we completed the acquisition of Ascenty for total cash and equity consideration of approximately $1.8 billion, net of cash purchased. The transaction was initially funded with $600.0 million of proceeds from a non-recourse, five-year secured term loan (see below); the issuance of approximately $254 million of Operating Partnership common units in exchange for the substantial majority of the Ascenty management's equity interests; and approximately $1.0 billion of unsecured corporate borrowings, comprised of a $375.0 million unsecured term loan (see below) and borrowings under the global revolving credit facility.
On December 19, 2018, the Operating Partnership entered into a term loan agreement, with Digital Realty Trust, Inc. as the parent guarantor, which we refer to as the Ascenty term loan agreement, which governs a $375.0 million 1-year senior unsecured term loan, which we refer to as the 2019 Term Loan. The 2019 Term Loan matures on December 19, 2019 with one six-month extension option. Interest rates equal the applicable index plus a margin of 100 basis points, which is based on the current credit ratings of our senior unsecured debt (effective rate of 3.47% as of December 31, 2018).
On December 20, 2018, our Brazilian subsidiary entered into a non-recourse credit agreement for up to $775.0 million in the aggregate, which consists of a $600.0 million 5-year secured term loan, which we refer to as the December 2023 Secured Loan, plus a $125.0 million delayed-draw term loan and a $50.0 million revolving credit facility. The December 2023 Secured Loan matures on December 20, 2023. The interest rate on the December 2023 Secured Loan equals the applicable index plus a margin of 425 basis points (effective rate of 7.04% as of December 31, 2018).
Separately, we entered into an independent bilateral equity commitment letter with Brookfield Infrastructure, an affiliate of Brookfield Asset Management, one of the largest owners and operators of infrastructure assets globally, under which Brookfield has committed to fund approximately $700 million, excluding Brookfield's share of transaction costs, in exchange for 49% of the total equity interests in a joint venture entity expected to ultimately own Ascenty. The agreement with Brookfield is subject to certain closing conditions and is expected to close in the first quarter of 2019.
Future Uses of Cash
Our Parent Company may from time to time seek to retire, redeem or repurchase its equity or the debt securities of our Operating Partnership or its subsidiaries through cash purchases and/or exchanges for equity securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases, redemptions or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions or other factors. The amounts involved may be material.
We are also subject to the commitments discussed below under “Dividends and Distributions.”
Dividends and Distributions
Our Parent Company is required to distribute 90% of its taxable income (excluding capital gains) on an annual basis in order for it to continue to qualify as a REIT for federal income tax purposes. Accordingly, our Parent Company intends to make, but is not contractually bound to make, regular quarterly distributions to its common stockholders from cash flow from our Operating Partnership’s operating activities. While historically our Parent Company has satisfied this distribution requirement by making cash distributions to its stockholders, it may choose to satisfy this requirement by making distributions of cash or other property. All such distributions are at the discretion of our Parent Company’s board of directors. Our Parent Company considers market factors and our Operating Partnership’s performance in addition to REIT requirements in determining distribution levels. Our Parent Company has distributed at least 100% of its taxable income annually since inception to minimize corporate level federal income taxes. Amounts accumulated for distribution to stockholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with our intention to maintain our Parent Company’s status as a REIT.
As a result of this distribution requirement, our Operating Partnership cannot rely on retained earnings to fund its on-going operations to the same extent that other companies whose parent companies are not REITs can. Our Parent Company may need to continue to raise capital in the debt and equity markets to fund our Operating Partnership’s working capital needs, as well as potential developments at new or existing properties, acquisitions or investments in existing or newly created joint ventures. In addition, our Parent Company may be required to use borrowings under our global revolving credit facility, if necessary, to meet REIT distribution requirements and maintain our Parent Company’s REIT status.
Our Parent Company declared the following dividends on its common and preferred stock during the years ended December 31, 2018, 2017 and 2016 (in thousands, except per share amounts):
| Date dividend declared | Dividend payable date | Series C Preferred Stock | Series E Preferred Stock | Series F Preferred Stock | Series G Preferred Stock | Series H Preferred Stock | Series I Preferred Stock | Series J Preferred Stock | Common Stock | ||||||||||||||||||||||||||
| February 17, 2016 | March 31, 2016 | — | $ | 5,031 | $ | 3,023 | $ | 3,672 | $ | 6,730 | $ | 3,969 | — | $ | 131,587 | (1) | |||||||||||||||||||
| May 11, 2016 | June 30, 2016 | — | 5,031 | 3,023 | 3,672 | 6,730 | 3,969 | — | 131,607 | (1) | |||||||||||||||||||||||||
| August 10, 2016 | September 30, 2016 | — | — | (2) | 3,023 | 3,672 | 6,730 | 3,969 | — | 131,657 | (1) | ||||||||||||||||||||||||
| November 9, 2016 | December 30, 2016 for Preferred Stock; January 13, 2017 for Common Stock | — | — | 3,023 | 3,672 | 6,730 | 3,969 | — | 141,882 | (1) | |||||||||||||||||||||||||
| — | $ | 10,062 | $ | 12,092 | $ | 14,688 | $ | 26,920 | $ | 15,876 | — | $ | 536,733 | ||||||||||||||||||||||
| March 1, 2017 | March 31, 2017 | — | — | $ | 3,023 | $ | 3,672 | $ | 6,730 | $ | 3,969 | — | $ | 148,358 | (3) | ||||||||||||||||||||
| May 8, 2017 | June 30, 2017 | — | — | — | (4) | 3,672 | 6,730 | 3,969 | — | 150,814 | (3) | ||||||||||||||||||||||||
| August 7, 2017 | September 29, 2017 | — | — | — | 3,672 | 6,730 | 3,969 | — | 191,041 | (3) | |||||||||||||||||||||||||
| November 2, 2017 | December 29, 2017 for Preferred Stock; January 12, 2018 for Common Stock | $ | 3,963 | (5) | — | — | 3,672 | 6,730 | 3,969 | $ | 4,200 | (5) | 191,067 | (3) | |||||||||||||||||||||
| $ | 3,963 | $ | — | $ | 3,023 | $ | 14,688 | $ | 26,920 | $ | 15,876 | $ | 4,200 | $ | 681,280 | ||||||||||||||||||||
| March 1, 2018 | March 30, 2018 | $ | 3,333 | — | — | $ | 3,672 | $ | 6,730 | $ | 3,969 | $ | 2,625 | $ | 208,015 | (6) | |||||||||||||||||||
| May 8, 2018 | June 29, 2018 | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 208,071 | (6) | |||||||||||||||||||||||||
| August 14, 2018 | September 28, 2018 | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 208,166 | (6) | |||||||||||||||||||||||||
| November 12, 2018 | December 31, 2018 for Preferred Stock; January 15, 2019 for Common Stock | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 208,415 | (6) | |||||||||||||||||||||||||
| $ | 13,332 | — | — | $ | 14,688 | $ | 26,920 | $ | 15,876 | $ | 10,500 | $ | 832,667 | ||||||||||||||||||||||
| Annual rate of dividend per share | $ | 1.65625 | $ | 1.75000 | $ | 1.65625 | $ | 1.46875 | $ | 1.84375 | $ | 1.58750 | $ | 1.31250 |
| (1) | $3.520 annual rate of dividend per share. |
| (2) | Redeemed on September 15, 2016 for $25.35972 per share, or a redemption price of $25.00 per share, plus accrued and unpaid dividends up to but not including the redemption date of approximately $4.1 million in the aggregate. In connection with the redemption, the previously incurred offering costs of approximately $10.3 million were recorded as a reduction to net income available to common stockholders. |
| (3) | $3.720 annual rate of dividend per share. |
| (4) | Redeemed on April 5, 2017 for $25.01840 per share, or a redemption price of $25.00 per share, plus accrued and unpaid dividends up to but not including the redemption date of approximately $0.1 million in the aggregate. In connection with the redemption, the previously incurred offering costs of approximately $6.3 million were recorded as a reduction to net income available to common stockholders. |
| (5) | Represents a pro rata dividend from and including the original issue date to and including December 31, 2017. |
| (6) | $4.040 annual rate of dividend per share. |
Distributions out of our Parent Company’s current or accumulated earnings and profits are generally classified as ordinary income whereas distributions in excess of our Parent Company’s current and accumulated earnings and profits, to the extent of a stockholder’s U.S. federal income tax basis in our Parent Company’s stock, are generally classified as a return of capital.
Distributions in excess of a stockholder’s U.S. federal income tax basis in our Parent Company’s stock are generally characterized as capital gain. Cash provided by operating activities has been generally sufficient to fund distributions on an annual basis, however, we may also need to utilize borrowings under the global revolving credit facility to fund distributions.
The expected tax treatment of distributions on our Parent Company’s common stock paid in 2018 is as follows: approximately 80% ordinary income and 20% return of capital. Our preferred dividends will be treated as 100% ordinary income. The tax treatment of distributions on our Parent Company’s common and preferred stock paid in 2017 was as follows: approximately 95% ordinary income and 5% capital gain distribution. The tax treatment of distributions on our Parent Company’s common and preferred stock paid in 2016 was as follows: approximately 98% ordinary income and 2% capital gain distribution.
Liquidity and Capital Resources of the Operating Partnership
In this “Liquidity and Capital Resources of the Operating Partnership” section, the terms “we”, “our” and “us” refer to our Operating Partnership together with its consolidated subsidiaries or our Operating Partnership and our Parent Company together with their consolidated subsidiaries, as the context requires.
Analysis of Liquidity and Capital Resources
Our Parent Company is our sole general partner and consolidates our results of operations for financial reporting purposes. Because we operate on a consolidated basis with our Parent Company, the section entitled “Liquidity and Capital Resources of the Parent Company” should be read in conjunction with this section to understand our liquidity and capital resources on a consolidated basis.
As of December 31, 2018, we had $126.7 million of cash and cash equivalents, excluding $8.5 million of restricted cash. Restricted cash primarily consists of contractual capital expenditures plus other deposits.
Our short-term liquidity requirements primarily consist of operating expenses, development costs and other expenditures associated with our properties, distributions to our Parent Company in order for it to make dividend payments on its preferred stock, distributions to our Parent Company in order for it to make dividend payments to its stockholders required to maintain its REIT status, distributions to the unitholders of common limited partnership interests in Digital Realty Trust, L.P., capital expenditures, debt service on our loans and senior notes, and, potentially, acquisitions. We expect to meet our short-term liquidity requirements through net cash provided by operations, restricted cash accounts established for certain future payments and by drawing upon our global revolving credit facilities.
We are committed to maintaining a conservative capital structure. We target a debt-to-adjusted EBITDA ratio at or less than 5.5x, fixed charge coverage of greater than three times, and floating rate debt at less than 20% of total outstanding debt. In addition, we strive to maintain a well-laddered debt maturity schedule, and we seek to maximize the menu of our available sources of capital, while minimizing the related cost.
On June 21, 2018, we issued $650.0 million in aggregate principal amount of notes, maturing on July 15, 2028 with an interest rate of 4.450% per annum, which we refer to as the 2028 Notes. The purchase price paid by the initial purchasers was 99.852% of the principal amount. The 2028 Notes are our general unsecured senior obligations, rank equally in right of payment with all our other senior unsecured indebtedness and are fully and unconditionally guaranteed by Digital Realty Trust, Inc. Interest on the 2028 Notes is payable on January 15 and July 15 of each year, beginning on January 15, 2019. The net proceeds from the offering after deducting the original issue discount of approximately $1.0 million and underwriting commissions and expenses of approximately $5.7 million was approximately $643.3 million. We used the net proceeds from this offering to temporarily repay borrowings under our global revolving credit facility and for general corporate purposes.
On October 17, 2018, Digital Stout Holding, LLC, a wholly owned subsidiary of the Operating Partnership, issued and sold £400.0 million (approximately $524.6 million based on the exchange rate on October 17, 2018) aggregate principal amount of 3.750% Guaranteed Notes due 2030, or the 2030 Notes. The 2030 Notes are senior unsecured obligations of Digital Stout Holding, LLC and are fully and unconditionally guaranteed by the Parent Company and the Operating Partnership. Net proceeds from the offering were approximately £393.5 million (approximately $516.1 million based on the exchange rate on October 17, 2018) after deducting managers’ discounts and estimated offering expenses. We used the net proceeds from the offering of the 2030 Notes primarily to repay borrowings outstanding under the Operating Partnership’s global credit facility and term loan.
On October 24, 2018, we refinanced our global revolving credit facility and entered into a global senior credit agreement for a $2.35 billion senior unsecured revolving credit facility, which we refer to as the 2018 global revolving credit facility, that replaced the $2.0 billion revolving credit facility executed on January 15, 2016. In addition, we have the ability from time to time to increase the size of the global revolving credit facility and the unsecured term loans (discussed below), in any
combination, by up to $1.25 billion, subject to the receipt of lender commitments and other conditions precedent. The 2018 global revolving credit facility matures on January 24, 2023, with two six-month extension options available. The interest rate for borrowings under the 2018 global revolving credit facility equals the applicable index plus a margin which is based on the credit ratings of our long-term debt and is currently 90 basis points. An annual facility fee on the total commitment amount of the facility, based on the credit ratings of our long-term debt, currently 20 basis points, is payable quarterly. The 2018 global revolving credit facility provides for borrowings in U.S., Canadian, Singapore, Australian and Hong Kong dollars, as well as Euro, British pound sterling and Japanese yen and includes the ability to add additional currencies in the future. As of December 31, 2018, interest rates are based on 1-month LIBOR, 1-month GBP LIBOR, 1-month EURIBOR, 1-month HIBOR, 1-month JPY LIBOR, 1-month SOR and 1-month CDOR, plus a margin of 0.90%. We have used and intend to use available borrowings under the 2018 global revolving credit facility to acquire additional properties, fund development opportunities and for general working capital and other corporate purposes, including potentially for the repurchase, redemption or retirement of outstanding debt or equity securities. The 2018 global revolving credit facility contains various restrictive covenants, including limitations on our ability to incur additional indebtedness, make certain investments or merge with another company, and requirements to maintain financial coverage ratios, including with respect to unencumbered assets. In addition, the 2018 global revolving credit facility restricts Digital Realty Trust, Inc. from making distributions to its stockholders, or redeeming or otherwise repurchasing shares of its capital stock, after the occurrence and during the continuance of an event of default, except in limited circumstances including as necessary to enable Digital Realty Trust, Inc. to maintain its qualification as a REIT and to minimize the payment of income or excise tax. As of December 31, 2018, we were in compliance with all of such covenants. As of December 31, 2018, approximately $1.5 billion was drawn under this facility and $44.5 million of letters of credit were issued, leaving approximately $0.8 billion available for use.
On October 24, 2018, we entered into a credit agreement for a ¥33.3 billion (approximately $296.5 million based on the exchange rate on October 24, 2018) senior unsecured revolving credit facility, which we refer to as the Yen revolving credit facility. The Yen revolving credit facility provides for borrowings in Japanese yen. In addition, we have the ability from time to time to increase the size of the Yen revolving credit facility to up to ¥93.3 billion (approximately $831.1 million based on the exchange rate on October 24, 2018), subject to receipt of lender commitments and other conditions precedent. The Yen revolving credit facility matures on January 24, 2024. The interest rate for borrowings under the Yen revolving credit facility equals the applicable index plus a margin which is based on the credit ratings of our long-term debt and is currently 50 basis points. A quarterly unused commitment fee, which is calculated using the average daily unused revolving credit commitment, is based on the credit ratings of our long-term debt, and is currently 10 basis points. The Yen revolving credit facility contains various restrictive covenants, including limitations on our ability to incur additional indebtedness, make certain investments or merge with another company, and requirements to maintain financial coverage ratios, including with respect to unencumbered assets. In addition, the Yen revolving credit facility restricts Digital Realty Trust, Inc. from making distributions to its stockholders, or redeeming or otherwise repurchasing shares of its capital stock, after the occurrence and during the continuance of an event of default, except in limited circumstances including as necessary to enable Digital Realty Trust, Inc. to maintain its qualification as a REIT and to minimize the payment of income or excise tax. As of December 31, 2018, we were in compliance with all of such covenants. As of December 31, 2018, approximately $134.6 million was drawn under this facility, leaving approximately $158.7 million available for use.
As of December 31, 2018, we have capitalized approximately $15.4 million of financing costs, net of accumulated amortization, related to the 2018 global revolving credit facility and the Yen facility in the aggregate.
On October 24, 2018, we refinanced our senior unsecured multi-currency term loan facility and entered into an amended and restated term loan agreement, which we refer to as the 2018 term loan agreement, which governs (i) a $300.0 million 5-year senior unsecured term loan, which we refer to as the 2023 Term Loan, and (ii) an approximately $512 million 5-year senior unsecured term loan, which we refer to as the 2024 Term Loan. The 2018 term loan agreement replaced the $1.55 billion term loan agreement executed on January 15, 2016. The 2023 Term Loan matures on January 15, 2023 and the 2024 Term Loan matures on January 24, 2023 with two six-month extension options. In addition, we have the ability from time to time to increase the aggregate size of lending under the 2018 term loan agreement and the 2018 global revolving credit facility (discussed above), in any combination, by up to $1.25 billion, subject to receipt of lender commitments and other conditions precedent. Interest rates are based on our senior unsecured debt ratings and are currently 100 basis points over the applicable index for floating rate advances for the 2023 Term Loan and the 2024 Term Loan. Funds may be drawn in U.S., Canadian, Singapore, Australian and Hong Kong dollars. Based on exchange rates in effect at December 31, 2018, the balance outstanding is approximately $0.8 billion, excluding deferred financing costs. We have used borrowings under the term loans for acquisitions, repayment of indebtedness, development, working capital and general corporate purposes. The covenants under the 2023 Term Loan and 2024 Term Loan are consistent with our 2018 global revolving credit facility and, as of December 31, 2018, we were in compliance with all of such covenants. As of December 31, 2018, we have capitalized approximately $4.2 million of financing costs, net of accumulated amortization, related to the unsecured term loans.
For a discussion of the potential impact of current global economic and market conditions on our liquidity and capital resources, see “—Factors Which May Influence Future Results of Operations—Global market and economic conditions” above.
Our Parent Company commenced its at-the-market equity distribution program in June 2011, which is discussed under “Liquidity and Capital Resources of the Parent Company” above. To date, our Parent Company has generated net proceeds of approximately $342.7 million from the issuance of approximately 5.7 million shares of common stock under the program at an average price of $60.35 per share after payment of approximately $3.5 million of commissions to the sales agents and before offering expenses. The proceeds from the issuances were contributed to us in exchange for the issuance of approximately 5.7 million common units to our Parent Company. No sales were made under the program during the years ended December 31, 2018, 2017 and 2016. As of December 31, 2018, shares of common stock having an aggregate offering price of $53.8 million remained available for offer and sale under the program. The 2011 Equity Distribution Agreements were terminated in connection with the entry into the 2019 Equity Distribution Agreements on January 4, 2019.
On January 4, 2019, our Parent Company entered into new equity distribution agreements, which is discussed under “Liquidity and Capital Resources of the Parent Company” above. To date, no sales have been made under the program.
The Operating Partnership sold the following real estate properties during the year ended December 31, 2018:
| Location | Metro Area | Date Sold | Gross Proceeds (in millions) | Gain (loss) on sale (in millions) | ||||||||
| 200 Quannapowitt Parkway | Boston | Jan 25, 2018 | $ | 15.0 | $ | (0.4 | ) | |||||
| 34551 Ardenwood Boulevard | Silicon Valley | Feb 9, 2018 | 73.3 | 25.3 | ||||||||
| 3065 Gold Camp Drive | Sacramento | Mar 14, 2018 | 14.2 | 5.4 | ||||||||
| 11085 Sun Center Drive | Sacramento | Mar 14, 2018 | 36.8 | 9.1 | ||||||||
| Austin Portfolio | Austin | Apr 19, 2018 | 47.6 | 12.0 | ||||||||
| 2010 East Centennial Circle | Phoenix | May 22, 2018 | 5.5 | (0.5 | ) | |||||||
| 1125 Energy Park Drive | Minneapolis | May 31, 2018 | 7.0 | 2.8 | ||||||||
| 360 Spear Street | San Francisco | Sep 21, 2018 | 92.3 | 26.7 | ||||||||
| $ | 291.7 | $ | 80.4 |
None of our property sales to date represented a significant component or significant shift in strategy that would require discontinued operations presentation.
The growing acceptance by private institutional investors of the data center asset class has generally pushed capitalization rates lower, as such private investors may often have lower return expectations than us. As a result, we anticipate near-term single asset acquisitions activity to comprise a smaller percentage of our growth while this market dynamic persists.
Construction ($ in thousands)
| As of December 31, 2018 | As of December 31, 2017 | ||||||||||||||||||||||||||||
| Net Rentable Square Feet (1) | Current Investment (2) | Future Investment (3) | Total Cost | Net Rentable Square Feet (1) | Current Investment (4) | Future Investment (3) | Total Cost | ||||||||||||||||||||||
| Development Lifecycle | |||||||||||||||||||||||||||||
| Land | (6) | 548,833 | — | 548,833 | (6) | 352,406 | — | 352,406 | |||||||||||||||||||||
| Development Construction in Progress | |||||||||||||||||||||||||||||
| Space Held for Development (5) | 1,805,844 | 396,440 | — | 396,440 | 1,573,758 | $ | 416,553 | — | $ | 416,553 | |||||||||||||||||||
| Base Building Construction | 1,724,740 | 214,634 | $ | 223,360 | 437,994 | 1,333,763 | 222,093 | $ | 149,507 | 371,600 | |||||||||||||||||||
| Data Center Construction | 1,103,465 | 586,995 | 521,387 | 1,108,382 | 1,366,393 | 748,006 | 500,674 | 1,248,680 | |||||||||||||||||||||
| Equipment Pool & Other Inventory | N/A | 14,558 | — | 14,558 | 7,245 | — | 7,245 | ||||||||||||||||||||||
| Campus, Tenant Improvements & Other | N/A | 23,408 | 16,228 | 39,636 | 5,787 | 8,360 | 14,147 | ||||||||||||||||||||||
| Total Development Construction in Progress | 4,634,049 | 1,236,035 | 760,975 | 1,997,010 | 4,273,914 | 1,399,684 | 658,541 | 2,058,225 | |||||||||||||||||||||
| Enhancement & Other | 6,918 | 11,495 | 18,413 | 8,416 | 27,209 | 35,625 | |||||||||||||||||||||||
| Recurring | 16,102 | 21,373 | 37,475 | 23,985 | 29,184 | 53,169 | |||||||||||||||||||||||
| Total Construction in Progress | $ | 1,807,888 | $ | 793,843 | $ | 2,601,731 | $ | 1,784,491 | $ | 714,934 | $ | 2,499,425 |
| (1) | Square footage is based on current estimates and project plans, and may change upon completion of the project or due to remeasurement. |
| (2) | Represents balances incurred through December 31, 2018 and included in building and improvements in the consolidated balance sheets. |
| (3) | Represents estimated cost to complete specific scope of work pursuant to contract, budget or approved capital plan. |
| (4) | Represents balances incurred through December 31, 2017 and included in building and improvements in the consolidated balance sheets. |
| (5) | Excludes space held for development related to the Ascenty Acquisition, unconsolidated joint ventures and properties held for sale. |
| (6) | Represents approximately 959 acres as of December 31, 2018 and approximately 539 acres as of December 31, 2017. |
Land inventory and space held for development reflect cumulative cost spent pending future development. Base building construction consists of ongoing improvements to building infrastructure in preparation for future data center fit-out. Datacenter construction includes 1.1 million square feet of Turn Key Flex®, colocation and Powered Base Building® products. Generally, we expect to deliver the space within 12 months; however, lease commencement dates may significantly impact final delivery schedules. Equipment pool and other inventory represent the value of long-lead time equipment and materials required for timely deployment and delivery of data center construction fit-out. Campus, tenant improvements and other costs include the value of development work which benefits space recently converted to our operating portfolio and is composed primarily of shared infrastructure projects and first-generation tenant improvements.
Future Uses of Cash
Our properties require periodic investments of capital for tenant-related capital expenditures and for general capital improvements. As of December 31, 2018, we had approximately 3.4 million square feet of space under active development and approximately 2.1 million square feet of space held for development. Turn-Key Flex® space is move-in-ready space for the placement of computer and network equipment required to provide a data center environment. Depending on demand for additional Turn-Key Flex® space, we expect to incur significant tenant improvement costs to build out and develop these types of spaces. At December 31, 2018, approximately 2.8 million square feet was under construction for Turn-Key Flex®, colocation and Powered Base Building® products, all of which are expected to be income producing on or after completion, in
five U.S. metropolitan areas, four European metropolitan areas, one Australian metropolitan areas, one Canadian metropolitan area and one Asian metropolitan area, consisting of approximately 1.7 million square feet of base building construction and 1.1 million square feet of data center construction. At December 31, 2018, we had open commitments, including amounts reimbursable of approximately $13.4 million, related to construction contracts of approximately $401.4 million.
We currently expect to incur approximately $1.2 billion to $1.4 billion of capital expenditures for our development programs during the year ending December 31, 2019, although this amount may increase or decrease, potentially materially, based on numerous factors, including changes in demand, leasing results and availability of debt or equity capital.
Historical Capital Expenditures
| Year Ended December 31, | |||||||
| (in thousands) | 2018 | 2017 | |||||
| Development projects | $ | 1,115,149 | $ | 912,217 | |||
| Enhancement and improvements | 14,240 | 6,340 | |||||
| Recurring capital expenditures | 132,226 | 136,290 | |||||
| Total capital expenditures (excluding indirect costs) | $ | 1,261,615 | $ | 1,054,847 |
For the year ended December 31, 2018, total capital expenditures increased $206.8 million to approximately $1.3 billion from $1.1 billion for the same period in 2017. Capital expenditures on our development projects plus our enhancement and improvements projects for the year ended December 31, 2018 were approximately $1.1 billion, which reflects an increase of approximately 23% from the same period in 2017. This increase was primarily due to increased spending for ground-up development projects (including development projects acquired in the DFT Merger), Turn-Key Flex space development and base building improvements. Our development capital expenditures are generally funded by our available cash and equity and debt capital. See “—Future Uses of Cash” above for a discussion of the amount of capital expenditures we expect to incur during the year ending December 31, 2019.
We are also subject to the commitments discussed below under “Commitments and Contingencies,” “Off-Balance Sheet Arrangements” and “Distributions.”
We actively pursue opportunities for potential acquisitions, with due diligence and negotiations often at different stages at different times. The dollar value of acquisitions for the year ending December 31, 2019 will be based on numerous factors, including customer demand, leasing results, availability of debt or equity capital and acquisition opportunities.
We may from time to time seek to retire or repurchase our outstanding debt or the equity of our Parent Company through cash purchases and/or exchanges for equity securities of our Parent Company in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions or other factors. The amounts involved may be material.
We expect to meet our short-term and long-term liquidity requirements, including to pay for scheduled debt maturities and to fund acquisitions and non-recurring capital improvements, with net cash from operations, future long-term secured and unsecured indebtedness and the issuance of equity and debt securities and the proceeds of equity issuances by our Parent Company. We also may fund future short-term and long-term liquidity requirements, including acquisitions and non-recurring capital improvements, using our global revolving credit facility pending permanent financing. If we are not able to obtain additional financing on terms attractive to us, or at all, including as a result of the circumstances described above under “Factors Which May Influence Future Results of Operations—Global market and economic conditions”, we may be required to reduce our acquisition or capital expenditure plans, which could have a material adverse effect upon our business and results of operations.
Distributions
All distributions on our units are at the discretion of our Parent Company’s board of directors. In 2018, 2017 and 2016, our Operating Partnership declared the following distributions (in thousands):
| Date distribution declared | Distribution payable date | Series C Preferred Units | Series E Preferred Units | Series F Preferred Units | Series G Preferred Units | Series H Preferred Units | Series I Preferred Units | Series J Preferred Units | Common Units | ||||||||||||||||||||||||||
| Feb 17, 2016 | March 31, 2016 | — | $ | 5,031 | $ | 3,023 | $ | 3,672 | $ | 6,730 | $ | 3,969 | — | $ | 131,587 | (1) | |||||||||||||||||||
| May 11, 2016 | June 30, 2016 | — | 5,031 | 3,023 | 3,672 | 6,730 | 3,969 | — | 131,607 | (1) | |||||||||||||||||||||||||
| Aug 10, 2016 | September 30, 2016 | — | — | (2) | 3,023 | 3,672 | 6,730 | 3,969 | — | 131,657 | (1) | ||||||||||||||||||||||||
| Nov 9, 2016 | December 31, 2016 for Preferred Units; January 13, 2017 for Common Units | — | — | 3,023 | 3,672 | 6,730 | 3,969 | — | 144,193 | (1) | |||||||||||||||||||||||||
| — | $ | 10,062 | $ | 12,092 | $ | 14,688 | $ | 26,920 | $ | 15,876 | — | $ | 539,044 | ||||||||||||||||||||||
| Mar 1, 2017 | March 31, 2017 | — | — | $ | 3,023 | $ | 3,672 | $ | 6,730 | $ | 3,969 | — | $ | 150,968 | (3) | ||||||||||||||||||||
| May 8, 2017 | June 30, 2017 | — | — | — | (4) | 3,672 | 6,730 | 3,969 | — | 153,176 | (3) | ||||||||||||||||||||||||
| Aug 7, 2017 | September 29, 2017 | — | — | — | 3,672 | 6,730 | 3,969 | — | 199,049 | (3) | |||||||||||||||||||||||||
| Nov 2, 2017 | December 29, 2017 for Preferred Units; January 12, 2018 for Common Units | $ | 3,963 | (5) | — | — | 3,672 | 6,730 | 3,969 | $ | 4,200 | (5) | 199,061 | (3) | |||||||||||||||||||||
| $ | 3,963 | — | $ | 3,023 | $ | 14,688 | $ | 26,920 | $ | 15,876 | $ | 4,200 | $ | 702,254 | |||||||||||||||||||||
| Mar 1, 2018 | March 30, 2018 | $ | 3,333 | — | — | $ | 3,672 | $ | 6,730 | $ | 3,969 | $ | 2,625 | $ | 216,953 | (6) | |||||||||||||||||||
| May 8, 2018 | June 29, 2018 | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 216,789 | (6) | |||||||||||||||||||||||||
| Aug 14, 2018 | September 28, 2018 | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 216,825 | (6) | |||||||||||||||||||||||||
| Nov 12, 2018 | December 31, 2018 for Preferred Units; January 15, 2019 for Common Units | 3,333 | — | — | 3,672 | 6,730 | 3,969 | 2,625 | 216,838 | (6) | |||||||||||||||||||||||||
| $ | 13,332 | — | — | $ | 14,688 | $ | 26,920 | $ | 15,876 | $ | 10,500 | $ | 867,405 | ||||||||||||||||||||||
| Annual rate of distribution per unit | $ | 1.65625 | $ | 1.75000 | $ | 1.65625 | $ | 1.46875 | $ | 1.84375 | $ | 1.58750 | $ | 1.31250 |
| (1) | $3.520 annual rate of distribution per unit. |
| (2) | Redeemed on September 15, 2016 for $25.35972 per unit, or a redemption price of $25.00 per unit, plus accrued and unpaid distributions up to but not including the redemption date of approximately $4.1 million in the aggregate. In connection with the redemption, the previously incurred offering costs of approximately $10.3 million were recorded as a reduction to net income available to common unitholders. |
| (3) | $3.720 annual rate of distribution per unit. |
| (4) | Redeemed on April 5, 2017 for $25.01840 per unit, or a redemption price of $25.00 per unit, plus accrued and unpaid distributions up to but not including the redemption date of approximately $0.1 million in the aggregate. In connection with the redemption, the previously incurred offering costs of approximately $6.3 million were recorded as a reduction to net income available to common unitholders. |
| (5) | Represents a pro rata distribution from and including the original issue date to and including December 31, 2017. |
| (6) | $4.040 annual rate of distribution per unit. |
As of December 31, 2018, we were a party to interest rate swap agreements which hedge variability in cash flows related the U.S. LIBOR and CDOR-based tranches of the unsecured term loans. Under these swaps, we pay variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amounts. See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk.”
The following table summarizes our debt, interest, lease and construction contract payments due by period as of December 31, 2018 (dollars in thousands):
| Obligation | 2019 | 2020-2021 | 2022-2023 | Thereafter | Total | |||||||||||||||
| Long-term debt principal payments (1) | $ | 518,982 | $ | 1,521,132 | $ | 4,453,332 | $ | 4,708,144 | $ | 11,201,590 | ||||||||||
| Interest payable (2) | 416,474 | 709,058 | 534,210 | 561,621 | 2,221,363 | |||||||||||||||
| Operating leases | 84,712 | 173,608 | 162,683 | 539,047 | 960,050 | |||||||||||||||
| Construction contracts (3) | 401,410 | — | — | — | 401,410 | |||||||||||||||
| $ | 1,421,578 | $ | 2,403,798 | $ | 5,150,225 | $ | 5,808,812 | $ | 14,784,413 |
| (1) | Includes $1.7 billion of borrowings under our global revolving credit facilities and $0.8 billion of borrowings under our unsecured term loan and excludes $0.1 million of loan premiums related to assumed mortgage loans, $1.2 million discount on the 5.875% 2020 notes, $0.4 million discount on the 3.400% 2020 notes, $0.2 million discount on the 5.250% 2021 notes, $1.7 million discount on the 3.625% 2022 notes, $2.0 million discount on the 3.950% 2022 notes, $1.3 million on the 4.750% 2023 notes, $1.0 million on the 2.625% 2024 notes, $0.9 million on the 2.750% 2024 notes, $2.2 million on the 4.250% 2025 notes, $0.2 million on the 2.750% 2023 notes, $0.7 million on the 3.700% 2027 notes, $0.9 million on the 4.450% 2028 Notes, $2.7 million on the 3.300% 2029 notes and $4.4 million on the 3.750% 2030 Notes. All amounts exclude deferred financing costs. |
| (2) | Interest payable is based on the interest rate in effect on December 31, 2018, including the effect of interest rate swaps. Interest payable excluding the effect of interest rate swaps is as follows (in thousands): |
| 2019 | $ | 418,864 | |
| 2020-2021 | 713,837 | ||
| 2022-2023 | 538,050 | ||
| Thereafter | 565,908 | ||
| $ | 2,236,659 |
| (3) | From time to time in the normal course of our business, we enter into various construction contracts with third parties that may obligate us to make payments. At December 31, 2018, we had open commitments, including amounts reimbursable of approximately $13.4 million, related to construction contracts of approximately $401.4 million. |
Outstanding Consolidated Indebtedness
The table below summarizes our debt maturities and principal payments as of December 31, 2018 (in thousands):
| Global Revolving Credit Facilities (1) | Unsecured Term Loans | Senior Notes | Secured Debt | Total Debt | |||||||||||||||
| 2019 | $ | — | $ | 375,000 | $ | 143,338 | $ | 644 | $ | 518,982 | |||||||||
| 2020 | — | — | 1,000,000 | 1,132 | 1,001,132 | ||||||||||||||
| 2021 | — | — | 400,000 | 120,000 | 520,000 | ||||||||||||||
| 2022 | — | — | 800,000 | 150,000 | 950,000 | ||||||||||||||
| 2023 | 1,528,592 | 808,120 | 732,620 | 434,000 | 3,503,332 | ||||||||||||||
| Thereafter | 134,564 | — | 4,573,580 | — | 4,708,144 | ||||||||||||||
| Subtotal | $ | 1,663,156 | $ | 1,183,120 | $ | 7,649,538 | $ | 705,776 | $ | 11,201,590 | |||||||||
| Unamortized discount | — | — | (19,859 | ) | — | (19,859 | ) | ||||||||||||
| Unamortized premium | — | — | — | 148 | 148 | ||||||||||||||
| Total | $ | 1,663,156 | $ | 1,183,120 | $ | 7,629,679 | $ | 705,924 | $ | 11,181,879 |
| (1) | Subject to two six-month extension options exercisable by us. The bank group is obligated to grant the extension options provided we give proper notice, we make certain representations and warranties and no default exists under the global revolving credit facility, as applicable. |
The table below summarizes our debt, as of December 31, 2018 (in millions):
| Debt Summary: | |||
| Fixed rate | $ | 7,487.4 | |
| Variable rate debt subject to interest rate swaps | 783.1 | ||
| Total fixed rate debt (including interest rate swaps) | 8,270.5 | ||
| Variable rate—unhedged | 2,911.4 | ||
| Total | $ | 11,181.9 | |
| Percent of Total Debt: | |||
| Fixed rate (including hedged variable rate debt) | 74.0 | % | |
| Variable rate | 26.0 | % | |
| Total | 100.0 | % | |
| Weighted Average Interest Rate as of December 31, 2018 (1): | |||
| Fixed rate (including hedged variable rate debt) | 3.79 | % | |
| Variable rate | 3.37 | % | |
| Total interest rate | 3.68 | % |
| (1) | Excludes impact of deferred financing cost amortization. |
As of December 31, 2018, we had approximately $11.2 billion of outstanding consolidated long-term debt as set forth in the table above. Our ratio of debt to total enterprise value was approximately 31% (based on the closing price of Digital Realty Trust, Inc.’s common stock on December 31, 2018 of $106.55). For this purpose, our total enterprise value is defined as the sum of the market value of Digital Realty Trust, Inc.’s outstanding common stock (which may decrease, thereby increasing our debt to total enterprise value ratio), plus the liquidation value of Digital Realty Trust, Inc.’s preferred stock, plus the aggregate value of our Operating Partnership’s units not held by Digital Realty Trust, Inc. (with the per unit value equal to the market value of one share of Digital Realty Trust, Inc.’s common stock and excluding long-term incentive units, Class C units and Class D units), plus the book value of our total consolidated indebtedness.
The variable rate debt shown above bore interest at interest rates based on various one-month LIBOR, EURIBOR, GBP LIBOR, SOR, BBR, HIBOR, JPY LIBOR, CDOR and U.S. Prime rates, depending on the respective agreement governing the
debt, including our global revolving credit facility and unsecured term loans. As of December 31, 2018, our debt had a weighted average term to initial maturity of approximately 5.3 years (or approximately 5.5 years assuming exercise of extension options).
Off-Balance Sheet Arrangements
As of December 31, 2018, we were party to interest rate swap agreements related to $783.1 million of outstanding principal amount on our variable rate debt. See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk.”
As of December 31, 2018, our pro-rata share of mortgage debt of unconsolidated joint ventures was approximately $268.7 million, of which $10.2 million is subject to interest rate swap agreements.
Cash Flows
The following summary discussion of our cash flows is based on the consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.
Comparison of Year Ended December 31, 2018 to Year Ended December 31, 2017 and Comparison of Year Ended December 31, 2017 to Year Ended December 31, 2016
The following table shows cash flows and ending cash, cash equivalent and restricted cash balances for the years ended December 31, 2018, 2017 and 2016 (in thousands).
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Net cash provided by operating activities | $ | 1,385,324 | $ | 1,023,305 | $ | 911,242 | |||||
| Net cash used in investing activities | (3,035,993 | ) | (1,357,153 | ) | (1,303,597 | ) | |||||
| Net cash provided by financing activities | 1,757,269 | 321,200 | 350,617 | ||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 106,600 | $ | (12,648 | ) | $ | (41,738 | ) |
Cash provided by operating activities in 2018 increased approximately $362.0 million over 2017 and cash provided by operating activities in 2017 increased approximately $112.1 million over 2016. The 2018 increase was driven by year-over-year increase in the cash flow from properties acquired in the September 2017 DFT Merger. The increases in cash flow were offset by properties sold in 2017 and 2018 and an increase in interest expense. The 2017 increase was driven by year-over-year increase in the cash flow from properties acquired in the July 2016 European Portfolio Acquisition and the cash flow from properties acquired in the September 2017 DFT Merger. The increases in cash flow were offset by properties sold in 2016 and 2017 and an increase in interest expense.
Net cash used in investing activities consisted of the following amounts (in thousands).
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | Change | |||||||||
| Ascenty acquisition | $ | (1,563,830 | ) | $ | — | $ | (1,563,830 | ) | |||
| Improvements to investments in real estate | (1,325,162 | ) | (1,150,619 | ) | (174,543 | ) | |||||
| Acquisitions of real estate | (410,712 | ) | (415,764 | ) | 5,052 | ||||||
| Prepaid construction costs and other investments | (13,254 | ) | — | (13,254 | ) | ||||||
| Proceeds from sale of properties, net of sales costs | 286,204 | 89,333 | 196,871 | ||||||||
| Distribution from debt proceeds from closing of joint venture | — | 135,973 | (135,973 | ) | |||||||
| Investment in unconsolidated joint ventures | (673 | ) | (93,405 | ) | 92,732 | ||||||
| Excess proceeds from forward contracts | — | 63,956 | (63,956 | ) | |||||||
| Other | (8,566 | ) | 13,373 | (21,939 | ) | ||||||
| Net cash used in investing activities | $ | (3,035,993 | ) | $ | (1,357,153 | ) | $ | (1,678,840 | ) |
| Year Ended December 31, | |||||||||||
| 2017 | 2016 | Change | |||||||||
| Improvements to investments in real estate | $ | (1,150,619 | ) | $ | (758,081 | ) | (392,538 | ) | |||
| Acquisitions of real estate | (415,764 | ) | (873,285 | ) | 457,521 | ||||||
| Prepaid construction costs and other investments | — | (32,095 | ) | 32,095 | |||||||
| Proceeds from sale of properties, net of sales costs | 89,333 | 359,319 | (269,986 | ) | |||||||
| Distribution from debt proceeds from closing of joint venture | 135,973 | — | 135,973 | ||||||||
| Investment in unconsolidated joint ventures | (93,405 | ) | — | (93,405 | ) | ||||||
| Excess proceeds from forward contracts | 63,956 | — | 63,956 | ||||||||
| Other | 13,371 | 545 | 12,826 | ||||||||
| Net cash used in investing activities | $ | (1,357,155 | ) | $ | (1,303,597 | ) | $ | (53,558 | ) |
Net cash flows provided by financing activities for the Company consisted of the following amounts (in thousands).
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Proceeds from borrowings, net of repayments | $ | 849,348 | $ | (1,448,867 | ) | $ | (498,515 | ) | |||
| Net proceeds from issuance of common and preferred stock, including equity plans | 7,068 | 411,309 | 1,090,171 | ||||||||
| Redemption of preferred stock | — | (182,500 | ) | (287,500 | ) | ||||||
| Net proceeds from unsecured senior notes and secured debt | 1,769,006 | 2,265,060 | 675,591 | ||||||||
| Dividend and distribution payments | (930,782 | ) | (715,209 | ) | (605,390 | ) | |||||
| Capital contributions from (distributions to) noncontrolling interests in consolidated joint ventures, net | 66,124 | (8,593 | ) | (527 | ) | ||||||
| Other | (3,495 | ) | — | (23,213 | ) | ||||||
| Net cash provided by financing activities | $ | 1,757,269 | $ | 321,200 | $ | 350,617 |
The increase in cash provided by financing activities was due to proceeds from borrowings, net of repayments increasing during the year ended December 31, 2018 as compared to 2017 offset by higher proceeds in 2017 from the issuance of the 2019 Notes, 2.750% 2024 Notes, 2029 Notes, 2.750% 2023 Notes and 2027 Notes as compared to the proceeds in 2018 from the issuance of the 2028 Notes and 2030 Notes. The increase in dividend and distribution payments for the year ended December 31, 2018 as compared to 2017, which was a result of an increase in the number of shares outstanding due to the DFT Merger and increased dividend amount per share of common stock in 2018 as compared to 2017. The 2018 borrowing activity was used in part to fund a portion of the Ascenty Acquisition.
Net cash provided by financing activities decreased by $29.4 million in 2017 primarily as a result of an increase in net proceeds from the issuance of unsecured senior notes in 2017 as compared to 2016, offset by increased repayments of borrowings on the global revolving credit facility, a decrease in net equity issuances and an increase in dividends and distributions paid in 2017 as compared to 2016. The increase in dividend and distribution payments for the year ended December 31, 2017 as compared to the same period in 2016 was due to an increase in the number of shares outstanding and dividend amount per share of common stock in 2017 as compared to 2016 and the payment of dividends on our series J preferred stock during the year ended December 31, 2017, whereas this series of preferred stock was not outstanding in year ended December 31, 2016. The 2017 borrowing activity was used to fund a portion of the repayment, redemption and/or discharge of DFT debt and the payment of certain transaction fees and expenses incurred in connection with the DFT Merger. The 2016 equity issuance was driven primarily by the European Portfolio Acquisition.
Net cash flows provided by financing activities for the Operating Partnership consisted of the following amounts (in thousands).
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Proceeds from borrowings, net of repayments | $ | 849,348 | $ | (1,448,867 | ) | $ | (498,515 | ) | |||
| General partner contributions, net | 7,068 | 228,809 | 802,671 | ||||||||
| Net proceeds from unsecured senior notes | 1,769,006 | 2,265,060 | 675,591 | ||||||||
| Distribution payments | (930,782 | ) | (715,209 | ) | (605,390 | ) | |||||
| Capital contributions from (distributions to) noncontrolling interests in consolidated joint ventures, net | 66,124 | (8,593 | ) | (527 | ) | ||||||
| Other | (3,495 | ) | — | (23,213 | ) | ||||||
| Net cash provided by financing activities | $ | 1,757,269 | $ | 321,200 | $ | 350,617 |
The increase in cash provided by financing activities was due to proceeds from borrowings, net of repayments increasing during the year ended December 31, 2018 as compared to 2017 offset by higher proceeds in 2017 from the issuance of the 2019 Notes, 2.750% 2024 Notes, 2029 Notes, 2.750% 2023 Notes and 2027 Notes as compared to the proceeds in 2018 from the issuance of the 2028 Notes and 2030 Notes. The increase in distribution payments for the year ended December 31, 2018 as compared to 2017, which was a result of an increase in the number of common units outstanding due to the DFT Merger and increased distribution amount per common unit in 2018 as compared to 2017. The 2018 borrowing activity was used in part to fund a portion of the Ascenty Acquisition.
Net cash provided by financing activities decreased by $29.4 million in 2017 primarily as a result of an increase in net proceeds from the issuance of unsecured senior notes in 2017 as compared to 2016, offset by increased repayments of borrowings on the global revolving credit facility, a decrease in net equity issuances and an increase in distributions paid in 2017 as compared to 2016. The increase in distribution payments for the year ended December 31, 2017 as compared to the same period in 2016 was due to an increase in the number of units outstanding and distribution amount per common unit in 2017 as compared to 2016 and the payment of distributions on our series J preferred units during the year ended December 31, 2017, whereas this series of preferred units was not outstanding in year ended December 31, 2016. The 2017 borrowing activity was used to fund a portion of the repayment, redemption and/or discharge of DFT debt and the payment of certain transaction fees and expenses incurred in connection with the DFT Merger. The 2016 equity issuance was driven primarily by the European Portfolio Acquisition.
Noncontrolling Interests in Operating Partnership
Noncontrolling interests relate to the common units in our Operating Partnership that are not owned by Digital Realty Trust, Inc., which, as of December 31, 2018, amounted to 4.9% of our Operating Partnership common units. Historically, our Operating Partnership has issued common units to third party sellers in connection with our acquisition of real estate interests from such third parties.
Limited partners have the right to require our Operating Partnership to redeem part or all of their common units for cash based upon the fair market value of an equivalent number of shares of Digital Realty Trust, Inc. common stock at the time of the redemption. Alternatively, we may elect to acquire those common units in exchange for shares of Digital Realty Trust, Inc. common stock on a one-for-one basis, subject to adjustment in the event of stock splits, stock dividends, issuance of stock rights, specified extraordinary distributions and similar events. In connection with the DFT Merger, approximately 0.2 million common units of the Operating Partnership were issued to certain former unitholders in DuPont Fabros Technology, L.P., which are subject to certain restrictions and, accordingly, are not presented as permanent capital in the consolidated balance sheet.
Inflation
Many of our leases provide for separate real estate tax and operating expense escalations. In addition, many of the leases provide for fixed base rent increases. We believe that inflationary increases may be at least partially offset by the contractual rent increases and expense escalations described above.
Funds From Operations
We calculate funds from operations, or FFO, in accordance with the standards established by the National Association of Real Estate Investment Trusts, or Nareit. FFO represents net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of property, excluding a gain from a pre-existing relationship and after adjustments for impairment charges, real estate related depreciation and amortization (excluding amortization of deferred financing costs), non-controlling interests in operating partnership, unconsolidated partnerships and joint ventures. Management uses FFO as a supplemental performance measure because, in excluding real estate related depreciation and amortization, gains and losses from property dispositions and certain other gains and after adjustments for unconsolidated partnerships, joint ventures and certain other items, it provides a performance measure that, when compared year over year, captures trends in occupancy rates, rental rates and operating costs. We also believe that, as a widely recognized measure of the performance of REITs, FFO will be used by investors as a basis to compare our operating performance with that of other REITs. However, because FFO excludes depreciation and amortization and captures neither the changes in the value of our data centers that result from use or market conditions, nor the level of capital expenditures and capitalized leasing commissions necessary to maintain the operating performance of our data centers, all of which have real economic effect and could materially impact our financial condition and results from operations, the utility of FFO as a measure of our performance is limited. Other REITs may not calculate FFO in accordance with the Nareit definition and, accordingly, our FFO may not be comparable to other REITs’ FFO. FFO should be considered only as a supplement to net income computed in accordance with GAAP as a measure of our performance.
Reconciliation of Net Income Available to Common Stockholders to Funds From Operations (FFO)
(in thousands, except per share and unit data)
(unaudited)
| Year Ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Net income available to common stockholders | $ | 249,930 | $ | 173,148 | $ | 332,088 | |||||
| Adjustments: | |||||||||||
| Noncontrolling interests in operating partnership | 10,180 | 3,770 | 5,298 | ||||||||
| Real estate related depreciation and amortization (1) | 1,173,917 | 830,252 | 682,810 | ||||||||
| Real estate related depreciation and amortization related to investment in unconsolidated joint ventures | 14,587 | 11,566 | 11,246 | ||||||||
| Impairment of investments in real estate | — | 28,992 | — | ||||||||
| Impairment charge on Telx trade name | — | — | 6,122 | ||||||||
| Gain on sale of properties | (80,049 | ) | (40,354 | ) | (169,902 | ) | |||||
| Noncontrolling interests share of gain on sale of property | — | 3,900 | — | ||||||||
| FFO available to common stockholders and unitholders (2) | $ | 1,368,565 | $ | 1,011,274 | $ | 867,662 | |||||
| Basic FFO per share and unit | $ | 6.39 | $ | 5.68 | $ | 5.69 | |||||
| Diluted FFO per share and unit (2) | $ | 6.37 | $ | 5.65 | $ | 5.67 | |||||
| Weighted average common stock and units outstanding | |||||||||||
| Basic | 214,313 | 178,056 | 152,360 | ||||||||
| Diluted (2) | 214,951 | 178,892 | 153,086 | ||||||||
| (1) Real estate related depreciation and amortization was computed as follows: | |||||||||||
| Depreciation and amortization per income statement | 1,186,896 | 842,464 | 699,324 | ||||||||
| Impairment charge on Telx trade name | — | — | (6,122 | ) | |||||||
| Non-real estate depreciation | (12,979 | ) | (12,212 | ) | (10,392 | ) | |||||
| Real estate related depreciation and amortization | $ | 1,173,917 | $ | 830,252 | $ | 682,810 |
| (2) | For all periods presented, we have excluded the effect of dilutive series C, series E, series F, series G, series H, series I and series J preferred stock, as applicable, that may be converted upon the occurrence of specified change in control transactions as described in the articles supplementary governing the series C, series E, series F, series G, series H, series I and series J preferred stock, as applicable, which we consider highly improbable. |
| Year Ended December 31, | ||||||||
| 2018 | 2017 | 2016 | ||||||
| Weighted average common stock and units outstanding | 214,313 | 178,056 | 152,360 | |||||
| Add: Effect of dilutive securities | 638 | 836 | 726 | |||||
| Weighted average common stock and units outstanding—diluted | 214,951 | 178,892 | 153,086 |
Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK