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, 2014, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use properties which are operated as 89 predominantly retail real estate projects comprising approximately 20.2 million square feet. In total, the real estate projects were 95.6% leased and 94.7% occupied at December 31, 2014. A joint venture in which we own a 30% interest owned six retail real estate projects totaling approximately 0.8 million square feet as of December 31, 2014. In total, the joint venture properties in which we own a 30% interest were 86.1% leased and 82.8% occupied at December 31, 2014. We have paid quarterly dividends to our shareholders continuously since our founding in 1962 and have increased our dividends per common share for 47 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 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, 2014 and 2013, our allowance for doubtful accounts was $12.4 million and $12.7 million, respectively. Historically, we have recognized bad debt expense between 0.4% and 1.3% of rental income and it was 0.3% in 2014 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 $6.7 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, 2014 and 2013, accounts receivable includes approximately $66.1 million and $60.6 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, and general economic and real estate factors. Certain events, such as 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.
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.
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.
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 $277 million and $7 million, respectively, for 2014 and $275 million and $6 million, respectively, for 2013. We capitalized external and internal costs related to other property improvements of $45 million and $2 million, respectively, for 2014 and $48 million and $1 million, respectively, for 2013. We capitalized external and internal costs related to leasing activities of $29 million and $7 million, respectively, for 2014 and $9 million and $6 million, respectively, for 2013. The amount of capitalized internal costs
for salaries and related benefits for development and redevelopment activities, other property improvements, and leasing activities were $7 million, $1 million, and $6 million, respectively, for 2014 and $6 million, $1 million, and $5 million, respectively, for 2013. Total capitalized costs were $367 million and $345 million for 2014 and 2013, respectively.
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.
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 and Recently Issued Accounting Pronouncements
See Note 2 to the consolidated financial statements.
2014 Significant Property Acquisitions and Disposition
Effective January 1, 2014, we acquired a controlling interest in The Grove at Shrewsbury, a 187,000 square foot shopping center in Shrewsbury, New Jersey, and Brook 35, a 99,000 square foot shopping center in Sea Girt, New Jersey for a gross value of $161 million. Our effective economic interest approximates 84% and was funded by the assumption of our share of $68 million of mortgage debt, 632,000 downREIT operating partnership units, and $13 million of cash (which was in an escrow account at December 31, 2013). Approximately $1.7 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. Additionally, $71.1 million was allocated to redeemable and nonredeemable noncontrolling interests. We incurred $2.0 million of acquisition costs, of which $1.0 million were incurred in 2014, and are included in "general and administrative expenses" in 2014 and 2013 on the accompanying consolidated statements of comprehensive income.
We entered into an agreement to acquire the interest of one of the noncontrolling interest holders in The Grove at Shrewsbury in 2015. As this noncontrolling interest is mandatorily redeemable, it has been classified as a liability of approximately $9 million and is included in "other liabilities and deferred credits" on the December 31, 2014 consolidated balance sheet. An additional noncontrolling interest holder has the right to require us to acquire its interests in The Grove at Shrewsbury and Brook 35 at the then current fair market value beginning on January 1, 2017.
On July 24, 2014, the joint venture arrangement with affiliates of a discretionary fund created and advised by ING Clarion Partners sold the fee interest in Pleasant Shops in Weymouth, Massachusetts for a sales price of $34.3 million, resulting in a gain on sale of $14.5 million. Our share of the gain was $4.4 million. The joint venture partners received distributions totaling $32.8 million as a result of the sale, of which our distribution was $10.4 million.
Subsequent Event - 2015 Property Acquisition
In January 2015, we acquired a controlling interest in San Antonio Center, a 376,000 square foot shopping center in Mountain View, California based on a total value of $62.2 million. Our effective interest approximates 80% and was funded by the assumption of our share of $18.7 million of mortgage debt, which has a stated interest rate of 5.27% and matures on January 1, 2016, approximately 58,000 downREIT operating partnership units and approximately $27 million of cash. We incurred $0.7 million of acquisition costs in 2014 which are included in "general and administrative expenses."
2014 Significant Debt and Equity Transactions
In connection with the acquisition of The Grove at Shrewsbury and Brook 35 on January 1, 2014, we assumed mortgage loans with a face amount of $68.3 million and a fair value of $73.8 million. The mortgage loans are secured by the individual properties with the following contractual terms:
| Principal | Stated Interest Rate | Maturity Date | ||||||
| (In millions) | ||||||||
| Brook 35 Plaza | $ | 11.5 | 5.46 | % | July 1, 2014 | |||
| The Grove at Shrewsbury (East) | $ | 45.4 | 5.82 | % | October 1, 2017 | |||
| The Grove at Shrewsbury (West) | $ | 11.4 | 6.38 | % | March 1, 2018 |
During 2014, we refinanced or issued the following loans or debt securities:
| Amount | Stated Interest Rate | Refinance/Issuance Date | Maturity Date | ||||||||
| (In millions) | |||||||||||
| Brook 35 Plaza Mortgage Loan | Refinance | $ | 11.5 | 4.65 | % | June 2, 2014 | July 1, 2029 | ||||
| 4.50% Senior Notes (1) | Issuance | $ | 250.0 | 4.50 | % | November 14, 2014 | December 1, 2044 | ||||
| THE AVENUE at White Marsh Mortgage Loan | Refinance | $ | 52.7 | 3.35 | % | December 15, 2014 | January 1, 2022 | ||||
(1) The net proceeds from this note offering after issuance discounts, underwriting fees and other costs were approximately $244.6 million.
During 2014, we fully repaid or redeemed the following loans or debt securities:
| Payoff Amount | Repayment Date | Maturity Date | ||||||
| (In millions) | ||||||||
| Melville Mall Mortgage Loan | $ | 20.3 | June 3, 2014 | September 1, 2014 | ||||
| East Bay Bridge Mortgage Loan (1) | $ | 61.0 | December 10, 2014 | March 1, 2016 | ||||
| 5.65% Senior Notes (2) | $ | 125.0 | December 12, 2014 | June 1, 2016 | ||||
(1) The total amount due at payoff of $64.0 million included a prepayment premium of $3.0 million and accrued but unpaid interest of $0.1 million. The prepayment premium is included in "early extinguishment of debt" in 2014
(2) The redemption price of $134.5 million included a make-whole premium of approximately $9.2 million and accrued but unpaid interest of $0.2 million. The make-whole premium is included in "early extinguishment of debt" in 2014.
On August 28, 2014, we amended our term loan agreement and lowered the spread over LIBOR by 40 basis points from 130 basis points to 90 basis points based on our current credit rating. The amendment also provides us the option to extend the maturity date by one year.
On February 12, 2014 we replaced our existing at the market (“ATM”) equity program with a new ATM equity 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, 2014, we issued 469,200 common shares at the weighted average price per share of $132.54 for net cash proceeds of $61.5 million and paid $0.6 million in commissions and less than $0.1 million in additional offering expenses related to the sales of these common shares. For the year ended December 31, 2014, we issued 1,768,583 common shares at a weighted average price per share of $122.09 for net cash proceeds of $213.6 million and paid $2.2 million in commissions and $0.2 million in additional offering expenses related to the sales of these common shares. As of December 31, 2014, we had the capacity to issue up to $84.1 million in common shares under our ATM equity program.
Outlook
We seek growth in earnings, funds from operations, and cash flows primarily through a combination of the following:
| • | growth in our same-center portfolio, |
| • | growth in our portfolio from property development and redevelopments, and |
| • | expansion of our portfolio through property acquisitions. |
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 generally continued to see an encouraging operating environment for many of our tenants as well as strong levels of interest from prospective tenants for our retail spaces. While there can be no assurance that these conditions will continue, we remain optimistic given the trends we have seen over the past few years. We believe the locations of our centers and diverse tenant base partially mitigates any negative change in the economic environment; however, any significant reduction in our tenants' abilities to pay base rent, percentage rent or other charges, will adversely affect our financial condition and results of operations. We seek to maintain a mix of strong national, regional, and local retailers. At December 31, 2014, no single tenant accounted for more than 3.1% of annualized base rent.
Our properties are located primarily in densely populated and/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 2015, we expect to have redevelopment projects stabilizing with projected costs of approximately $67 million.
We continue our ongoing redevelopment efforts at Santana Row. Our most recent 212 unit residential building was completed during second quarter. The building was 98.6% leased as of December 31, 2014, and had a total cost of $76 million. We are also proceeding with our next phase of redevelopment which is a six story building including approximately 225,500 square feet of office space, 1,500 square feet of retail space, and 670 parking spaces. After current phases, we have approximately 9 acres remaining for further redevelopment and entitlements in place for an additional 348 residential units and 69,000 square feet of commercial space. We are currently in the process of seeking additional entitlements and have under control an additional 12 acres of land adjacent to Santana Row.
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, 2014 is approximately $359 million. The project currently has zoning entitlements to build 3.4 million square feet of commercial-use buildings, 1,843 residential units, and a 170 room hotel. The first phase consists of approximately 326,000 square feet of retail space and 98,000 square feet of office space (both owned by the Trust) and 450 residential units owned by AvalonBay Communities. The Massachusetts Bay Transit Authority (MBTA) constructed the new orange line T-Stop at the property, which opened in September 2014. Minimal amounts of construction remain to be completed on the first phase. The retail space in Phase I opened during 2014 and currently is 97.3% leased; the office space will open in 2015. Phase I is expected to stabilize in 2015/2016. Total expected costs for Phase I of Assembly Row range from $190 million to $200 million (net of reimbursements) of which $189 million has been incurred to date. In total, we invested $74 million in Assembly Row in 2014, net of public funding, and expect to invest between $20 million and $30 million in Assembly Row in 2015.
Additionally, we entered into a ground lease agreement with Partners HealthCare to bring more than 700,000 square feet of office space and an additional 100,000 square feet of retail space to Assembly Row. The ground lease agreement includes a purchase option. Partners HealthCare commenced construction on this new building in September 2014 and plans to relocate over 4,500 employees to Assembly Row starting in 2016.
Our Pike & Rose project in North Bethesda, MD, a long-term multi-phased mixed-use project, currently has zoning entitlements to build 1.6 million square feet of commercial-use buildings and 1,605 residential units. Phase I of Pike & Rose involved demolition of roughly 25% of the gross leasable area at Mid-Pike Plaza (which was completed during the second quarter of 2012). The remainder of Mid-Pike Plaza was fully demolished in the third quarter of 2014. Phase I of Pike & Rose includes 493 residential units, 151,000 square feet of retail space and 79,000 square feet of office space. In late June 2014, our 174 unit residential building opened and is 85.1% leased as of December 31, 2014. Approximately 79,000 square feet of the retail space in Phase I opened in 2014 and we expect the remaining retail, office and 319 unit residential building to open in 2015. We expect Phase I to stabilize in 2015/2016. Total expected costs for Phase I of Pike & Rose range from $255 million to $265 million of which $217 million has been incurred to date.
Additionally, we are proceeding with development of Phase II of Pike & Rose and expect building construction to commence in the first half of 2015. Phase II is expected to include approximately 185,000 square feet of retail space, a 177-room select-service hotel and 264 residential units. Total expected costs range from $195 million to $200 million and stabilization is expected in 2018/2019. The hotel will be owned and operated by a joint venture in which we will be a partner. Phase II is also expected to include 104 for-sale condominium units with an expected cost of $50 million to $53 million. We invested $128 million in Pike & Rose in 2014 and expect to invest between $80 million and $110 million in Pike & Rose in 2015.
The development of future phases of Assembly Row, Pike & Rose and Santana Row will be pursued opportunistically based on, among other things, market conditions, tenant demand, and our evaluation of whether those phases will generate an appropriate financial return.
We continue to review acquisition opportunities in our primary markets that complement our portfolio and provide long-term growth opportunities. Initially, some of our acquisitions do not 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. We may 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, 2014, the leasable square feet in our properties was 94.7% occupied and 95.6% 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, 2014 and the comparison of 2014 and 2013, all or a portion of 78 properties were considered same-center and thirteen properties were considered redevelopment or expansion. For the year ended December 31, 2014, two properties were moved from same-center to redevelopment, one property was moved from redevelopment to same-center, and one property was moved from redevelopment as it was vacant and was demolished in 2014, compared to the designations as of December 31, 2013. For the year ended December 31, 2013 and the comparison of 2013 and 2012, all or a portion of 79 properties were considered same-center and eleven properties were considered redevelopment or expansion. For the year ended December 31, 2013, three properties were moved from acquisition to same-center and one property was moved from redevelopment to same-center compared to the designations as of December 31, 2012. 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, 2014 COMPARED TO YEAR ENDED DECEMBER 31, 2013
| Change | ||||||||||||||
| 2014 | 2013 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 666,322 | $ | 620,089 | $ | 46,233 | 7.5 | % | ||||||
| Other property income | 14,758 | 12,169 | 2,589 | 21.3 | % | |||||||||
| Mortgage interest income | 5,010 | 5,155 | (145 | ) | (2.8 | )% | ||||||||
| Total property revenue | 686,090 | 637,413 | 48,677 | 7.6 | % | |||||||||
| Rental expenses | 135,417 | 118,695 | 16,722 | 14.1 | % | |||||||||
| Real estate taxes | 76,506 | 71,759 | 4,747 | 6.6 | % | |||||||||
| Total property expenses | 211,923 | 190,454 | 21,469 | 11.3 | % | |||||||||
| Property operating income | 474,167 | 446,959 | 27,208 | 6.1 | % | |||||||||
| Other interest income | 94 | 433 | (339 | ) | (78.3 | )% | ||||||||
| Income from real estate partnerships | 1,243 | 1,498 | (255 | ) | (17.0 | )% | ||||||||
| Interest expense | (93,941 | ) | (104,977 | ) | 11,036 | (10.5 | )% | |||||||
| Early extinguishment of debt | (10,545 | ) | (13,304 | ) | 2,759 | (20.7 | )% | |||||||
| General and administrative expense | (32,316 | ) | (31,970 | ) | (346 | ) | 1.1 | % | ||||||
| Depreciation and amortization | (170,814 | ) | (160,828 | ) | (9,986 | ) | 6.2 | % | ||||||
| Total other, net | (306,279 | ) | (309,148 | ) | 2,869 | (0.9 | )% | |||||||
| Income from continuing operations | 167,888 | 137,811 | 30,077 | 21.8 | % | |||||||||
| Discontinued operations - income | — | 942 | (942 | ) | (100.0 | )% | ||||||||
| Discontinued operations - gain on sale of real estate | — | 23,861 | (23,861 | ) | (100.0 | )% | ||||||||
| Gain on sale of real estate | 4,401 | 4,994 | (593 | ) | (11.9 | )% | ||||||||
| Net income | 172,289 | 167,608 | 4,681 | 2.8 | % | |||||||||
| Net income attributable to noncontrolling interests | (7,754 | ) | (4,927 | ) | (2,827 | ) | 57.4 | % | ||||||
| Net income attributable to the Trust | $ | 164,535 | $ | 162,681 | $ | 1,854 | 1.1 | % |
Property Revenues
Total property revenue increased $48.7 million, or 7.6%, to $686.1 million in 2014 compared to $637.4 million in 2013. The percentage occupied at our shopping centers decreased to 94.7% at December 31, 2014 compared to 95.1% at December 31, 2013. 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 $46.2 million, or 7.5%, to $666.3 million in 2014 compared to $620.1 million in 2013 due primarily to the following:
| • | an increase of $17.7 million at same-center properties due primarily to higher rental rates of approximately $9.4 million and a $7.4 million increase in recovery income (largely the result of reimbursements for higher snow removal costs), |
| • | an increase of $16.6 million attributable to properties acquired in 2014 and 2013, |
| • | an increase of $8.0 million at redevelopment properties due primarily to the lease-up of our new 212 unit residential building at Santana Row and the net impact of other redevelopment properties, and |
| • | an increase of $6.4 million from Assembly Row and Pike &Rose as portions of both projects opened in 2014, |
partially offset by,
| • | a decrease of $1.9 million from Mid-Pike Plaza as the property was demolished in 2014 for the future development of Pike & Rose. |
Other Property Income
Other property income increased $2.6 million, or 21.3%, to $14.8 million in 2014 compared to $12.2 million in 2013. Included in other property income are items which, although recurring, inherently 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 $21.5 million, or 11.3%, to $211.9 million in 2014 compared to $190.5 million in 2013. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $16.7 million, or 14.1%, to $135.4 million in 2014 compared to $118.7 million in 2013. This increase is primarily due to the following:
| • | an increase of $5.6 million in repairs and maintenance expenses at same-center and redevelopment properties primarily due to higher snow removal costs, |
| • | an increase of $5.4 million related to Assembly Row and Pike & Rose, as portions of these projects opened in 2014, |
| • | an increase of $3.2 million related to properties acquired in 2014 and 2013, |
| • | an increase of $1.6 million in bad debt expense at same-center properties, and |
| • | an increase of $0.8 million in utilities at our same-center and redevelopment properties primarily due to higher electric costs and usage as a result of the harsh winter. |
As a result of the changes in rental income and rental expenses as discussed above, rental expenses as a percentage of rental income plus other property income increased to 19.9% for the year ended December 31, 2014 from 18.8% for the year ended December 31, 2013.
Real Estate Taxes
Real estate tax expense increased $4.7 million, or 6.6% to $76.5 million in 2014 compared to $71.8 million in 2013 due primarily to higher assessments and lower refunds at our same-center and redevelopment properties and real estate taxes on properties acquired in 2014 and 2013.
Property Operating Income
Property operating income increased $27.2 million, or 6.1%, to $474.2 million in 2014 compared to $447.0 million in 2013. This increase is primarily due to growth in earnings at same-center properties, properties acquired in 2014 and 2013, and earnings from our redevelopment properties, partially offset by a decline in earnings at Mid-Pike Plaza, which was demolished in 2014.
Other
Interest Expense
Interest expense decreased $11.0 million, or 10.5%, to $93.9 million in 2014 compared to $105.0 million in 2013. This decrease is due primarily to the following:
| • | a decrease of $12.0 million due to a lower overall weighted average borrowing rate, and |
| • | an increase of $4.8 million in capitalized interest due primarily to our ongoing development projects at Assembly Row and Pike & Rose, |
partially offset by
| • | an increase of $5.6 million due to higher borrowings. |
Gross interest costs were $114.9 million and $121.2 million in 2014 and 2013, respectively. Capitalized interest was $21.0 million and $16.2 million in 2014 and 2013, respectively.
Early Extinguishment of Debt
The $10.5 million early extinguishment of debt in 2014 relates to the make-whole premium paid as part of the early redemption of our 5.65% senior notes, the prepayment premium on our East Bay Bridge mortgage loan, and the related write-off of unamortized debt fees and mortgage premium balance.
The $13.3 million early extinguishment of debt in 2013 relates to the make-whole premiums paid as part of the early redemption of our 5.40% senior notes and 5.95% senior notes, the prepayment premium on our 7.5% mortgage loans, and the related write-off of unamortized debt fees.
Depreciation and Amortization
Depreciation and amortization expense increased $10.0 million, or 6.2%, to $170.8 million in 2014 from $160.8 million in 2013. This increase is due primarily to 2014 acquisitions and redevelopment projects placed in service in 2014, partially offset by accelerated depreciation in 2013 due to the change in use of a redevelopment property.
Discontinued Operations— Income
Income from discontinued operations represents the operating income of properties that were disposed prior to January 1, 2014, which were required to be reported separately from results of ongoing operations. The reported operating income of $0.9 million for 2013 primarily represents the operating income for the period during which we owned properties sold in 2013.
Discontinued Operations—Gain on Sale of Real Estate
The $23.9 million gain on sale of real estate from discontinued operations for 2013 is due to the sale of the fee interest in our final building at Fifth Avenue on July 22, 2013 and the sale of the fee interest in our building in Forest Hills on September 10, 2013.
Gain on Sale of Real Estate
The $4.4 million gain on sale of real estate for 2014 is due to our portion of the gain resulting from the Partnership's sale of the fee interest in Pleasant Shops in Weymouth, Massachusetts.
The $5.0 million gain on sale of real estate for 2013 is primarily due to the sale of the fee interest in the land under an office building at our Village of Shirlington property in Arlington, Virginia, that was subject to a long term ground lease. The ground lease included an option for the tenant to purchase the fee interest.
YEAR ENDED DECEMBER 31, 2013 COMPARED TO YEAR ENDED DECEMBER 31, 2012
| Change | ||||||||||||||
| 2013 | 2012 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 620,089 | $ | 580,114 | $ | 39,975 | 6.9 | % | ||||||
| Other property income | 12,169 | 20,211 | (8,042 | ) | (39.8 | )% | ||||||||
| Mortgage interest income | 5,155 | 5,466 | (311 | ) | (5.7 | )% | ||||||||
| Total property revenue | 637,413 | 605,791 | 31,622 | 5.2 | % | |||||||||
| Rental expenses | 118,695 | 112,616 | 6,079 | 5.4 | % | |||||||||
| Real estate taxes | 71,759 | 66,454 | 5,305 | 8.0 | % | |||||||||
| Total property expenses | 190,454 | 179,070 | 11,384 | 6.4 | % | |||||||||
| Property operating income | 446,959 | 426,721 | 20,238 | 4.7 | % | |||||||||
| Other interest income | 433 | 689 | (256 | ) | (37.2 | )% | ||||||||
| Income from real estate partnership | 1,498 | 1,757 | (259 | ) | (14.7 | )% | ||||||||
| Interest expense | (104,977 | ) | (113,336 | ) | 8,359 | (7.4 | )% | |||||||
| Early extinguishment of debt | (13,304 | ) | — | (13,304 | ) | 100.0 | % | |||||||
| General and administrative expense | (31,970 | ) | (31,158 | ) | (812 | ) | 2.6 | % | ||||||
| Depreciation and amortization | (160,828 | ) | (141,701 | ) | (19,127 | ) | 13.5 | % | ||||||
| Total other, net | (309,148 | ) | (283,749 | ) | (25,399 | ) | 9.0 | % | ||||||
| Income from continuing operations | 137,811 | 142,972 | (5,161 | ) | (3.6 | )% | ||||||||
| Discontinued operations - income | 942 | 1,400 | (458 | ) | (32.7 | )% | ||||||||
| Discontinued operations - gain on sale of real estate | 23,861 | — | 23,861 | 100.0 | % | |||||||||
| Gain on sale of real estate | 4,994 | 11,860 | (6,866 | ) | (57.9 | )% | ||||||||
| Net income | 167,608 | 156,232 | 11,376 | 7.3 | % | |||||||||
| Net income attributable to noncontrolling interests | (4,927 | ) | (4,307 | ) | (620 | ) | 14.4 | % | ||||||
| Net income attributable to the Trust | $ | 162,681 | $ | 151,925 | $ | 10,756 | 7.1 | % |
Property Revenues
Total property revenue increased $31.6 million, or 5.2%, to $637.4 million in 2013 compared to $605.8 million in 2012. The percentage occupied at our shopping centers increased to 95.1% at December 31, 2013 compared to 94.9% at December 31, 2012. 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 $40.0 million, or 6.9%, to $620.1 million in 2013 compared to $580.1 million in 2012 due primarily to the following:
| • | an increase of $23.3 million at same-center properties due primarily to higher rental rates of approximately $11.6 million, higher occupancy of approximately $3.9 million, and an increase in recovery income due to higher recoverable expenses, |
| • | an increase of $14.0 million attributable to properties acquired in 2013 and 2012, and |
| • | an increase of $2.0 million at redevelopment properties due primarily to the lease-up and stabilization of certain of our redevelopment properties partially offset by lower income from Mid-Pike Plaza as the property was prepared for the development of Pike & Rose. |
Other Property Income
Other property income decreased $8.0 million, or 39.8%, to $12.2 million in 2013 compared to $20.2 million in 2012. Included in other property income are items which, although recurring, inherently tend to fluctuate more than rental income from period to period, such as lease termination fees. This decrease is primarily due to lower lease termination fees at same-center properties, largely from a $6.0 million lease termination fee received in 2012 from an anchor tenant at Ellisburg Shopping Center.
Property Expenses
Total property expenses increased $11.4 million, or 6.4%, to $190.5 million in 2013 compared to $179.1 million in 2012. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $6.1 million, or 5.4%, to $118.7 million in 2013 compared to $112.6 million in 2012. This increase is primarily due to the following:
| • | an increase of $4.0 million in repairs and maintenance expenses at same-center and redevelopment properties primarily due to snow removal costs, |
| • | an increase of $2.1 million related to properties acquired in 2013 and 2012, |
| • | an increase of $1.3 million in marketing expenses primarily at our Assembly Row and Pike & Rose projects, |
partially offset by
| • | a decrease of $1.7 million in bad debt expense. |
Rental expenses as a percentage of rental income plus other property income was 18.8% for the years ended December 31, 2013 and 2012.
Real Estate Taxes
Real estate tax expense increased $5.3 million, or 8.0% to $71.8 million in 2013 compared to $66.5 million in 2012 due primarily to net higher assessments at same-center properties and properties acquired in 2013 and 2012.
Property Operating Income
Property operating income increased $20.2 million, or 4.7%, to $447.0 million in 2013 compared to $426.7 million in 2012. This increase is primarily due to growth in earnings at same-center properties, properties acquired in 2013 and 2012, and redevelopment properties.
Other
Interest Expense
Interest expense decreased $8.4 million, or 7.4%, to $105.0 million in 2013 compared to $113.3 million in 2012. This decrease is due primarily to the following:
| • | a decrease of $11.6 million due to a lower overall weighted average borrowing rate, and |
| • | an increase of $6.1 million in capitalized interest, |
partially offset by
| • | an increase of $9.3 million due to higher borrowings. |
Gross interest costs were $121.2 million and $123.4 million in 2013 and 2012, respectively. Capitalized interest was $16.2 million and $10.1 million in 2013 and 2012, respectively.
Early Extinguishment of Debt
The $13.3 million early extinguishment of debt in 2013 relates to the make-whole premiums paid as part of the early redemption of our 5.40% senior notes and 5.95% senior notes, the prepayment premium on our 7.5% mortgage loans, and the related write-off of unamortized debt fees.
General and Administrative Expense
General and administrative expense increased $0.8 million, or 2.6%, to $32.0 million in 2013 from $31.2 million in 2012. This increase is due primarily to an increase in employee related costs and transaction costs partially offset by costs incurred in 2012 related to the CFO transition.
Depreciation and Amortization
Depreciation and amortization expense increased $19.1 million, or 13.5%, to $160.8 million in 2013 from $141.7 million in 2012. This increase is due primarily to 2013 and 2012 acquisitions and accelerated depreciation due to the change in use of a redevelopment property.
Discontinued Operations— Income
Income from discontinued operations represents the operating income of properties that were disposed prior to January 1, 2014, which were required to be reported separately from results of ongoing operations. The reported operating income of $0.9 million and $1.4 million for 2013 and 2012, respectively, primarily represents the operating income for the period during which we owned properties sold in 2013.
Discontinued Operations—Gain on Sale of Real Estate
The $23.9 million gain on sale of real estate from discontinued operations for 2013 is due to the sale of the fee interest in our final building at Fifth Avenue on July 22, 2013 and the sale of the fee interest in our building in Forest Hills on September 10, 2013.
Gain on Sale of Real Estate
The $5.0 million gain on sale of real estate for 2013 is primarily due to the sale of the fee interest in the land under an office building at our Village of Shirlington property in Arlington, Virginia, that was subject to a long term ground lease. The ground lease included an option for the tenant to purchase the fee interest.
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 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.
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.
At December 31, 2014, we had $48.0 million of cash and cash equivalents and no borrowings outstanding on our $600.0 million revolving credit facility that matures on April 21, 2017, subject to a one-year extension at our option. In addition, we have an option (subject to bank approval) to increase the credit facility through an accordion feature to $1.0 billion. Our $275.0 million unsecured term loan that matures on November 21, 2018, subject to a one-year extension at our option, 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, 2014, we had the capacity to issue up to $84.1 million in common shares under our ATM equity program.
For 2014, the maximum amount of borrowings outstanding under our revolving credit facility was $79.5 million, the weighted average amount of borrowings outstanding was $12.5 million and the weighted average interest rate, before amortization of debt fees, was 1.07%. In November 2014, we accessed the public debt markets issuing $250 million of 30-year unsecured senior notes which bear interest at 4.5%. The opportunistic issuance resulted in net proceeds of $244.6 million which were used to address $186 million of our 2016 debt maturities.
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 and capital expenditures.
Our overall capital requirements during 2015 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 2015 which is the result of the continued development at both Assembly Row and Pike & Rose with openings of portions of both projects in 2015, the commencement of construction on Phase II of Pike & Rose, and the current phase of Santana Row. 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, | |||||||
| 2014 | 2013 | ||||||
| (In thousands) | |||||||
| Cash provided by operating activities | $ | 346,130 | $ | 314,498 | |||
| Cash used in investing activities | (396,150 | ) | (345,198 | ) | |||
| Cash provided by financing activities | 9,044 | 82,639 | |||||
| (Decrease) increase in cash and cash equivalents | (40,976 | ) | 51,939 | ||||
| Cash and cash equivalents, beginning of year | 88,927 | 36,988 | |||||
| Cash and cash equivalents, end of year | $ | 47,951 | $ | 88,927 |
Net cash provided by operating activities increased $31.6 million to $346.1 million during 2014 from $314.5 million during 2013. The increase was primarily attributable to higher net income before certain non-cash items.
Net cash used in investing activities increased $51.0 million to $396.2 million during 2014 from $345.2 million during 2013. The increase was primarily attributable to:
| • | $93.7 million increase in capital investments and leasing costs in 2014 primarily related to our development projects at Assembly Row and Pike & Rose, |
| • | $42.9 million in proceeds from the sale of real estate in 2013, and |
| • | $6.7 million contribution to our real estate partnership to repay the mortgage loans of two of its properties, |
partially offset by
| • | $78.1 million decrease in acquisitions of real estate, |
| • | $10.4 million in distributions from our real estate partnership from the sale of Pleasant Shops in July 2014, and |
| • | $3.6 million received from the payoff of a mortgage loan receivable in July 2014. |
Net cash provided by financing activities decreased $73.6 million to $9.0 million during 2014 from $82.6 million in 2013. The decrease was primarily attributable to:
| • | $319.8 million decrease from net proceeds on senior note issuances due to $244.6 million from our 4.50% senior notes issued in November 2014 as compared to $564.4 million from the issuance of our 2.75% senior notes in May 2013 and our 3.95% senior notes in December 2013, and |
| • | $22.2 million increase in dividends paid to shareholders due to an increase in the dividend rate and increased number of shares outstanding, |
partially offset by
| • | $159.1 million decrease due to the redemption of $125.0 million of senior notes in 2014, as compared to the redemption of $285.0 million of senior notes in 2013, |
| • | $79.3 million decrease in repayment of mortgages, capital leases and notes payable due to the payoff of two mortgages totaling $84.3 million in 2014 compared to the repayment of six mortgages totaling $161.7 million in 2013, and |
| • | $29.6 million increase in net proceeds from the issuance of common shares due primarily to the sale of 1.8 million shares under our ATM equity program at a weighted average price of $122.09 during 2014 compared to 1.7 million shares at a weighted average price of $108.01 during 2013. |
Contractual Commitments
The following table provides a summary of our fixed, noncancelable obligations as of December 31, 2014:
| 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) | $ | 3,181,151 | $ | 259,064 | $ | 602,388 | $ | 437,453 | $ | 1,882,246 | |||||||||
| Fixed rate debt - unconsolidated real estate partnership (principal and interest)(2) | 11,288 | 614 | 10,674 | — | — | ||||||||||||||
| Capital lease obligations (principal and interest) | 189,182 | 5,787 | 11,585 | 11,600 | 160,210 | ||||||||||||||
| Variable rate debt (principal only)(3) | 9,400 | — | 9,400 | — | — | ||||||||||||||
| Operating leases | 165,763 | 1,478 | 4,910 | 5,164 | 154,211 | ||||||||||||||
| Real estate commitments(4)(5) | 76,332 | 8,832 | — | — | 67,500 | ||||||||||||||
| Development, redevelopment, and capital improvement obligations | 232,276 | 181,065 | 50,948 | 263 | — | ||||||||||||||
| Contractual operating obligations | 24,291 | 14,916 | 8,375 | 940 | 60 | ||||||||||||||
| Total contractual obligations | $ | 3,889,683 | $ | 471,756 | $ | 698,280 | $ | 455,420 | $ | 2,264,227 |
| (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 0.06% at December 31, 2014 and our revolving credit facility, which currently has no outstanding balance and bears interest at LIBOR plus 0.90%. |
| (4) | A master lease on Melville Mall includes a fixed price put option requiring us to purchase the property for $5.0 million. This obligation is included in real estate commitments. |
| (5) | Includes a $9 million liability to one of the noncontrolling interest holders in The Grove at Shrewsbury which is expected to be settled in 2015. |
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, 2014, our estimated liability upon exercise of the put option would range from approximately $72 million to $76 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, 2014, a total of 917,255 operating partnership units are outstanding.
(d) 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. Based on management’s current estimate of fair market value as of December 31, 2014, our estimated maximum liability upon exercise of the put option would range from approximately $9 million to $10 million.
(e) Two of the members in Plaza El Segundo have the right to require us to purchase their 10.0% and 11.8% ownership interests 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. Based on management’s current estimate of fair market value as of December 31, 2014, our estimated maximum liability upon exercise of the put option would range from approximately $18 million to $21 million. 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) Effective January 1, 2017, the other member in The Grove at Shrewsbury and Brook 35 has the right to require us to purchase all of its approximately 4.8% interest in The Grove at Shrewsbury and approximately 8.8% interest in Brook 35 at the interests' then-current fair market value.
(g) At December 31, 2014, we had letters of credit outstanding of approximately $13.0 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, 2014, the Partnership owned six 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, 2014, our investment in the Partnership was $32.4 million and the Partnership had approximately $34.4 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, 2014 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, 2014:
| Description of Debt | Original Debt Issued | Principal Balance as of December 31, 2014 | Stated Interest Rate as of December 31, 2014 | Maturity Date | |||||||
| (Dollars in thousands) | |||||||||||
| Mortgages payable (1) | |||||||||||
| Secured fixed rate | |||||||||||
| Barracks Road | 44,300 | $ | 35,985 | 7.95 | % | November 1, 2015 | |||||
| Hauppauge | 16,700 | 13,566 | 7.95 | % | November 1, 2015 | ||||||
| Lawrence Park | 31,400 | 25,507 | 7.95 | % | November 1, 2015 | ||||||
| Wildwood | 27,600 | 22,420 | 7.95 | % | November 1, 2015 | ||||||
| Wynnewood | 32,000 | 25,994 | 7.95 | % | November 1, 2015 | ||||||
| Brick Plaza | 33,000 | 26,415 | 7.42 | % | November 1, 2015 | ||||||
| Plaza El Segundo | Acquired | 175,000 | 6.33 | % | August 5, 2017 | ||||||
| The Grove at Shrewsbury (East) | Acquired | 44,519 | 5.82 | % | October 1, 2017 | ||||||
| The Grove at Shrewsbury (West) | Acquired | 11,242 | 6.38 | % | March 1, 2018 | ||||||
| Rollingwood Apartments | 24,050 | 22,130 | 5.54 | % | May 1, 2019 | ||||||
| 29th Place | Acquired | 4,941 | 5.91 | % | January 31, 2021 | ||||||
| THE AVENUE at White Marsh | 52,705 | 52,705 | 3.35 | % | January 1, 2022 | ||||||
| Montrose Crossing | 80,000 | 75,867 | 4.20 | % | January 10, 2022 | ||||||
| Brook 35 | 11,500 | 11,500 | 4.65 | % | July 1, 2029 | ||||||
| Chelsea | Acquired | 7,074 | 5.36 | % | January 15, 2031 | ||||||
| Subtotal | 554,865 | ||||||||||
| Net unamortized premium | 8,833 | ||||||||||
| Total mortgages payable | 563,698 | ||||||||||
| Notes payable | |||||||||||
| Unsecured fixed rate | |||||||||||
| Term Loan (2) | 275,000 | 275,000 | LIBOR + 0.90% | November 21, 2018 | |||||||
| Various | 7,239 | 6,119 | 11.31 | % | Various through 2028 | ||||||
| Unsecured variable rate | |||||||||||
| Escondido (municipal bonds) (3) | 9,400 | 9,400 | 0.06 | % | October 1, 2016 | ||||||
| Revolving credit facility (4) | 600,000 | — | LIBOR + 0.90% | April 21, 2017 | |||||||
| Total notes payable | 290,519 | ||||||||||
| Senior notes and debentures | |||||||||||
| Unsecured fixed rate | |||||||||||
| 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 | ||||||
| 2.75% notes | 275,000 | 275,000 | 2.75 | % | June 1, 2023 | ||||||
| 3.95% notes | 300,000 | 300,000 | 3.95 | % | January 15, 2024 | ||||||
| 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 | ||||||
| 4.50% notes | 250,000 | 250,000 | 4.50 | % | December 1, 2044 | ||||||
| Subtotal | 1,494,200 | ||||||||||
| Net unamortized discount | (10,387 | ) | |||||||||
| Total senior notes and debentures | 1,483,813 | ||||||||||
| Capital lease obligations | |||||||||||
| Various | 71,647 | Various | Various through 2106 | ||||||||
| Total debt and capital lease obligations | $ | 2,409,677 |
| 1) | Mortgages payable do not include our 30% share ($10.3 million) of the $34.4 million debt of the partnership with a discretionary fund created and advised by ING Clarion Partners. |
| 2) | We entered into two interest rate swap agreements that fix the LIBOR portion of the interest rate on the term loan at 1.72%. The spread on the term loan was reduced from 130 basis points to 90 basis points on August 28, 2014 resulting in a fixed rate of 2.62%. |
| 3) | 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. |
| 4) | The maximum amount drawn under our revolving credit facility during 2014 was $79.5 million and the weighted average effective interest rate on borrowings under our revolving credit facility, before amortization of debt fees, was 1.07%. |
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, 2014, 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, 2014:
| Unsecured | Secured | Capital Lease | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| 2015 | $ | 369 | $ | 153,395 | $ | 31 | $ | 153,795 | ||||||||
| 2016 | 9,806 | 3,774 | 30 | 13,610 | ||||||||||||
| 2017 | 200,451 | (1) | 220,438 | 34 | 420,923 | |||||||||||
| 2018 | 275,500 | 13,326 | 37 | 288,863 | ||||||||||||
| 2019 | 553 | 22,731 | 42 | 23,326 | ||||||||||||
| Thereafter | 1,298,040 | 141,201 | 71,473 | 1,510,714 | ||||||||||||
| $ | 1,784,719 | $ | 554,865 | $ | 71,647 | $ | 2,411,231 | (2) |
| 1) | Our $600.0 million revolving credit facility matures on April 21, 2017, subject to a one-year extension at our option. As of December 31, 2014, there was no balance outstanding 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 and senior notes as of December 31, 2014. |
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 (loss) income which is included in accumulated other comprehensive loss on our consolidated balance sheet and our consolidated statement 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.
As of December 31, 2014, we are party to two interest rate swap agreements that effectively fixed the rate on the term loan at 2.62%. Both swaps were designated and qualified as cash flow hedges and were recorded at fair value. Hedge ineffectiveness has not impacted earnings in 2014, 2013 and 2012, and we do not anticipate it will have a significant effect in the future.
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.
In addition to FFO, we have also included FFO excluding the "early extinguishment of debt" charges in 2014 and 2013 which relate to the early redemption of our 5.65% senior notes and East Bay Bridge mortgage loan in 2014, and our 5.40% senior notes, 5.95% senior notes, and 7.50% mortgages loans in 2013. We believe the unusual nature of these charges, being make-whole payments on the remaining principal and interest on the redeemed notes/mortgages, is worthy of separate evaluation and consequently have provided both relevant metrics.
The reconciliation of net income to FFO available for common shareholders and to FFO available for common shareholders excluding early extinguishment of debt is as follows:
| Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2012 | |||||||||
| (In thousands, except per share data) | |||||||||||
| Net income | $ | 172,289 | $ | 167,608 | $ | 156,232 | |||||
| Net income attributable to noncontrolling interests | (7,754 | ) | (4,927 | ) | (4,307 | ) | |||||
| Gain on sale of real estate | (4,401 | ) | (28,855 | ) | (11,860 | ) | |||||
| Depreciation and amortization of real estate assets | 152,505 | 144,873 | 125,611 | ||||||||
| Amortization of initial direct costs of leases | 12,391 | 10,694 | 10,935 | ||||||||
| Depreciation of joint venture real estate assets | 1,555 | 1,504 | 1,513 | ||||||||
| Funds from operations | 326,585 | 290,897 | 278,124 | ||||||||
| Dividends on preferred shares | (541 | ) | (541 | ) | (541 | ) | |||||
| Income attributable to operating partnership units | 3,027 | 888 | 943 | ||||||||
| Income attributable to unvested shares | (1,474 | ) | (1,306 | ) | (1,289 | ) | |||||
| Funds from operations available for common shareholders | 327,597 | 289,938 | 277,237 | ||||||||
| Early extinguishment of debt, net of allocation to unvested shares | 10,498 | 13,244 | — | ||||||||
| Funds from operations available for common shareholders excluding early extinguishment of debt | $ | 338,095 | $ | 303,182 | $ | 277,237 | |||||
| Weighted average number of common shares, diluted (1) | 68,410 | 65,778 | 64,389 | ||||||||
| Funds from operations available for common shareholders, per diluted share | $ | 4.79 | $ | 4.41 | $ | 4.31 | |||||
| Funds from operations available for common shareholders excluding early extinguishment of debt, per diluted share | $ | 4.94 | $ | 4.61 | $ | 4.31 |
| (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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