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
Forward-Looking Statements
Certain statements in this section or elsewhere in this report may be deemed “forward-looking statements”. See “Item 1A. Risk Factors” in this report for important information regarding these forward-looking statements and certain risk and uncertainties that may affect us. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing in “Item 8. Financial Statements and Supplementary Data” of this report.
Overview
We are an equity real estate investment trust (“REIT”) specializing in the ownership, management, and redevelopment of high quality retail and mixed-use properties located primarily in densely populated and affluent communities in strategically selected metropolitan markets in the Northeast and Mid-Atlantic regions of the United States, as well as in California. As of December 31, 2012, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use properties which are operated as 88 predominantly retail real estate projects comprising approximately 19.6 million square feet. In total, the real estate projects were 95.3% leased and 94.9% occupied at December 31, 2012. A joint venture in which we own a 30% interest owned seven retail real estate projects totaling approximately 1.0 million square feet as of December 31, 2012. In total, the joint venture properties in which we own a 30% interest were 86.3% leased and 86.1% occupied at December 31, 2012. We have paid quarterly dividends to our shareholders continuously since our founding in 1962 and have increased our dividends per common share for 45 consecutive years.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, referred to as “GAAP”, requires management to make estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using management’s best judgment, after considering past and current events and economic conditions. In addition, information relied upon by management in preparing such estimates includes internally generated financial and operating information, external market information, when available, and when necessary, information obtained from consultations with third party experts. Actual results could differ from these estimates. A discussion of possible risks which may affect these estimates is included in “Item 1A. Risk Factors” of this report. Management considers an accounting estimate to be critical if changes in the estimate could have a material impact on our consolidated results of operations or financial condition.
Our significant accounting policies are more fully described in Note 2 to the consolidated financial statements; however, the most critical accounting policies, which involve the use of estimates and assumptions as to future uncertainties and, therefore, may result in actual amounts that differ from estimates, are as follows:
Revenue Recognition and Accounts Receivable
Our leases with tenants are classified as operating leases. Substantially all such leases contain fixed escalations which occur at specified times during the term of the lease. Base rents are recognized on a straight-line basis from when the tenant controls the space through the term of the related lease, net of valuation adjustments, based on management’s assessment of credit, collection and other business risk. Percentage rents, which represent additional rents based upon the level of sales achieved by certain tenants, are recognized at the end of the lease year or earlier if we have determined the required sales level is achieved and the percentage rents are collectible. Real estate tax and other cost reimbursements are recognized on an accrual basis over the periods in which the related expenditures are incurred. For a tenant to terminate its lease agreement prior to the end of the agreed term, we may require that they pay a fee to cancel the lease agreement. Lease termination fees for which the tenant has relinquished control of the space are generally recognized on the termination date. When a lease is terminated early but the tenant continues to control the space under a modified lease agreement, the lease termination fee is generally recognized evenly over the remaining term of the modified lease agreement.
Current accounts receivable from tenants primarily relate to contractual minimum rent and percentage rent as well as real estate tax and other cost reimbursements. Accounts receivable from straight-line rent is typically longer term in nature and relates to the cumulative amount by which straight-line rental income recorded to date exceeds cash rents billed to date under the contractual lease agreement.
We make estimates of the collectability of our current accounts receivable and straight-line rents receivable which requires significant judgment by management. The collectability of receivables is affected by numerous factors including current economic conditions, bankruptcies, and the ability of the tenant to perform under the terms of their lease agreement. While we make estimates of potentially uncollectible amounts and provide an allowance for them through bad debt expense, actual collectability could differ from those estimates which could affect our net income. With respect to the allowance for current uncollectible tenant receivables, we assess the collectability of outstanding receivables by evaluating such factors as nature and age of the receivable, past history and current financial condition of the specific tenant including our assessment of the tenant’s ability to meet its contractual lease obligations, and the status of any pending disputes or lease negotiations with the tenant. At December 31, 2012 and 2011, our allowance for doubtful accounts was $15.9 million and $17.6 million, respectively. Historically, we have recognized bad debt expense between 0.4% and 1.3% of rental income and it was 0.4% in 2012 reflecting positive economic changes and their impact to our tenants. A change in the estimate of collectability of a receivable would result in a change to our allowance for doubtful accounts and correspondingly bad debt expense and net income. For example, in the event our estimates were not accurate and we were required to increase our allowance by 1% of rental income, our bad debt expense would have increased and our net income would have decreased by $5.8 million.
Due to the nature of the accounts receivable from straight-line rents, the collection period of these amounts typically extends beyond one year. Our experience relative to unbilled straight-line rents is that a portion of the amounts otherwise recognizable as revenue is never billed to or collected from tenants due to early lease terminations, lease modifications, bankruptcies and other factors. Accordingly, the extended collection period for straight-line rents along with our evaluation of tenant credit risk may result in the nonrecognition of a portion of straight-line rental income until the collection of such income is reasonably assured. If our evaluation of tenant credit risk changes indicating more straight-line revenue is reasonably collectible than previously estimated and realized, the additional straight-line rental income is recognized as revenue. If our evaluation of tenant credit risk changes indicating a portion of realized straight-line rental income is no longer collectible, a reserve and bad debt expense is recorded. At December 31, 2012 and 2011, accounts receivable include approximately $56.1 million and $50.5 million, respectively, related to straight-line rents. Correspondingly, these estimates of collectability have a direct impact on our net income.
Real Estate
The nature of our business as an owner, redeveloper and operator of retail shopping centers and mixed-use properties means that we invest significant amounts of capital. Depreciation and maintenance costs relating to our properties constitute substantial costs for us as well as the industry as a whole. We capitalize real estate investments and depreciate them on a straight-line basis in accordance with GAAP and consistent with industry standards based on our best estimates of the assets’ physical and economic useful lives. We periodically review the estimated lives of our assets and implement changes, as necessary, to these estimates and, therefore, to our depreciation rates. These reviews may take into account such factors as the historical retirement and replacement of our assets, expected redevelopments, the repairs required to maintain the condition of our assets, and general economic and real estate factors. Certain events could occur that would materially affect our estimates
and assumptions related to depreciation. Unforeseen competition or changes in customer shopping habits could substantially alter our assumptions regarding our ability to realize the expected return on investment in the property and therefore reduce the economic life of the asset and affect the amount of depreciation expense to be charged against both the current and future revenues. These assessments have a direct impact on our net income. The longer the economic useful life, the lower the depreciation expense will be for that asset in a fiscal period, which in turn will increase our net income. Similarly, having a shorter economic useful life would increase the depreciation for a fiscal period and decrease our net income.
Land, buildings and real estate under development are recorded at cost. We compute depreciation using the straight-line method with useful lives ranging generally from 35 years to a maximum of 50 years on buildings and major improvements. Maintenance and repair costs are charged to operations as incurred. Tenant work and other major improvements, which improve or extend the life of the asset, are capitalized and depreciated over the life of the lease or the estimated useful life of the improvements, whichever is shorter. Minor improvements, furniture and equipment are capitalized and depreciated over useful lives ranging from 2 to 20 years.
The capitalized costs associated with developments and redevelopments are depreciated over the life of the improvement. Capitalized costs associated with leases are depreciated or amortized over the base term of the lease. Unamortized leasing costs are charged to expense if the applicable tenant vacates before the expiration of its lease. Undepreciated tenant work is written-off if the applicable tenant vacates and the tenant work is replaced or has no future value. Additionally, we make estimates as to the probability of certain development and redevelopment projects being completed. If we determine the redevelopment is no longer probable of completion, we immediately expense all capitalized costs which are not recoverable.
When applicable, as lessee, we classify our leases of land and building as operating or capital leases. We are required to use judgment and make estimates in determining the lease term, the estimated economic life of the property and the interest rate to be used in determining whether or not the lease meets the qualification of a capital lease and is recorded as an asset.
Certain external and internal costs directly related to the development, redevelopment and leasing of real estate, including pre-construction costs, real estate taxes, insurance, construction costs and salaries and related costs of personnel directly involved, are capitalized. We capitalized external and internal costs related to both development and redevelopment activities of $129 million and $6 million, respectively, for 2012 and $96 million and $4 million, respectively, for 2011. We capitalized external and internal costs related to other property improvements of $52 million and $1 million, respectively, for 2012 and $46 million and $1 million, respectively, for 2011. We capitalized external and internal costs related to leasing activities of $9 million and $6 million, respectively, for 2012 and $8 million and $5 million, respectively, for 2011. The amount of capitalized internal costs for salaries and related benefits for development and redevelopment activities, other property improvements, and leasing activities were $5 million, $1 million, and $5 million, respectively, for 2012 and $4 million, $1 million, and $5 million, respectively, for 2011.
Additionally, interest costs on developments and major redevelopments are capitalized as part of developments and redevelopments not yet placed in service. Capitalization of interest commences when development activities and expenditures begin and end upon completion, which is when the asset is ready for its intended use. Generally, rental property is considered substantially complete and ready for its intended use upon completion of tenant improvements, but no later than one year from completion of major construction activity. We make judgments as to the time period over which to capitalize such costs and these assumptions have a direct impact on net income because capitalized costs are not subtracted in calculating net income. If the time period for capitalizing interest is extended, more interest is capitalized, thereby decreasing interest expense and increasing net income during that period.
Real Estate Acquisitions
Upon acquisition of operating real estate properties, we estimate the fair value of assets and liabilities acquired including land, building, improvements, leasing costs, intangibles such as in-place leases, assumed debt, and current assets and liabilities, if any. Based on these estimates, we allocate the purchase price to the applicable assets and liabilities. We utilize methods similar to those used by independent appraisers in estimating the fair value of acquired assets and liabilities. The value allocated to in-place leases is amortized over the related lease term and reflected as rental income in the statement of operations. We consider qualitative and quantitative factors in evaluating the likelihood of a tenant exercising a below market renewal option and include such renewal options in the calculation of in-place lease value when we consider these to be bargain renewal options. If the value of below market lease intangibles includes renewal option periods, we include such renewal periods in the amortization period utilized. If a tenant vacates its space prior to contractual termination of its lease, the unamortized balance of any in-place lease value is written off to rental income.
Long-Lived Assets and Impairment
There are estimates and assumptions made by management in preparing the consolidated financial statements for which the actual results will be determined over long periods of time. This includes the recoverability of long-lived assets, including our properties that have been acquired or redeveloped and our investment in certain joint ventures. Management’s evaluation of impairment includes review for possible indicators of impairment as well as, in certain circumstances, undiscounted and discounted cash flow analysis. Since most of our investments in real estate are wholly-owned or controlled assets which are held for use, a property with impairment indicators is first tested for impairment by comparing the undiscounted cash flows, including residual value, to the current net book value of the property. If the undiscounted cash flows are less than the net book value, the property is written down to expected fair value.
The calculation of both discounted and undiscounted cash flows requires management to make estimates of future cash flows including revenues, operating expenses, required maintenance and development expenditures, market conditions, demand for space by tenants and rental rates over long periods. Because our properties typically have a long life, the assumptions used to estimate the future recoverability of book value requires significant management judgment. Actual results could be significantly different from the estimates. These estimates have a direct impact on net income, because recording an impairment charge results in a negative adjustment to net income.
Contingencies
We are sometimes involved in lawsuits, warranty claims, and environmental matters arising in the ordinary course of business. Management makes assumptions and estimates concerning the likelihood and amount of any potential loss relating to these matters. We accrue a liability for litigation if an unfavorable outcome is probable and the amount of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, we accrue the best estimate within the range; however, if no amount within the range is a better estimate than any other amount, the minimum within the range is accrued. Any difference between our estimate of a potential loss and the actual outcome would result in an increase or decrease to net income.
In addition, we reserve for estimated losses, if any, associated with warranties given to a buyer at the time an asset is sold or other potential liabilities relating to that sale, taking any insurance policies into account. These warranties may extend up to ten years and the calculation of potential liability requires significant judgment. If changes in facts and circumstances indicate that warranty reserves are understated, we will accrue additional reserves at such time a liability has been incurred and the costs can be reasonably estimated. Warranty reserves are released once the legal liability period has expired or all related work has been substantially completed. Any changes to our estimated warranty losses would result in an increase or decrease in net income.
Self-Insurance
We are self-insured for general liability costs up to predetermined retained amounts per claim, and we believe that we maintain adequate accruals to cover our retained liability. We currently do not maintain third party stop-loss insurance policies to cover liability costs in excess of predetermined retained amounts. Our accrual for self-insurance liability is determined by management and is based on claims filed and an estimate of claims projected to be incurred but not yet reported. Management considers a number of factors, including third-party actuarial analysis and future increases in costs of claims, when making these determinations. If our liability costs differ from these accruals, it will increase or decrease our net income.
Recently Adopted Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update (“ASU”) 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The pronouncement was issued to provide a uniform framework for fair value measurements and related disclosures between U.S. GAAP and International Financial Reporting Standards (“IFRS”). ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. We adopted the standard effective January 1, 2012 and it did not have a significant impact to our consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to present components of other comprehensive income solely as part of the statement of shareholders’ equity and requires the presentation of components of net income and components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB deferred the requirement to present reclassification adjustments for each component of accumulated other comprehensive income in both net income and other comprehensive income on the face of the financial
statements. We adopted the standards effective January 1, 2012 and modified the presentation in our consolidated financial statements accordingly.
Recently Issued Accounting Pronouncement
In February 2013, the FASB issued ASU 2013-2, “Comprehensive Income (Topic 220): Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-2 requires entities to disclose certain information relating to amounts reclassified out of accumulated other comprehensive income. This pronouncement is effective for us in the first quarter of 2013 and is not expected to have a significant impact to our consolidated financial statements.
2012 Significant Property Acquisitions
In July and September 2012, we acquired three residential apartment buildings with 47 units located adjacent to Santana Row for $9.0 million. These properties provide potential future redevelopment opportunities for Santana Row.
On December 21, 2012, we acquired the fee interest in East Bay Bridge, a 438,000 square foot shopping center located in Emeryville and Oakland, California. The purchase price was $116.6 million which included the assumption of a mortgage loan with a face amount of $62.9 million and a fair value of approximately $67.6 million. Approximately $0.9 million and $47.8 million of net assets acquired were allocated to other assets for “above market leases” and other liabilities for “below market leases”, respectively. Additionally, we acquired a 37,000 square foot single-tenant office/warehouse building in Ontario, California for $2.5 million as part of the transaction. We incurred a total of $0.9 million of acquisition costs which are included in “general and administrative expenses” in 2012.
2012 Significant Equity and Debt Transactions and Subsequent Event
On May 8, 2012, we replaced our existing at the market (“ATM”) equity program with a new program in which we may from time to time offer and sell common shares having an aggregate offering price of up to $300.0 million. We intend to use the net proceeds to fund potential acquisition opportunities, fund our development and redevelopment pipeline, repay amounts outstanding under our revolving credit facility and/or for general corporate purposes. For the three months ended December 31, 2012, we issued 167,736 common shares at a weighted average price per share of $104.46 for net cash proceeds of $17.3 million and paid $0.2 million in commissions related to the sales of these common shares. For the year ended December 31, 2012, we issued 1,040,946 common shares at a weighted average price per share of $103.69 for net cash proceeds of $106.4 million and paid $1.4 million in commissions related to the sales of these common shares. As of December 31, 2012, we had the capacity to issue up to $213.4 million in common shares under our ATM equity program.
During 2012 and subsequent to year-end, we repaid the following loans at par:
| Payoff Amount | Repayment Date | Maturity Date | |||||
| (In millions) | |||||||
| Courtyard Shops Mortgage Loan | $ | 6.9 | June 1, 2012 | July 1, 2012 | |||
| 6.00% Senior Notes | 175.0 | July 16, 2012 | July 16, 2012 | ||||
| Mount Vernon Mortgage Loan | 10.2 | October 22, 2012 | April 15, 2028 | ||||
| Bethesda Row Mortgage Loan | 20.0 | November 2, 2012 | January 1, 2013 | ||||
| Bethesda Row Mortgage Loan | 3.9 | December 3, 2012 | February 1, 2013 | ||||
| White Marsh Plaza Mortgage Loan | 9.0 | January 2, 2013 | April 1, 2013 | ||||
| $ | 225.0 |
On July 19, 2012, we issued $250.0 million of fixed rate senior notes that mature on August 1, 2022 and bear interest at 3.00%. The net proceeds from this note offering after issuance discounts, underwriting fees, and other costs were approximately $244.8 million.
In connection with the acquisition of East Bay Bridge on December 21, 2012, we assumed a mortgage loan with a face amount of $62.9 million and a fair value of approximately $67.6 million. The mortgage loan bears interest at 5.13% and matures on March 1, 2016.
Final Purchase Price Allocation of 2011 Property Acquisitions
During 2012, we finalized the purchase price allocations for our December 2011 acquisitions of controlling interests in Montrose Crossing and Plaza El Segundo. The purchase price for Montrose Crossing was $141.5 million and our 89.9% ownership interest was $127.2 million which was funded with cash and our pro-rata share of $80.0 million of new mortgage
debt. Approximately $2.9 million and $3.8 million of net assets acquired were allocated to other assets for "above market leases" and other liabilities for "below market leases", respectively. The purchase price for Plaza El Segundo was $192.7 million and our 48.2% ownership interest was funded with $8.5 million of cash and the assumption of our pro-rata share of the existing $175.0 million mortgage debt. Approximately $7.5 million and $2.3 million of net assets acquired were allocated to other assets for "above market leases" and other liabilities for "below market leases", respectively. The balance sheet at December 31, 2011, has been adjusted to reflect the final purchase price allocation for both properties.
Chief Financial Officer Transition
On August 15, 2012, James M. Taylor, a senior managing director in the real estate investment banking group of an affiliate of Wells Fargo, succeeded Andrew Blocher as our chief financial officer. We believe that the addition of Mr. Taylor to our executive ranks will enhance our ability to source and evaluate corporate business development and strategic opportunities. For more information about Mr. Taylor's appointment, see our Current Report on Form 8-K filed with the SEC on July 11, 2012.
Outlook
We seek growth in earnings, funds from operations, and cash flows primarily through a combination of the following:
| • | growth in our portfolio from property development and redevelopments, |
| • | growth in our same-center portfolio, and |
| • | expansion of our portfolio through property acquisitions. |
Our properties are located in densely populated or affluent areas with high barriers to entry which allow us to take advantage of redevelopment opportunities that enhance our operating performance through renovation, expansion, reconfiguration, and/or retenanting. We evaluate our properties on an ongoing basis to identify these types of opportunities. In 2013, we expect to have redevelopment projects stabilizing with projected costs of approximately $30 million.
Additionally, we continue to invest in the development at Assembly Row which is a long-term development project we expect to be involved in over the coming years. The carrying value of the development portion of this project at December 31, 2012 is approximately $170 million. The project currently has zoning entitlements to build 2.3 million square feet of commercial-use buildings, 2,100 residential units, and a 200 room hotel. In December 2011, we entered into agreements with AvalonBay Communities ("AvalonBay") for a portion of the first phase of development at Assembly Row which will include 450 residential units (by AvalonBay) and approximately 326,000 square feet of retail space and 90,000 square feet of office space (both by the Trust). The Massachusetts Bay Transit Authority (MBTA) will also construct the new orange line T-Stop at the property. Our construction on the first phase commenced during the first quarter 2012. Total expected costs for Phase I of Assembly Row range from $190 million to $200 million of which $43 million has been incurred to date. We expect Phase I to stabilize in 2015. Additionally during 2012, we continued our infrastructure work. In total, we invested $22 million in Assembly Row in 2012, net of public funding, and expect to invest between $100 million and $115 million in 2013, net of expected public funding.
In the third quarter 2012, we broke ground on the first phase of Pike & Rose in Rockville, MD, a long-term multi-phased mixed-use project located on a portion of our Mid-Pike Plaza property. The property currently has zoning entitlements to build 1.7 million square feet of commercial-use buildings and 1,583 residential units. Phase I of Pike & Rose involves demolition of roughly 25% of the existing gross leasable area at Mid-Pike Plaza (which was completed during the second quarter 2012) and construction of 493 residential units, 151,000 square feet of retail space and 79,000 square feet of office space. Total expected costs for Phase I of Pike & Rose range from $245 million to $255 million of which $29 million has been incurred to date. We expect Phase I of the project to stabilize in 2015/2016. We invested $43 million in Pike & Rose in 2012 and expect to invest between $75 million to $110 million in 2013.
We continue our ongoing redevelopment efforts at Santana Row and are currently under construction on a 212 unit residential building which we expect to stabilize in 2014. Santana Row currently has zoning entitlements to build an additional 348 residential units and 200,000 square feet of retail and office space. Projected costs of the 212 unit residential building are $70 million to $75 million of which $22 million has been incurred to date. We expect to incur the remaining costs for the project throughout 2013 and early 2014.
The development of future phases of Assembly Row, Pike & Rose and Santana Row will be pursued opportunistically based on, among other things, market conditions, our evaluation of whether those phases will generate an appropriate financial return and our ability to structure the development of those future phases, through entitlement sales, third party capital investment or otherwise.
Our same-center growth is primarily driven by increases in rental rates on new leases and lease renewals and changes in portfolio occupancy. Over the long-term, the infill nature and strong demographics of our properties provide a strategic advantage allowing us to maintain relatively high occupancy and increase rental rates. We have continued to see signs of improvement for many of our tenants as well as increased interest from prospective tenants for our retail spaces. While there can be no assurance that these positive signs will continue, we remain cautiously optimistic regarding the improved trends we have seen over the past two years. While we have seen improvements over much of our portfolio, we continue to see some tenants being negatively impacted by the economic environment and some filing for bankruptcy, though at a lower rate than in previous years. We believe the locations of our centers and diverse tenant base mitigates the negative impact of the economic environment, however, any reduction in our tenants' abilities to pay base rent, percentage rent or other charges, will adversely affect our financial condition and results of operations. During 2013, we expect to see increases in rental income as a result of our significant leasing activity over the past two years which resulted in higher occupancy starting in the latter half of 2012. We seek to maintain a mix of strong national, regional, and local retailers. At December 31, 2012, no single tenant accounted for more than 3.2% of annualized base rent.
We continue to review acquisition opportunities in our primary markets that complement our portfolio and provide long-term growth opportunities. Some of our acquisitions do not initially contribute significantly to earnings growth; however, we believe they provide long-term re-leasing growth, redevelopment opportunities, and other strategic opportunities. Any growth from acquisitions is contingent on our ability to find properties that meet our qualitative standards at prices that meet our financial hurdles. Changes in interest rates may affect our success in achieving earnings growth through acquisitions by affecting both the price that must be paid to acquire a property, as well as our ability to economically finance the property acquisition. Generally, our acquisitions are initially financed by available cash and/or borrowings under our revolving credit facility which may be repaid later with funds raised through the issuance of new equity or new long-term debt. On occasion we also finance our acquisitions through the issuance of common shares, preferred shares, or downREIT units as well as through new or assumed mortgages.
At December 31, 2012, the leasable square feet in our properties was 94.9% occupied and 95.3% leased. The leased rate is higher than the occupied rate due to leased spaces that are being redeveloped or improved or that are awaiting permits and, therefore, are not yet ready to be occupied. Our occupancy and leased rates are subject to variability over time due to factors including acquisitions, the timing of the start and stabilization of our redevelopment projects, lease expirations and tenant bankruptcies.
Same-Center
Throughout this section, we have provided certain information on a “same-center” basis. Information provided on a same-center basis includes the results of properties that we owned and operated for the entirety of both periods being compared except for properties for which significant redevelopment or expansion occurred during either of the periods being compared and properties classified as discontinued operations. For the year ended December 31, 2012 and the comparison of 2012 and 2011, all or a portion of 77 properties were considered same-center and eight properties were considered redevelopment or expansion. For the year ended December 31, 2012, four properties were removed from same-center and two properties were added to same-center compared to the designations as of December 31, 2011. For the year ended December 31, 2011 and the comparison of 2011 and 2010, all or a portion of 79 properties were considered same-center and seven properties were considered redevelopment or expansion. For the year ended December 31, 2011, three properties were removed from same-center and one property was added to same-center compared to the designations as of December 31, 2010. While there is judgment surrounding changes in designations, we typically move redevelopment properties to same-center once they have stabilized, which is typically considered 95% occupancy or when the growth expected from the redevelopment has been included in the comparable periods. We typically remove properties from same center when the redevelopment has or is expected to have a significant impact to property operating income within the calendar year. Acquisitions are moved to same-center once we have owned the property for the entirety of comparable periods and the property is not under significant redevelopment or expansion.
YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011
| Change | ||||||||||||||
| 2012 | 2011 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 582,335 | $ | 538,701 | $ | 43,634 | 8.1 | % | ||||||
| Other property income | 20,217 | 9,260 | 10,957 | 118.3 | % | |||||||||
| Mortgage interest income | 5,466 | 5,098 | 368 | 7.2 | % | |||||||||
| Total property revenue | 608,018 | 553,059 | 54,959 | 9.9 | % | |||||||||
| Rental expenses | 112,760 | 109,549 | 3,211 | 2.9 | % | |||||||||
| Real estate taxes | 66,799 | 60,620 | 6,179 | 10.2 | % | |||||||||
| Total property expenses | 179,559 | 170,169 | 9,390 | 5.5 | % | |||||||||
| Property operating income | 428,459 | 382,890 | 45,569 | 11.9 | % | |||||||||
| Other interest income | 689 | 218 | 471 | 216.1 | % | |||||||||
| Income from real estate partnerships | 1,757 | 1,808 | (51 | ) | (2.8 | )% | ||||||||
| Interest expense | (113,336 | ) | (98,465 | ) | (14,871 | ) | 15.1 | % | ||||||
| Early extinguishment of debt | — | 296 | (296 | ) | (100.0 | )% | ||||||||
| General and administrative expense | (31,158 | ) | (28,985 | ) | (2,173 | ) | 7.5 | % | ||||||
| Depreciation and amortization | (142,039 | ) | (126,208 | ) | (15,831 | ) | 12.5 | % | ||||||
| Total other, net | (284,087 | ) | (251,336 | ) | (32,751 | ) | 13.0 | % | ||||||
| Income from continuing operations | 144,372 | 131,554 | 12,818 | 9.7 | % | |||||||||
| Discontinued operations - income | — | 957 | (957 | ) | (100.0 | )% | ||||||||
| Discontinued operations - gain on deconsolidation of VIE | — | 2,026 | (2,026 | ) | (100.0 | )% | ||||||||
| Discontinued operations - gain on sale of real estate | — | 15,075 | (15,075 | ) | (100.0 | )% | ||||||||
| Gain on sale of real estate | 11,860 | — | 11,860 | 100.0 | % | |||||||||
| Net income | 156,232 | 149,612 | 6,620 | 4.4 | % | |||||||||
| Net income attributable to noncontrolling interests | (4,307 | ) | (5,695 | ) | 1,388 | (24.4 | )% | |||||||
| Net income attributable to the Trust | $ | 151,925 | $ | 143,917 | $ | 8,008 | 5.6 | % |
Property Revenues
Total property revenue increased $55.0 million, or 9.9%, to $608.0 million in 2012 compared to $553.1 million in 2011. The percentage occupied at our shopping centers increased to 94.9% at December 31, 2012 compared to 92.4% at December 31, 2011. Changes in the components of property revenue are discussed below.
Rental Income
Rental income consists primarily of minimum rent, cost reimbursements from tenants and percentage rent. Rental income increased $43.6 million, or 8.1%, to $582.3 million in 2012 compared to $538.7 million in 2011 due primarily to the following:
| • | an increase of $29.3 million attributable to properties acquired in 2011 and 2012, |
| • | an increase of $8.9 million at same-center properties due primarily to increased occupancy, higher rental rates on new and renewal leases and an increase in parking income, and |
| • | an increase of $4.3 million at redevelopment properties due primarily to increased occupancy at certain properties, mainly our new residential building at Santana Row and higher rental rates on new leases partially offset by lower income from Mid-Pike as the property is prepared for the development of Pike & Rose. |
Other Property Income
Other property income increased $11.0 million, or 118.3%, to $20.2 million in 2012 compared to $9.3 million in 2011. Included in other property income are items which, although recurring, tend to fluctuate more than rental income from period to period, such as lease termination fees. This increase is primarily due to an increase in lease termination fees at same-center properties.
Property Expenses
Total property expenses increased $9.4 million, or 5.5%, to $179.6 million in 2012 compared to $170.2 million in 2011. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $3.2 million, or 2.9%, to $112.8 million in 2012 compared to $109.5 million in 2011. This increase is primarily due to the following:
| • | an increase of $3.3 million related to properties acquired in 2011 and 2012, |
| • | an increase of $0.9 million in operating costs due primarily to higher demolition costs, |
| • | an increase of $0.8 million in marketing expenses at our Assembly Row and Pike & Rose projects, and |
| • | an increase of $0.5 million in insurance expenses primarily at same-center properties, |
partially offset by
| • | a decrease of $2.0 million in repairs and maintenance at same-center properties primarily due to lower snow removal costs partially offset by higher maintenance costs. |
As a result of the changes in rental income, other property income and rental expenses as discussed above, rental expenses as a percentage of rental income plus other property income decreased to 18.7% in 2012 from 20.0% in 2011.
Real Estate Taxes
Real estate tax expense increased $6.2 million, or 10.2% to $66.8 million in 2012 compared to $60.6 million in 2011 due primarily to properties acquired in 2011 and 2012 and higher assessments at redevelopment and same-center properties.
Property Operating Income
Property operating income increased $45.6 million, or 11.9%, to $428.5 million in 2012 compared to $382.9 million in 2011. This increase is primarily due to properties acquired in 2011 and 2012, and growth in earnings at same-center properties and redevelopment properties.
Other
Interest Expense
Interest expense increased $14.9 million, or 15.1%, to $113.3 million in 2012 compared to $98.5 million in 2011. This increase is due primarily to the following:
| • | an increase of $12.9 million due to mortgage loans secured by Plaza El Segundo and Montrose Crossing both of which were acquired in 2011, and |
| • | an increase of $4.7 million due to higher borrowings, |
partially offset by
| • | an increase of $2.0 million in capitalized interest, and |
| • | a decrease of $0.7 million due to a lower overall average borrowing rate. |
Gross interest costs were $123.4 million and $106.6 million in 2012 and 2011, respectively. Capitalized interest was $10.1 million and $8.1 million in 2012 and 2011, respectively.
Early Extinguishment of Debt
The $0.3 million of income from early extinguishment of debt in 2011 is due to the write-off of unamortized debt premium net of a 3.0% prepayment premium and unamortized debt fees related to the payoff of our mortgage loan on Tower Shops prior to its contractual prepayment date.
General and Administrative Expense
General and administrative expense increased $2.2 million, or 7.5%, to $31.2 million in 2012 from $29.0 million in 2011. This increase is due primarily to costs related to our CFO change and higher personnel related costs partially offset by lower acquisition costs in 2012 compared to 2011.
Depreciation and Amortization
Depreciation and amortization expense increased $15.8 million, or 12.5%, to $142.0 million in 2012 from $126.2 million in 2011. This increase is due primarily to 2011 acquisitions and capital improvements at same-center and redevelopment properties.
Discontinued Operations— Income
Income from discontinued operations represents the operating income of properties that have been disposed or will be disposed, which is required to be reported separately from results of ongoing operations. The reported operating income of $1.0 million for 2011 primarily represents the operating income for the period during which we owned properties sold/disposed of in 2011.
Discontinued Operations— Gain on Deconsolidation of VIE
The $2.0 million gain on deconsolidation of VIE in 2011, is the result of the refinancing of a mortgage note receivable on a shopping center in Norwalk, Connecticut, resulting in us no longer being the primary beneficiary of the VIE. See Note 4 to the consolidated financial statements for further discussion of this transaction.
Discontinued Operations—Gain on Sale of Real Estate
The $15.1 million gain on sale of real estate from discontinued operations for 2011 is primarily due to the sale of Feasterville Shopping Center on July 12, 2011.
Gain on Sale of Real Estate
The $11.9 million gain on sale of real estate in 2012 is due to the sale of our Newbury Street Partnership's entire portfolio of three buildings on October 31, 2011. Due to the timing of receiving financial information from the general partner, our share of earnings was recorded one quarter in arrears. Therefore, we recognized the gain on sale of $11.9 million in 2012.
YEAR ENDED DECEMBER 31, 2011 COMPARED TO YEAR ENDED DECEMBER 31, 2010
| Change | ||||||||||||||
| 2011 | 2010 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 538,701 | $ | 522,651 | $ | 16,050 | 3.1 | % | ||||||
| Other property income | 9,260 | 14,545 | (5,285 | ) | (36.3 | )% | ||||||||
| Mortgage interest income | 5,098 | 4,601 | 497 | 10.8 | % | |||||||||
| Total property revenue | 553,059 | 541,797 | 11,262 | 2.1 | % | |||||||||
| Rental expenses | 109,549 | 110,519 | (970 | ) | (0.9 | )% | ||||||||
| Real estate taxes | 60,620 | 58,663 | 1,957 | 3.3 | % | |||||||||
| Total property expenses | 170,169 | 169,182 | 987 | 0.6 | % | |||||||||
| Property operating income | 382,890 | 372,615 | 10,275 | 2.8 | % | |||||||||
| Other interest income | 218 | 256 | (38 | ) | (14.8 | )% | ||||||||
| Income from real estate partnerships | 1,808 | 1,060 | 748 | 70.6 | % | |||||||||
| Interest expense | (98,465 | ) | (101,882 | ) | 3,417 | (3.4 | )% | |||||||
| Early extinguishment of debt | 296 | (2,801 | ) | 3,097 | (110.6 | )% | ||||||||
| General and administrative expense | (28,985 | ) | (24,189 | ) | (4,796 | ) | 19.8 | % | ||||||
| Litigation provision | — | (330 | ) | 330 | (100.0 | )% | ||||||||
| Depreciation and amortization | (126,208 | ) | (118,878 | ) | (7,330 | ) | 6.2 | % | ||||||
| Total other, net | (251,336 | ) | (246,764 | ) | (4,572 | ) | 1.9 | % | ||||||
| Income from continuing operations | 131,554 | 125,851 | 5,703 | 4.5 | % | |||||||||
| Discontinued operations - income | 957 | 976 | (19 | ) | (1.9 | )% | ||||||||
| Discontinued operations - gain on deconsolidation of VIE | 2,026 | — | 2,026 | 100.0 | % | |||||||||
| Discontinued operations - gain on sale of real estate | 15,075 | 1,000 | 14,075 | 1,407.5 | % | |||||||||
| Gain on sale of real estate | — | 410 | (410 | ) | (100.0 | )% | ||||||||
| Net income | 149,612 | 128,237 | 21,375 | 16.7 | % | |||||||||
| Net income attributable to noncontrolling interests | (5,695 | ) | (5,447 | ) | (248 | ) | 4.6 | % | ||||||
| Net income attributable to the Trust | $ | 143,917 | $ | 122,790 | $ | 21,127 | 17.2 | % |
Property Revenues
Total property revenue increased $11.3 million, or 2.1%, to $553.1 million in 2011 compared to $541.8 million in 2010. The percentage occupied at our shopping centers decreased to 92.4% at December 31, 2011 compared to 93.2%% at December 31, 2010. Changes in the components of property revenue are discussed below.
Rental Income
Rental income consists primarily of minimum rent, cost reimbursements from tenants and percentage rent. Rental income increased $16.1 million, or 3.1%, to $538.7 million in 2011 compared to $522.7 million in 2010 due primarily to the following:
| • | an increase of $7.8 million attributable to properties acquired in 2010 and 2011, |
| • | an increase of $5.5 million at redevelopment properties due primarily to increased occupancy at certain properties and higher rental rates on new and renewal leases, and |
| • | an increase of $2.8 million at same-center properties due primarily to higher rental rates on new and renewal leases and an increase in percentage rent partially offset by lower recovery income as a result of lower recoverable expenses (primarily snow removal costs). |
Other Property Income
Other property income decreased $5.3 million, or 36.3%, to $9.3 million in 2011 compared to $14.5 million in 2010. Included in other property income are items which, although recurring, tend to fluctuate more than rental income from period to period,
such as lease termination fees. This decrease is primarily due to a decrease in lease termination fees at redevelopment and same-center properties.
Property Expenses
Total property expenses increased $1.0 million, or 0.6%, to $170.2 million in 2011 compared to $169.2 million in 2010. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses decreased $1.0 million, or 0.9%, to $109.5 million in 2011 compared to $110.5 million in 2010. This decrease is primarily due to the following:
| • | a decrease of $3.5 million in bad debt expense at same-center properties, |
| • | a decrease of $1.4 million in repairs and maintenance at same-center properties primarily due to lower snow removal costs, and |
| • | a decrease of $0.8 million in ground rent due to the fourth quarter 2010 purchases of the fee interest in the land under Pentagon Row and a portion of Bethesda Row, |
partially offset by
| • | an increase of $2.1 million in marketing expense primarily due to our Assembly Row project and certain same-center properties, |
| • | an increase of $1.5 million related to properties acquired in 2010 and 2011, and |
| • | an increase of $1.1 million in other operating costs. |
As a result of the changes in rental income, other property income and rental expenses as discussed above, rental expenses as a percentage of rental income plus other property income decreased to 20.0% in 2011 from 20.6% in 2010.
Real Estate Taxes
Real estate tax expense increased $2.0 million, or 3.3% to $60.6 million in 2011 compared to $58.7 million in 2010 due primarily to properties acquired in 2010 and 2011 and higher assessments at redevelopment properties.
Property Operating Income
Property operating income increased $10.3 million, or 2.8%, to $382.9 million in 2011 compared to $372.6 million in 2010. This increase is primarily due to growth in earnings at same-center properties, properties acquired in 2010 and 2011 and redevelopment properties.
Other
Income from Real Estate Partnerships
Income from real estate partnerships increased $0.7 million, or 70.6%, to $1.8 million in 2011 compared to $1.1 million in 2010. The increase is primarily due to $0.4 million of formation and acquisition related expenses from our Newbury Street Partnership in 2010.
Interest Expense
Interest expense decreased $3.4 million, or 3.4%, to $98.5 million in 2011 compared to $101.9 million in 2010. This decrease is due primarily to the following:
| • | a decrease of $5.7 million due to a lower overall weighted average borrowing rate, and |
| • | an increase of $1.8 million in capitalized interest, |
partially offset by
| • | an increase of $4.1 million due to higher borrowings. |
Gross interest costs were $106.6 million and $108.2 million in 2011 and 2010, respectively. Capitalized interest was $8.1 million and $6.3 million in 2011 and 2010, respectively.
Early Extinguishment of Debt
The $0.3 million of income from early extinguishment of debt in 2011 is due to the write-off of unamortized debt premium net of a 3.0% prepayment premium and unamortized debt fees related to the payoff of our mortgage loan on Tower Shops prior to its contractual prepayment date. The $2.8 million early extinguishment of debt expense in 2010 is due to the write-off of unamortized debt fees related to the $250.0 million payoff of the term loan prior to its maturity date.
General and Administrative Expense
General and administrative expense increased $4.8 million, or 19.8%, to $29.0 million in 2011 from $24.2 million in 2010. This increase is due primarily to $3.4 million of transaction costs related to our December 2011 acquisitions of Montrose Crossing and Plaza El Segundo and higher personnel related costs.
Depreciation and Amortization
Depreciation and amortization expense increased $7.3 million, or 6.2%, to $126.2 million in 2011 from $118.9 million in 2010. This increase is due primarily to 2010 and 2011 acquisitions, accelerated depreciation due to the change in use of certain redevelopment building and capital improvements at same-center properties.
Discontinued Operations— Income
Income from discontinued operations represents the operating income of properties that have been disposed or will be disposed, which is required to be reported separately from results of ongoing operations. The reported operating income of $1.0 million for both 2011 and 2010 primarily represents the operating income for the period during which we owned properties sold/disposed of in 2011 and 2010.
Discontinued Operations— Gain on Deconsolidation of VIE
The $2.0 million gain on deconsolidation of VIE in 2011, is the result of the refinancing of a mortgage note receivable on a shopping center in Norwalk, Connecticut, resulting in us no longer being the primary beneficiary of the VIE. See Note 4 to the consolidated financial statements for further discussion of this transaction.
Discontinued Operations—Gain on Sale of Real Estate
The $15.1 million gain on sale of real estate from discontinued operations in 2011 is primarily due to the sale of Feasterville Shopping Center on July 12, 2011. The $1.0 million gain on sale of real estate from discontinued operations for 2010 relates to the final settlement reached with the contractors responsible for performing defective work in previous years related to the work done in connection with the sale of certain condominium units at Santana Row.
Gain on Sale of Real Estate
The $0.4 million gain on sale of real estate in 2010 is due to condemnation proceeds, net of costs, at one of our Northern Virginia properties in order to expand a local road.
Liquidity and Capital Resources
Due to the nature of our business and strategy, we typically generate significant amounts of cash from operations. The cash generated from operations is primarily paid to our common and preferred shareholders in the form of dividends. As a REIT, we must generally make annual distributions to shareholders of at least 90% of our taxable income.
Our short-term liquidity requirements consist primarily of normal recurring operating expenses, obligations under our capital and operating leases, regular debt service requirements (including debt service relating to additional or replacement debt, as well as scheduled debt maturities), recurring expenditures, non-recurring expenditures (such as tenant improvements and redevelopments) and dividends to common and preferred shareholders. Our long-term capital requirements consist primarily of maturities under our long-term debt agreements, development and redevelopment costs and potential acquisitions.
We intend to operate with and maintain a conservative capital structure that will allow us to maintain strong debt service coverage and fixed-charge coverage ratios as part of our commitment to investment-grade debt ratings. In the short and long term, we may seek to obtain funds through the issuance of additional equity, unsecured and/or secured debt financings, joint venture relationships relating to existing properties or new acquisitions, and property dispositions that are consistent with this conservative structure.
Cash and cash equivalents decreased $30.8 million to $37.0 million at December 31, 2012; however, cash and cash equivalents are not the only indicator of our liquidity. We also have a $400.0 million unsecured revolving credit facility which matures on July 6, 2015 and had no borrowings outstanding at December 31, 2012. In addition, we have an option (subject to bank approval) to increase the credit facility through an accordion feature to $800.0 million. Our $275.0 million unsecured term loan that matures on November 21, 2018 also has an option (subject to bank approval) to increase the term loan through an accordion feature to $350.0 million. As of December 31, 2012, we had the capacity to issue up to $213.4 million in common shares under our ATM equity program.
For 2012, the maximum amount of borrowings outstanding under our revolving credit facility was $186.0 million, the weighted average amount of borrowings outstanding was $1.5 million and the weighted average interest rate, before amortization of debt fees, was 1.4%. We have approximately $163.0 million of debt maturing in 2013, of which $135.0 million relates to our 5.40% senior notes that mature in December 2013. We currently believe that cash flows from operations, cash on hand, our ATM equity program, our revolving credit facility and our general ability to access the capital markets will be sufficient to finance our operations and fund our debt service requirements (including maturities) and capital expenditures.
Our overall capital requirements during 2013 will depend upon acquisition opportunities, the level of improvements and redevelopments on existing properties and the timing and cost of development of Assembly Row, Pike & Rose and future phases of Santana Row. While the amount of future expenditures will depend on numerous factors, we expect to continue to see higher levels of capital investments in our properties under development and redevelopment in 2013 which is the result of the 212 unit residential building at Santana Row, a portion of which will be completed during 2013, and the continued construction of Phase 1 at both Assembly Row and Pike & Rose with expected openings of portions of both projects in 2014. Over the next two years, we expect to invest approximately $425 million related to the current phases of these three projects. With respect to other capital investments related to our existing properties, we expect to incur levels consistent with prior years. Our capital investments will be funded on a short-term basis with cash flow from operations, cash on hand and/or our revolving credit facility, and on a long-term basis, with long-term debt or equity including shares issued under our ATM equity program. If necessary, we may access the debt or equity capital markets to finance significant acquisitions. Given our past ability to access the capital markets, we expect debt or equity to be available to us. Although there is no intent at this time, if market conditions deteriorate, we may also delay the timing of certain development and redevelopment projects as well as limit future acquisitions, reduce our operating expenditures, or re-evaluate our dividend policy.
In addition to conditions in the capital markets which could affect our ability to access those markets, the following factors could affect our ability to meet our liquidity requirements:
| • | restrictions in our debt instruments or preferred shares may limit us from incurring debt or issuing equity at all, or on acceptable terms under then-prevailing market conditions; and |
| • | we may be unable to service additional or replacement debt due to increases in interest rates or a decline in our operating performance. |
Summary of Cash Flows
| Year Ended December 31, | |||||||
| 2012 | 2011 | ||||||
| (In thousands) | |||||||
| Cash provided by operating activities | $ | 296,633 | $ | 244,711 | |||
| Cash used in investing activities | (273,558 | ) | (196,369 | ) | |||
| Cash (used in) provided by financing activities | (53,893 | ) | 3,667 | ||||
| (Decrease) increase in cash and cash equivalents | (30,818 | ) | 52,009 | ||||
| Cash and cash equivalents, beginning of year | 67,806 | 15,797 | |||||
| Cash and cash equivalents, end of year | $ | 36,988 | $ | 67,806 |
Net cash provided by operating activities increased $51.9 million to $296.6 million during 2012 from $244.7 million during 2011. The increase was primarily attributable to higher net income before certain non-cash items in 2012 and the payment in 2011 of the $16.2 million final judgment related to a previously disclosed lawsuit.
Net cash used in investing activities increased $77.2 million to $273.6 million during 2012 from $196.4 million during 2011. The increase was primarily attributable to:
| • | $38.2 million increase in capital investments in 2012, |
| • | $34.6 million cash received in October 2011 from our Newbury Street Partnership due to the sale of its properties, |
| • | $23.7 million in proceeds from the sales of real estate in 2011, primarily due to the sale of Feasterville Shopping Center, and |
| • | $8.7 million payment received in June 2011 related to the refinancing of a mortgage loan receivable, |
partially offset by
| • | $22.7 million decrease in acquisitions of real estate as we acquired East Bay Bridge in 2012 compared to three operating properties acquired in 2011, and |
| • | $6.9 million in contributions to the Newbury Street Partnership in 2011. |
Net cash used in financing activities increased $57.6 million to $53.9 million during 2012 from $3.7 million provided by financing activities in 2011. The increase was primarily attributable to:
| • | $272.2 million in net proceeds from the term loan in November 2011, |
| • | $100.0 million increase in senior note repayments as we repaid the $175.0 million 6.00% senior notes in July 2012 compared to the $75.0 million 4.5% senior notes in February 2011, |
| • | $42.7 million decrease in net proceeds from the issuance of common shares due primarily to the sale of 1.7 million shares under our ATM equity program in 2011 compared to 1.0 million in 2012, and |
| • | $10.6 million increase in dividends paid to shareholders due to an increase in the dividend rate and increased number of shares outstanding, |
partially offset by
| • | $244.8 million in net proceeds from the issuance of 3.00% senior notes in July 2012, |
| • | $81.2 million decrease in net repayments on our revolving credit facility, net of financing costs, and |
| • | $38.5 million decrease in repayment of mortgages, capital leases and notes payable primarily due to the payoff of three mortgages totaling $78.4 million in 2011 compared to four mortgages totaling $41.0 million in 2012. |
Contractual Commitments
The following table provides a summary of our fixed, noncancelable obligations as of December 31, 2012:
| Commitments Due by Period | |||||||||||||||||||
| Total | Less Than 1 Year | 1-3 Years | 3-5 Years | After 5 Years | |||||||||||||||
| (In thousands) | |||||||||||||||||||
| Fixed rate debt (principal and interest)(1) | $ | 2,654,616 | $ | 289,145 | $ | 704,368 | $ | 678,013 | $ | 983,090 | |||||||||
| Fixed rate debt - unconsolidated real estate partnership (principal and interest)(2) | 20,002 | 1,056 | 8,272 | 10,674 | — | ||||||||||||||
| Capital lease obligations (principal and interest) | 200,757 | 5,787 | 11,575 | 11,585 | 171,810 | ||||||||||||||
| Variable rate debt (principal only)(3) | 9,400 | — | — | 9,400 | — | ||||||||||||||
| Operating leases | 57,061 | 1,488 | 2,906 | 2,460 | 50,207 | ||||||||||||||
| Real estate commitments(4) | 67,500 | — | — | — | 67,500 | ||||||||||||||
| Development, redevelopment, and capital improvement obligations | 233,046 | 171,370 | 61,590 | 86 | — | ||||||||||||||
| Contractual operating obligations | 21,885 | 14,804 | 6,790 | 257 | 34 | ||||||||||||||
| Total contractual obligations | $ | 3,264,267 | $ | 483,650 | $ | 795,501 | $ | 712,475 | $ | 1,272,641 |
| (1) | Fixed rate debt includes our $275.0 million term loan as the rate is effectively fixed by two interest rate swap agreements. |
| (2) | Amounts reflect our share of principal and interest payments on our unconsolidated joint venture's fixed rate debt. |
| (3) | Variable rate debt includes a $9.4 million bond that had an interest rate of 0.21% at December 31, 2012 and our revolving credit facility, which currently has no outstanding balance and bears interest at LIBOR plus 1.15%. |
| (4) | A master lease on Melville Mall includes a fixed price put option requiring us to purchase the property for $5.0 million plus the assumption of the owners’ mortgage debt. The current mortgage loan matures on September 1, 2014, is |
expected to be refinanced at maturity, and has an outstanding contractual balance of $21.5 million at December 31, 2012. The real estate commitments currently include the fixed $5.0 million and all payments related to the current mortgage loan are included in fixed rate debt.
In addition to the amounts set forth in the table above and other liquidity requirements previously discussed, the following potential commitments exist:
(a) Under the terms of the Congressional Plaza partnership agreement, from and after January 1, 1986, an unaffiliated third party has the right to require us and the other minority partner to purchase its 29.47% interest in Congressional Plaza at the interest’s then-current fair market value. If the other minority partner defaults in their obligation, we must purchase the full interest. Based on management’s current estimate of fair market value as of December 31, 2012, our estimated liability upon exercise of the put option would range from approximately $65 million to $71 million.
(b) Under the terms of a partnership which owns a project in southern California, if certain leasing and revenue levels are obtained for the property owned by the partnership, the other partner may require us to purchase their 10% partnership interest at a formula price based upon property operating income. The purchase price for the partnership interest will be paid using our common shares or, subject to certain conditions, cash. If the other partner does not redeem their interest, we may choose to purchase the partnership interest upon the same terms.
(c) Under the terms of various other partnership agreements, the partners have the right to exchange their operating partnership units for cash or the same number of our common shares, at our option. As of December 31, 2012, a total of 320,646 operating partnership units are outstanding.
(d) Effective December 27, 2013, the other member in Montrose Crossing has the right to require us to purchase all of its 10.1% interest in Montrose Crossing at the interest's then-current fair market value. If the other member fails to exercise its put option, we have the right to purchase its interest on or after December 27, 2021 at fair market value.
(e) Effective December 30, 2013, two of the members have the right to require us to purchase their 10.0% and 11.8% ownership interests in Plaza El Segundo at the interests' then-current fair market value. If the members fail to exercise their put options, we have the right to purchase each of their interests on or after December 30, 2026 at fair market value. Also, between January 1, 2017 and February 1, 2017, we have an option to purchase the preferred interest of another member in Plaza El Segundo. The purchase price will be the lesser of fair value or the $4.9 million stated value of the preferred interest plus any accrued and unpaid preferred returns.
(f) At December 31, 2012, we had letters of credit outstanding of approximately $15.9 million which are collateral for existing indebtedness and other obligations of the Trust.
Off-Balance Sheet Arrangements
We have a joint venture arrangement (the “Partnership”) with affiliates of a discretionary fund created and advised by ING Clarion Partners (“Clarion”). We own 30% of the equity in the Partnership and Clarion owns 70%. We hold a general partnership interest, however, Clarion also holds a general partnership interest and has substantive participating rights. We cannot make significant decisions without Clarion’s approval. Accordingly, we account for our interest in the Partnership using the equity method. As of December 31, 2012, the Partnership owned seven retail real estate properties. We are the manager of the Partnership and its properties, earning fees for acquisitions, management, leasing and financing. We also have the opportunity to receive performance-based earnings through our Partnership interest. The Partnership is subject to a buy-sell provision which is customary in real estate joint venture agreements and the industry. Either partner may initiate this provision at any time, which could result in either the sale of our interest or the use of available cash or borrowings to acquire Clarion’s interest. Accounting policies for the Partnership are similar to accounting policies followed by the Trust. At December 31, 2012, our investment in the Partnership was $33.2 million and the Partnership had approximately $57.2 million of mortgages payable outstanding.
Other than the joint venture described above and items disclosed in the Contractual Commitments Table, we have no off-balance sheet arrangements as of December 31, 2012 that are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Debt Financing Arrangements
The following is a summary of our total debt outstanding as of December 31, 2012:
| Description of Debt | Original Debt Issued | Principal Balance as of December 31, 2012 | Stated Interest Rate as of December 31, 2012 | Maturity Date | |||||||
| (Dollars in thousands) | |||||||||||
| Mortgages payable (1) | |||||||||||
| Secured fixed rate | |||||||||||
| White Marsh Plaza (2) | Acquired | $ | 8,970 | 6.04 | % | April 1, 2013 | |||||
| Crow Canyon | Acquired | 19,485 | 5.40 | % | August 11, 2013 | ||||||
| Idylwood Plaza | 16,910 | 15,987 | 7.50 | % | June 5, 2014 | ||||||
| Leesburg Plaza | 29,423 | 27,818 | 7.50 | % | June 5, 2014 | ||||||
| Loehmann’s Plaza | 38,047 | 35,972 | 7.50 | % | June 5, 2014 | ||||||
| Pentagon Row | 54,619 | 51,640 | 7.50 | % | June 5, 2014 | ||||||
| Melville Mall (3) | Acquired | 21,536 | 5.25 | % | September 1, 2014 | ||||||
| THE AVENUE at White Marsh | Acquired | 55,336 | 5.46 | % | January 1, 2015 | ||||||
| Barracks Road | 44,300 | 38,070 | 7.95 | % | November 1, 2015 | ||||||
| Hauppauge | 16,700 | 14,352 | 7.95 | % | November 1, 2015 | ||||||
| Lawrence Park | 31,400 | 26,984 | 7.95 | % | November 1, 2015 | ||||||
| Wildwood | 27,600 | 23,719 | 7.95 | % | November 1, 2015 | ||||||
| Wynnewood | 32,000 | 27,500 | 7.95 | % | November 1, 2015 | ||||||
| Brick Plaza | 33,000 | 28,033 | 7.42 | % | November 1, 2015 | ||||||
| East Bay Bridge | Acquired | 62,946 | 5.13 | % | March 1, 2016 | ||||||
| Plaza El Segundo | Acquired | 175,000 | 6.33 | % | August 5, 2017 | ||||||
| Rollingwood Apartments | 24,050 | 22,890 | 5.54 | % | May 1, 2019 | ||||||
| 29th Place (Shoppers’ World) | Acquired | 5,286 | 5.91 | % | January 31, 2021 | ||||||
| Montrose Crossing | 80,000 | 78,755 | 4.20 | % | January 10, 2022 | ||||||
| Chelsea | Acquired | 7,454 | 5.36 | % | January 15, 2031 | ||||||
| Subtotal | 747,733 | ||||||||||
| Net unamortized premium | 13,056 | ||||||||||
| Total mortgages payable | 760,789 | ||||||||||
| Notes payable | |||||||||||
| Unsecured fixed rate | |||||||||||
| Term Loan (4) | 275,000 | 275,000 | LIBOR + 1.45% | November 21, 2018 | |||||||
| Various (5) | 18,574 | 15,175 | 5.27 | % | Various through 2027 | ||||||
| Unsecured variable rate | |||||||||||
| Revolving credit facility (6) | 400,000 | — | LIBOR + 1.15% | July 6, 2015 | |||||||
| Escondido (municipal bonds) (7) | 9,400 | 9,400 | 0.21 | % | October 1, 2016 | ||||||
| Total notes payable | 299,575 | ||||||||||
| Senior notes and debentures | |||||||||||
| Unsecured fixed rate | |||||||||||
| 5.40% notes | 135,000 | 135,000 | 5.40 | % | December 1, 2013 | ||||||
| 5.95% notes | 150,000 | 150,000 | 5.95 | % | August 15, 2014 | ||||||
| 5.65% notes | 125,000 | 125,000 | 5.65 | % | June 1, 2016 | ||||||
| 6.20% notes | 200,000 | 200,000 | 6.20 | % | January 15, 2017 | ||||||
| 5.90% notes | 150,000 | 150,000 | 5.90 | % | April 1, 2020 | ||||||
| 3.00% notes | 250,000 | 250,000 | 3.00 | % | August 1, 2022 | ||||||
| 7.48% debentures | 50,000 | 29,200 | 7.48 | % | August 15, 2026 | ||||||
| 6.82% medium term notes | 40,000 | 40,000 | 6.82 | % | August 1, 2027 | ||||||
| Subtotal | 1,079,200 | ||||||||||
| Net unamortized discount | (2,655 | ) | |||||||||
| Total senior notes and debentures | 1,076,545 | ||||||||||
| Capital lease obligations | |||||||||||
| Various | 71,693 | Various | Various through 2106 | ||||||||
| Total debt and capital lease obligations | $ | 2,208,602 |
| 1) | Mortgages payable do not include our 30% share ($17.1 million) of the $57.2 million debt of the partnership with a discretionary fund created and advised by ING Clarion Partners. |
| 2) | We repaid the loan at par on January 2, 2013. |
| 3) | We acquired control of Melville Mall through a 20-year master lease and secondary financing. Because we control the activities that most significantly impact this property and retain substantially all of the economic benefit and risk associated with it, this property is consolidated and the mortgage loan is reflected on the balance sheet, though it is not our legal obligation. |
| 4) | We entered into two interest rate swap agreements that effectively fix the rate on the term loan at 3.17%. |
| 5) | The interest rate of 5.3% represents the weighted average interest rate for ten unsecured fixed rate notes payable. These notes mature between January 31, 2013 and June 27, 2027. |
| 6) | The maximum amount drawn under our revolving credit facility during 2012 was $186.0 million and the weighted average effective interest rate on borrowings under our revolving credit facility, before amortization of debt fees, was 1.42%. |
| 7) | The bonds require monthly interest only payments through maturity. The bonds bear interest at a variable rate determined weekly, which would enable the bonds to be remarketed at 100% of their principal amount. The Escondido Promenade property is not encumbered by a lien. |
Our revolving credit facility, term loan and other debt agreements include financial and other covenants that may limit our operating activities in the future. As of December 31, 2012, we were in compliance with all of the financial and other covenants. If we were to breach any of our debt covenants and did not cure the breach within an applicable cure period, our lenders could require us to repay the debt immediately and, if the debt is secured, could immediately begin proceedings to take possession of the property securing the loan. Many of our debt arrangements, including our public notes, term loan and our revolving credit facility, are cross-defaulted, which means that the lenders under those debt arrangements can put us in default and require immediate repayment of their debt if we breach and fail to cure a default under certain of our other debt obligations. As a result, any default under our debt covenants could have an adverse effect on our financial condition, our results of operations, our ability to meet our obligations and the market value of our shares. Our organizational documents do not limit the level or amount of debt that we may incur.
The following is a summary of our scheduled principal repayments as of December 31, 2012:
| Unsecured | Secured | Capital Lease | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| 2013 | $ | 135,256 | $ | 40,296 | $ | 25 | $ | 175,577 | ||||||||
| 2014 | 160,249 | 158,855 | 25 | 319,129 | ||||||||||||
| 2015 | 275 | (1) | 206,007 | 27 | 206,309 | |||||||||||
| 2016 | 134,702 | 62,412 | 30 | 197,144 | ||||||||||||
| 2017 | 200,335 | 177,654 | 34 | 378,023 | ||||||||||||
| Thereafter | 747,958 | 102,509 | 71,552 | 922,019 | ||||||||||||
| $ | 1,378,775 | $ | 747,733 | $ | 71,693 | $ | 2,198,201 | (2) |
| 1) | Our $400.0 million revolving credit facility matures on July 6, 2015, subject to a one-year extension at our option. As of December 31, 2012, there was nothing drawn under this credit facility. |
| 2) | The total debt maturities differs from the total reported on the consolidated balance sheet due to the unamortized net premium or discount on certain mortgage loans, senior notes and debentures as of December 31, 2012. |
Interest Rate Hedging
We may use derivative instruments to manage exposure to variable interest rate risk. We generally enter into interest rate swaps to manage our exposure to variable interest rate risk and treasury locks to manage the risk of interest rates rising prior to the issuance of debt. We enter into derivative instruments that qualify as cash flow hedges and do not enter into derivative instruments for speculative purposes.
The interest rate swaps associated with our cash flow hedges are recorded at fair value on a recurring basis. We assess effectiveness of our cash flow hedges both at inception and on an ongoing basis. The effective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recorded in other comprehensive income which is included in accumulated other comprehensive loss on our consolidated balance sheet and our consolidated statement of of shareholders' equity. Our cash flow hedges become ineffective if critical terms of the hedging instrument and the debt instrument do not perfectly match such as notional amounts, settlement dates, reset dates, calculation period and LIBOR rate. In addition, we evaluate the default risk of the counterparty by monitoring the credit worthiness of the counterparty which includes reviewing debt ratings and financial performance. However, management does not anticipate non-performance by the counterparty. If a cash flow hedge is deemed ineffective, the ineffective portion of changes in fair value of the interest rate swaps associated with our cash flow hedges is recognized in earnings in the period affected.
In November 2011, we entered into two interest rate swap agreements that effectively fixed the rate on the $275.0 million term loan at 3.17%. Both swaps were designated and qualified as cash flow hedges and are recorded at fair value. Hedge ineffectiveness did not impact earnings in 2012 and 2011, and we do not anticipate it will have a significant effect in the future. We had no derivative instruments outstanding during 2010.
REIT Qualification
We intend to maintain our qualification as a REIT under Section 856(c) of the Code. As a REIT, we generally will not be subject to corporate federal income taxes on income we distribute to our shareholders as long as we satisfy certain technical requirements of the Code, including the requirement to distribute at least 90% of our taxable income to our shareholders.
Funds From Operations
Funds from operations (“FFO”) is a supplemental non-GAAP financial measure of real estate companies’ operating performance. The National Association of Real Estate Investment Trusts (“NAREIT”) defines FFO as follows: net income, computed in accordance with the U.S. GAAP, plus real estate related depreciation and amortization and excluding extraordinary items and gains and losses on the sale of real estate. We compute FFO in accordance with the NAREIT definition, and we have historically reported our FFO available for common shareholders in addition to our net income and net cash provided by operating activities. It should be noted that FFO:
| • | does not represent cash flows from operating activities in accordance with GAAP (which, unlike FFO, generally reflects all cash effects of transactions and other events in the determination of net income); |
| • | should not be considered an alternative to net income as an indication of our performance; and |
| • | is not necessarily indicative of cash flow as a measure of liquidity or ability to fund cash needs, including the payment of dividends. |
We consider FFO available for common shareholders a meaningful, additional measure of operating performance primarily because it excludes the assumption that the value of the real estate assets diminishes predictably over time, as implied by the historical cost convention of GAAP and the recording of depreciation. We use FFO primarily as one of several means of assessing our operating performance in comparison with other REITs. Comparison of our presentation of FFO to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
An increase or decrease in FFO available for common shareholders does not necessarily result in an increase or decrease in aggregate distributions because our Board of Trustees is not required to increase distributions on a quarterly basis unless necessary for us to maintain REIT status. However, we must distribute at least 90% of our taxable income to remain qualified as a REIT. Therefore, a significant increase in FFO will generally require an increase in distributions to shareholders although not necessarily on a proportionate basis.
The reconciliation of net income to FFO available for common shareholders is as follows:
| Year Ended December 31, | |||||||||||
| 2012 | 2011 | 2010 | |||||||||
| (In thousands) | |||||||||||
| Net income | $ | 156,232 | $ | 149,612 | $ | 128,237 | |||||
| Net income attributable to noncontrolling interests | (4,307 | ) | (5,695 | ) | (5,447 | ) | |||||
| Gain on sale of real estate | (11,860 | ) | (15,075 | ) | (1,410 | ) | |||||
| Gain on deconsolidation of VIE | — | (2,026 | ) | — | |||||||
| Depreciation and amortization of real estate assets | 125,611 | 113,188 | 107,187 | ||||||||
| Amortization of initial direct costs of leases | 10,935 | 10,432 | 9,552 | ||||||||
| Depreciation of joint venture real estate assets | 1,513 | 1,771 | 1,499 | ||||||||
| Funds from operations | 278,124 | 252,207 | 239,618 | ||||||||
| Dividends on preferred shares | (541 | ) | (541 | ) | (541 | ) | |||||
| Income attributable to operating partnership units | 943 | 981 | 980 | ||||||||
| Income attributable to unvested shares | (1,289 | ) | (1,071 | ) | (847 | ) | |||||
| Funds from operations available for common shareholders | $ | 277,237 | $ | 251,576 | $ | 239,210 | |||||
| Weighted average number of common shares, diluted (1) | 64,389 | 62,964 | 61,693 | ||||||||
| Funds from operations available for common shareholders, per diluted share | $ | 4.31 | $ | 4.00 | $ | 3.88 |
| (1) | The weighted average common shares used to compute FFO per diluted common share includes operating partnership units that were excluded from the computation of diluted EPS. Conversion of these operating partnership units is dilutive in the computation of FFO per diluted common share but is anti-dilutive for the computation of diluted EPS for the periods presented. |
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