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, California, and South Florida. As of December 31, 2016, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use properties which are operated as 96 predominantly retail real estate projects comprising approximately 22.6 million square feet. In total, the real estate projects were 94.4% leased and 93.3% occupied at December 31, 2016. We have paid quarterly dividends to our shareholders continuously since our founding in 1962 and have increased our dividends per common share for 49 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, 2016 and 2015, our allowance for doubtful accounts was $11.9 million and $11.7 million, respectively. Historically, we have recognized bad debt expense between 0.3% and 1.3% of rental income and it was 0.3% in 2016. 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 $7.9 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, 2016 and 2015, accounts receivable includes approximately $80.6 million and $72.7 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 calculate 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 $420 million and $9 million, respectively, for 2016 and $232 million and $8 million, respectively, for 2015. We capitalized external and internal costs related to other property improvements of $61 million and $3 million, respectively, for 2016 and $42 million and $2 million, respectively, for 2015. We capitalized external and internal costs related to leasing activities of $13 million and $6 million, respectively, for 2016 and $17 million and $6 million, respectively, for 2015. The amount of capitalized internal costs for salaries and related benefits for development and redevelopment activities, other property improvements, and leasing activities were $8 million, $2 million, and $6 million, for 2016 and $7 million, $1 million, and $6 million for 2015. Total capitalized costs were $511 million and $307 million for 2016 and 2015, 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, previous experience in our portfolio, 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.
2016 Property Acquisitions and Disposition
On January 13, 2016, we acquired our partner's 70% interest in our joint venture arrangement (the "Partnership") with affiliates of a discretionary fund created and advised by Clarion Partners ("Clarion") for $153.7 million, which included the payment of $130 million of cash and the assumption of mortgage loans totaling $34.4 million. As a result of the transaction, we gained control of the six underlying properties, and effective January 13, 2016, have consolidated the properties. We also recognized a gain on acquisition of the controlling interest of $25.7 million related to the difference between the carrying value and fair value of the previously held equity interest. Approximately $7.3 million and $4.9 million of net assets acquired were allocated to other assets for "above market leases," and other liabilities for "below market leases," respectively. We incurred $0.2 million of acquisition costs, of which $0.1 million were incurred in 2016, and included in "general and administrative expenses" on the consolidated statements of comprehensive income in 2016 and 2015.
On May 12, 2016, an unconsolidated joint venture that we hold an interest in sold a building in Coconut Grove, Florida. Our share of the gain, net of noncontrolling interests, was $0.5 million.
On July 26, 2016, we acquired an additional building in the Coconut Grove neighborhood of Miami, Florida for $5.9 million through our CocoWalk LLC entity. We incurred $0.2 million in acquisition costs which are included in "general and administrative expenses" in 2016.
On November 7, 2016, we acquired a building adjacent to our Barcroft Plaza property for $5.3 million, and incurred $0.1 million of acquisition costs which are included in "general and administrative expenses" in 2016.
Subsequent Event - 2017 Property Acquisition
On February 1, 2017, we acquired a leasehold interest in Hastings Ranch Plaza, a 274,000 square foot shopping center in Pasadena, California for $29.5 million.
2016 Significant Debt and Equity Transactions
On January 13, 2016, in connection with the acquisition of our partner's 70% interest in our unconsolidated real estate partnership, we assumed interest only mortgage loans with a face amount of $34.4 million and a fair value of $34.7 million. These mortgage loans had a weighted average interest rate of 5.95% and were repaid at par on April 1, 2016.
On March 7, 2016, we issued 1.0 million common shares at $149.43 per share, in an underwritten public offering, for cash proceeds of $149.3 million, net of expenses.
On April 20, 2016, we upsized our $600.0 million revolving credit facility to $800.0 million and extended the maturity date to April 20, 2020, subject to two six-month extensions at our option. Under the amended credit facility, the spread over LIBOR is 82.5 basis points based on our current credit rating. In addition, we have an option (subject to bank approval) to increase the credit facility through an accordion feature to $1.5 billion.
On July 12, 2016, we issued $250.0 million of fixed rate senior unsecured notes that mature on August 1, 2046 and bear interest at 3.625%. The notes were offered at 97.756% of the principal amount with a yield to maturity of 3.75%. The net proceeds from this note offering after issuance discounts, underwriting fees, and other costs were $241.8 million.
On October 1, 2016 we repaid the $9.4 million Escondido municipal bonds at par.
On November 4, 2016 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 $400.0 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, 2016, we issued 206,400 common shares under our ATM equity program at a weighted average price per
share of $141.16 for net cash proceeds of $28.7 million and paid $0.3 million in commissions and $0.1 million in additional offering expenses related to the sales of these common shares. For the year ended December 31, 2016, we issued 1,156,571 common shares under our ATM equity program at a weighted average price per share of $152.92 for net cash proceeds of $174.8 million and paid $1.8 million in commissions and $0.2 million in additional offering expenses related to the sales of these common shares. As of December 31, 2016, we had the capacity to issue up to $370.9 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 continued to see strong levels of interest from prospective tenants for our retail spaces; however, the time it takes to complete new lease deals is longer, as tenants have become more selective and more deliberate in their decision-making process. We have also experienced extended periods of time for some government agencies to process permits and inspections further delaying rent commencement on newly leased spaces. Additionally, we have seen an overall decrease in number of tenants available to fill anchor spaces. We believe the locations of our centers and diverse tenant base partially mitigates any negative changes 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, 2016, 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. We currently have redevelopment projects underway with a projected cost of approximately $188 million that we expect to stabilize in the next several years.
We continue our ongoing redevelopment efforts at Santana Row. In 2016, we completed and opened our $113 million six story building with 234,500 square feet of office space and 670 parking spaces that was pre-leased to Splunk Inc. We are also proceeding with an eight story 284,000 square foot office building which will include 29,000 square feet of retail space and 1,300 parking spaces. The building is expected to cost between $205 and $215 million and to deliver in 2019. After current phases, we have approximately 4 acres remaining for further redevelopment and entitlements in place for an additional 395 residential units and 321,000 square feet of commercial space. Additionally, we control 12 acres of land adjacent to Santana Row.
We continue to invest in the development at Assembly Row which is a long-term multi-phased mixed-use 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, 2016 is approximately $541 million. The project currently has zoning entitlements to build 3.4 million square feet of commercial-use buildings, 1,840 residential units, and a 170 room hotel. The first phase consists of approximately 331,000 square feet of retail space and 98,000 square feet of office space (both owned by the Trust) and 445 residential units owned by AvalonBay Communities (AvalonBay Communities has exercised their purchase option for the land related to the residential buildings, which is expected to close in 2017). The Massachusetts Bay Transit Authority (MBTA) constructed the new orange line T-Stop at the property, which opened in September 2014. The retail and office space in Phase I are fully delivered and are 100% leased. Total costs for Phase I of Assembly Row are $196 million.
We are also proceeding with development of Phase II of Assembly Row which will include 161,000 square feet of retail space, a 159 room boutique hotel and 447 residential units. The hotel will be owned and operated by a joint venture in which we are a partner. Total expected costs range from $270 million to $285 million and delivery is expected in 2017/2018. Phase II will also include 122 for-sale condominium units with an expected total cost of $70 million to $75 million. Additionally, as part of the second phase, we entered into a ground lease agreement with Partners HealthCare to bring 741,500 square feet of office space to Assembly Row. The ground lease agreement includes a purchase option, which was exercised and is expected to close in 2017. Partners HealthCare commenced construction on this new building in September 2014 and during the second quarter of 2016, started relocating its employees to Assembly Row.
We invested $153 million in Assembly Row in 2016 and expect to invest between $140 million and $165 million in Assembly Row in 2017, net of public funding.
Our Pike & Rose project in North Bethesda, MD, a long-term multi-phased mixed-use development 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 includes 493 residential units, 159,000 square feet of retail space and 80,000 square feet of office space. Phase I reached stabilized physical occupancy in the fourth quarter of 2016. Total costs for Phase I of Pike & Rose range from $265 million to $270 million.
Additionally, we are proceeding with development of Phase II of Pike & Rose. Phase II will include approximately 216,000 square feet of retail space, a 177 room select-service hotel and 272 residential units. Total expected costs range from $200 million to $207 million and delivery is expected in 2017/2018. The hotel will be owned and operated by a joint venture in which we are a partner. Phase II will also include 99 for-sale condominium units with an expected cost of $53 million to $58 million.
We invested $100 million in Pike & Rose in 2016 and expect to invest between $105 million and $130 million in Pike & Rose in 2017.
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, 2016, the leasable square feet in our properties was 93.3% occupied and 94.4% 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. For the year ended December 31, 2016 and the comparison of 2016 and 2015, all or a portion of 76 properties were considered same-center and 17 properties were considered redevelopment or expansion. For the year ended December 31, 2016, three properties or portions of properties were moved from same-center to redevelopment and one property was moved from redevelopment to same-center, compared to the designations as of December 31, 2015. For the year ended December 31, 2015 and the comparison of 2015 and 2014, all or a portion of 77 properties were considered same-center and 14 properties were considered redevelopment or expansion. For the year ended December 31, 2015, three properties were moved from acquisition to same-center, three properties were moved from same-center to redevelopment, two properties were removed from same-center as they were sold during 2015, and one property was moved from redevelopment to same-center, compared to the designations as of December 31, 2014. 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, 2016 COMPARED TO YEAR ENDED DECEMBER 31, 2015
| Change | ||||||||||||||
| 2016 | 2015 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 786,583 | $ | 727,812 | $ | 58,771 | 8.1 | % | ||||||
| Other property income | 11,015 | 11,810 | (795 | ) | (6.7 | )% | ||||||||
| Mortgage interest income | 3,993 | 4,390 | (397 | ) | (9.0 | )% | ||||||||
| Total property revenue | 801,591 | 744,012 | 57,579 | 7.7 | % | |||||||||
| Rental expenses | 158,326 | 147,593 | 10,733 | 7.3 | % | |||||||||
| Real estate taxes | 95,286 | 85,824 | 9,462 | 11.0 | % | |||||||||
| Total property expenses | 253,612 | 233,417 | 20,195 | 8.7 | % | |||||||||
| Property operating income (1) | 547,979 | 510,595 | 37,384 | 7.3 | % | |||||||||
| General and administrative expense | (33,399 | ) | (35,645 | ) | 2,246 | (6.3 | )% | |||||||
| Depreciation and amortization | (193,585 | ) | (174,796 | ) | (18,789 | ) | 10.7 | % | ||||||
| Operating income | 320,995 | 300,154 | 20,841 | 6.9 | % | |||||||||
| Other interest income | 374 | 149 | 225 | 151.0 | % | |||||||||
| Income from real estate partnerships | 50 | 1,416 | (1,366 | ) | (96.5 | )% | ||||||||
| Interest expense | (94,994 | ) | (92,553 | ) | (2,441 | ) | 2.6 | % | ||||||
| Early extinguishment of debt | — | (19,072 | ) | 19,072 | (100.0 | )% | ||||||||
| Total other, net | (94,570 | ) | (110,060 | ) | 15,490 | (14.1 | )% | |||||||
| Income from continuing operations | 226,425 | 190,094 | 36,331 | 19.1 | % | |||||||||
| Gain on sale of real estate and change in control of interests | 32,458 | 28,330 | 4,128 | 14.6 | % | |||||||||
| Net income | 258,883 | 218,424 | 40,459 | 18.5 | % | |||||||||
| Net income attributable to noncontrolling interests | (8,973 | ) | (8,205 | ) | (768 | ) | 9.4 | % | ||||||
| Net income attributable to the Trust | $ | 249,910 | $ | 210,219 | $ | 39,691 | 18.9 | % |
(1) Property operating income is a non-GAAP financial measure. See Item 6. Selected Financial Data for further discussion.
Property Revenues
Total property revenue increased $57.6 million, or 7.7%, to $801.6 million in 2016 compared to $744.0 million in 2015. The percentage occupied at our shopping centers decreased to 93.3% at December 31, 2016 compared to 93.5% at December 31, 2015. 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 $58.8 million, or 8.1%, to $786.6 million in 2016 compared to $727.8 million in 2015 due primarily to the following:
| • | an increase of $16.9 million attributable to properties acquired in 2015 and 2016, |
| • | an increase of $15.3 million from the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, |
| • | an increase of $11.7 million from Assembly Row and Pike & Rose as portions of both projects opened in 2015 and early 2016, |
| • | an increase of $10.6 million at redevelopment properties due primarily to the lease-up of The Point at Plaza El Segundo, as well as six of our other retail redevelopments, and the opening of the new office building at Santana Row, partially offset by lower occupancy as we start redeveloping centers, and |
| • | an increase of $9.5 million at same-center properties due primarily to higher rental rates of approximately $12.8 million, higher recoveries of $1.8 million primarily the net result of higher real estate tax expense offset by lower snow removal expense, partially offset by lower average occupancy of approximately $4.7 million, |
partially offset by,
| • | a decrease of $4.8 million due to the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively. |
Other Property Income
Other property income decreased $0.8 million, or 6.7%, to $11.0 million in 2016 compared to $11.8 million in 2015. The decrease is primarily due to a decrease in fee income as we no longer earn fees on the former Clarion joint venture properties.
Property Expenses
Total property expenses increased $20.2 million, or 8.7%, to $253.6 million in 2016 compared to $233.4 million in 2015. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $10.7 million, or 7.3%, to $158.3 million in 2016 compared to $147.6 million in 2015. This increase is primarily due to the following:
| • | an increase of $6.1 million related to properties acquired in 2015 and 2016, |
| • | an increase of $3.2 million from the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, |
| • | an increase of $2.0 million related to Assembly Row and Pike & Rose, as portions of both projects opened in 2015 and early 2016, |
| • | an increase of $2.0 million at redevelopment properties, |
partially offset by
| • | a decrease of $1.9 million in repairs and maintenance expenses at same-center properties primarily due to lower snow removal costs, and |
| • | a decrease of $1.1 million due to the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively. |
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 decreased slightly to 19.9% for the year ended December 31, 2016 from 20.0% for the year ended December 31, 2015.
Real Estate Taxes
Real estate tax expense increased $9.5 million, or 11.0% to $95.3 million in 2016 compared to $85.8 million in 2015 due primarily to the following:
| • | an increase of $4.2 million at same-center properties due to higher assessments, |
| • | an increase of $2.2 million from properties acquired in 2015 and 2016, |
| • | an increase of $1.9 million due to the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, |
| • | an increase of $1.1 million from redevelopment properties, and |
| • | an increase of $0.8 million related to Assembly Row and Pike & Rose, |
partially offset by
| • | a decrease of $0.8 million due to the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively. |
Property Operating Income
Property operating income increased $37.4 million, or 7.3%, to $548.0 million in 2016 compared to $510.6 million in 2015. This increase is primarily due to growth in earnings at same-center and redevelopment properties, the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, portions of Assembly Row and Pike & Rose opening in 2015 and early 2016, and properties acquired in 2015, partially offset by the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively.
Other Operating Expenses
General and Administrative Expense
General and administrative expense decreased $2.2 million, or 6.3%, to $33.4 million in 2016 from $35.6 million in 2015. This decrease is primarily due lower transaction costs, partially offset by higher personnel related costs.
Depreciation and Amortization
Depreciation and amortization expense increased $18.8 million, or 10.7%, to $193.6 million in 2016 from $174.8 million in 2015. This increase is due primarily to the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, Assembly Row and Pike & Rose, depreciation on redevelopment related assets, and properties acquired in 2015.
Operating Income
Operating income increased $20.8 million, or 6.9%, to $321.0 million in 2016 compared to $300.2 million in 2015. This increase is primarily due to properties acquired in 2015, portions of Assembly Row and Pike & Rose opening in 2015 and early 2016, growth in earnings at redevelopment and same-center properties, and the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, partially offset by the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively.
Other
Interest Expense
Interest expense increased $2.4 million, or 2.6%, to $95.0 million in 2016 compared to $92.6 million in 2015. This increase is due primarily to an increase of $8.6 million due to higher borrowings, partially offset by a decrease of $6.2 million due to a lower overall weighted average borrowing rate.
Gross interest costs were $113.0 million and $110.7 million in 2016 and 2015, respectively. Capitalized interest was $18.0 million and $18.1 million in 2016 and 2015, respectively.
Early Extinguishment of Debt
The $19.1 million early extinguishment of debt in 2015 relates to the make-whole premium paid as part of the early redemption of our 6.20% senior notes in the second quarter of 2015, partially offset by the related write-off of unamortized premium and debt fees.
Gain on Sale of Real Estate and Change in Control of Interests
The $32.5 million gain on sale of real estate and change in control of interests is primarily the result of our obtaining control of six properties when we acquired Clarion’s 70% interest in the partnership that owned those properties (see discussion in Note 3 to the consolidated financial statements). The properties were previously accounted for under the equity method of accounting. We consolidated these assets effective January 13, 2016, and consequently recognized a gain of $25.7 million upon obtaining the controlling interest. 2016 also included a $1.8 million gain related to the May 2016 sale of a building in Coconut Grove, Florida by an unconsolidated joint venture (our share of the gain, net of noncontrolling interests, was $0.5 million) and a $4.9 million gain due to the reversal of the warranty reserve for condominium units at Santana Row, as the statutorily mandated latent construction defect period ended in third quarter 2016 and no further claims have been filed.
The $28.3 million gain on sale of real estate for 2015 is due to the sale of our Houston Street property in April 2015 and the sale of our Courtyard Shops property in November 2015.
YEAR ENDED DECEMBER 31, 2015 COMPARED TO YEAR ENDED DECEMBER 31, 2014
| Change | ||||||||||||||
| 2015 | 2014 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 727,812 | $ | 666,322 | $ | 61,490 | 9.2 | % | ||||||
| Other property income | 11,810 | 14,758 | (2,948 | ) | (20.0 | )% | ||||||||
| Mortgage interest income | 4,390 | 5,010 | (620 | ) | (12.4 | )% | ||||||||
| Total property revenue | 744,012 | 686,090 | 57,922 | 8.4 | % | |||||||||
| Rental expenses | 147,593 | 135,417 | 12,176 | 9.0 | % | |||||||||
| Real estate taxes | 85,824 | 76,506 | 9,318 | 12.2 | % | |||||||||
| Total property expenses | 233,417 | 211,923 | 21,494 | 10.1 | % | |||||||||
| Property operating income (1) | 510,595 | 474,167 | 36,428 | 7.7 | % | |||||||||
| General and administrative expenses | (35,645 | ) | (32,316 | ) | (3,329 | ) | 10.3 | % | ||||||
| Depreciation and amortization | (174,796 | ) | (170,814 | ) | (3,982 | ) | 2.3 | % | ||||||
| Operating income | 300,154 | 271,037 | 29,117 | 10.7 | % | |||||||||
| Other interest income | 149 | 94 | 55 | 58.5 | % | |||||||||
| Income from real estate partnerships | 1,416 | 1,243 | 173 | 13.9 | % | |||||||||
| Interest expense | (92,553 | ) | (93,941 | ) | 1,388 | (1.5 | )% | |||||||
| Early extinguishment of debt | (19,072 | ) | (10,545 | ) | (8,527 | ) | 80.9 | % | ||||||
| Total other, net | (110,060 | ) | (103,149 | ) | (6,911 | ) | 6.7 | % | ||||||
| Income from continuing operations | 190,094 | 167,888 | 22,206 | 13.2 | % | |||||||||
| Gain on sale of real estate | 28,330 | 4,401 | 23,929 | 543.7 | % | |||||||||
| Net income | 218,424 | 172,289 | 46,135 | 26.8 | % | |||||||||
| Net income attributable to noncontrolling interests | (8,205 | ) | (7,754 | ) | (451 | ) | 5.8 | % | ||||||
| Net income attributable to the Trust | $ | 210,219 | $ | 164,535 | $ | 45,684 | 27.8 | % |
(1) Property operating income is a non-GAAP financial measure. See Item 6. Selected Financial Data for further discussion.
Property Revenues
Total property revenue increased $57.9 million, or 8.4%, to $744.0 million in 2015 compared to $686.1 million in 2014. The percentage occupied at our shopping centers decreased to 93.5% at December 31, 2015 compared to 94.7% at December 31, 2014. 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 $61.5 million, or 9.2%, to $727.8 million in 2015 compared to $666.3 million in 2014 due primarily to the following:
| • | an increase of $22.1 million from Assembly Row and Pike & Rose as portions of both projects opened beginning in second quarter 2014 through 2015, |
| • | an increase of $16.6 million attributable to properties acquired in 2015 and 2014, |
| • | an increase of $15.7 million at same-center properties due primarily to higher rental rates of approximately $10.0 million, a $4.0 million increase in recovery income (primarily the result of reimbursements for higher real estate taxes and other tenant reimbursables), and occupancy impacts of approximately $0.8 million, and |
| • | an increase of $10.4 million at redevelopment properties due primarily to the lease-up of our new 212 unit residential building at Santana Row and the lease-up of four of our retail redevelopments, |
partially offset by,
| • | a decrease of $3.8 million due to the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively. |
Other Property Income
Other property income decreased $2.9 million, or 20.0%, to $11.8 million in 2015 compared to $14.8 million in 2014. 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 and other fees at our same-center and redevelopment properties.
Property Expenses
Total property expenses increased $21.5 million, or 10.1%, to $233.4 million in 2015 compared to $211.9 million in 2014. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $12.2 million, or 9.0%, to $147.6 million in 2015 compared to $135.4 million in 2014. This increase is primarily due to the following:
| • | an increase of $5.3 million related to properties acquired in 2015 and 2014, |
| • | an increase of $4.3 million related to Assembly Row and Pike & Rose, as portions of these projects opened beginning in second quarter 2014, |
| • | an increase of $3.2 million in repairs and maintenance expenses at same-center and redevelopment properties primarily due to higher snow removal costs, and |
| • | an increase of $0.6 million in utilities at our same-center properties, |
partially offset by
| • | a decrease of $1.2 million due to the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively. |
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 20.0% for the year ended December 31, 2015 from 19.9% for the year ended December 31, 2014.
Real Estate Taxes
Real estate tax expense increased $9.3 million, or 12.2% to $85.8 million in 2015 compared to $76.5 million in 2014 due primarily to Assembly Row and Pike & Rose, higher assessments at our same-center and redevelopment properties, and properties acquired in 2015 and 2014, partially offset by the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively.
Property Operating Income
Property operating income increased $36.4 million, or 7.7%, to $510.6 million in 2015 compared to $474.2 million in 2014. This increase is primarily due to portions of Assembly Row and Pike & Rose opening beginning in second quarter 2014, growth in earnings at same-center and redevelopment properties, and properties acquired in 2015 and 2014, partially offset by the sale of our Houston Street and Courtyard Shops properties in April 2015 and November 2015, respectively.
Other Operating Expense
General and Administrative Expense
General and administrative expense increased $3.3 million, or 10.3%, to $35.6 million in 2015 from $32.3 million in 2014. This increase is primarily due to higher personnel related costs and higher transaction costs.
Depreciation and Amortization
Depreciation and amortization expense increased $4.0 million, or 2.3%, to $174.8 million in 2015 from $170.8 million in 2014. This increase is due primarily to depreciation on Assembly Row and Pike & Rose and properties acquired in 2015, partially offset by accelerated depreciation in 2014 due to the change in use of a redevelopment property.
Operating Income
Operating income increased $29.1 million, or 10.7%, to $300.2 million in 2015 compared to $271.0 million in 2014. This increase is primarily due to growth in earnings at our same-center and redevelopment properties, portions of Assembly Row
and Pike & Rose opening beginning in second quarter 2014, and properties acquired in 2015 and 2014, partially offset by higher personnel related costs.
Other
Interest Expense
Interest expense decreased $1.4 million, or 1.5%, to $92.6 million in 2015 compared to $93.9 million in 2014. This decrease is due primarily to the following:
| • | a decrease of $12.2 million due to a lower overall weighted average borrowing rate, and |
partially offset by
| • | an increase of $8.1 million due to higher borrowings. |
| • | a decrease of $2.8 million in capitalized interest due primarily to Phase I of Assembly Row and Pike & Rose, as portions of both projects opened beginning second quarter 2014. |
Gross interest costs were $110.7 million and $114.9 million in 2015 and 2014, respectively. Capitalized interest was $18.1 million and $21.0 million in 2015 and 2014, respectively.
Early Extinguishment of Debt
The $19.1 million early extinguishment of debt in 2015 relates to the make-whole premium paid as part of the early redemption of our 6.20% senior notes, partially offset by the related net write-off of unamortized premium and debt fees.
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.
Gain on sale of Real Estate
The $28.3 million gain on sale of real estate for 2015 is due to the sale of our Houston Street property in April 2015 and the
sale of our Courtyard Shops property in November 2015.
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.
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, 2016, we had $23.4 million of cash and cash equivalents and no outstanding balance on our revolving credit facility. On April 20, 2016, we upsized our $600.0 million revolving credit facility to $800.0 million and extended the maturity date to April 20, 2020, subject to two six-month extensions at our option. In addition, we have an option (subject to bank approval) to increase the credit facility through an accordion feature to $1.5 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, 2016, we had the capacity to issue up to $370.9 million in common shares under our ATM equity program.
For 2016, the maximum amount of borrowings outstanding under our revolving credit facility was $251.5 million, the weighted average amount of borrowings outstanding was $77.3 million and the weighted average interest rate, before amortization of debt fees, was 1.3%. On March 7, 2016 we issued 1.0 million common shares at $149.43 per share, in an underwritten public offering, for net cash proceeds of $149.3 million. On July 12, 2016, we issued $250.0 million of fixed rate senior unsecured notes that mature on August 1, 2046 and bear interest at 3.625%. The notes were offered at 97.756% of the principal amount with a yield to maturity of 3.75%. The net proceeds from this note offering after issuance discounts, underwriting fees, and other costs were $241.8 million. During 2017, we have $216.7 million of debt maturing. 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 2017 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 which is the result of construction on Phase II at both Assembly Row and Pike & Rose, construction of our next phase of Santana Row, and our redevelopment pipeline. 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, | |||||||
| 2016 | 2015 | ||||||
| (In thousands) | |||||||
| Cash provided by operating activities | $ | 419,254 | $ | 359,835 | |||
| Cash used in investing activities | (590,221 | ) | (353,763 | ) | |||
| Cash provided by (used in) financing activities | 173,289 | (32,977 | ) | ||||
| Increase (decrease) in cash and cash equivalents | 2,322 | (26,905 | ) | ||||
| Cash and cash equivalents, beginning of year | 21,046 | 47,951 | |||||
| Cash and cash equivalents, end of year | $ | 23,368 | $ | 21,046 |
Net cash provided by operating activities increased $59.4 million to $419.3 million during 2016 from $359.8 million during 2015. The increase was primarily attributable to higher net income before certain non-cash items, timing of payments from tenants, and the timing of interest payments and other operating costs.
Net cash used in investing activities increased $236.5 million to $590.2 million during 2016 from $353.8 million during 2015. The increase in net cash used was primarily attributable to:
| • | $150.7 million increase in capital investments and leasing costs as we continue to invest in Assembly Row, Pike & Rose, Santana Row, and other current redevelopments, and |
| • | $97.4 million decrease in proceeds from the sale of real estate, as we sold both Houston Street and Courtyard Shops in 2015, |
partially offset by
| • | $11.4 million decrease in acquisitions of real estate. |
Net cash provided by financing activities increased $206.3 million to $173.3 million provided during 2016 from $33.0 million used in 2015. The increase was primarily attributable to:
| • | the April 2015 redemption of $200.0 million of senior notes with a make-whole premium of $19.2 million, |
| • | a $218.2 million increase in net proceeds from the issuance of common shares as we issued 1.0 million common shares at $149.43 per share in an underwritten public offering in March 2016, and we sold 1.2 million common shares under our ATM equity program at a weighted average price of $152.92 during 2016 compared to 0.8 million shares at a weighted average price of $135.01 during 2015, and |
| • | a $131.8 million decrease in repayment of mortgages, capital leases and notes payable due to the payoff of $34.4 million of mortgage loans on April 1, 2016, compared to the payoff of seven mortgages totaling $165.1 million in 2015. |
partially offset by
| • | $241.8 million in net proceeds from the issuance of 3.625% senior notes in July 2016, compared to $456.2 million in net proceeds from the re-opening of the 4.50% senior notes in March 2015 and the issuance of 2.55% senior notes in September 2015, |
| • | a $110.4 million increase in net repayments on our revolving credit facility, |
| • | a $24.4 million increase in dividends paid to shareholders due to an increase in the dividend rate and increased number of shares outstanding, and |
| • | $13.0 million acquisition of the 10% noncontrolling interest of a partnership which owns a project in Southern California. |
Contractual Commitments
The following table provides a summary of our fixed, noncancelable obligations as of December 31, 2016:
| 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) | $ | 3,953,012 | $ | 328,834 | $ | 498,118 | $ | 622,547 | $ | 2,503,513 | |||||||||
| Capital lease obligations (principal and interest) | 177,232 | 5,797 | 11,600 | 11,600 | 148,235 | ||||||||||||||
| Variable rate debt (principal only)(2) | — | — | — | — | — | ||||||||||||||
| Operating leases | 185,345 | 2,070 | 6,195 | 6,382 | 170,698 | ||||||||||||||
| Real estate commitments | 70,070 | 2,570 | — | — | 67,500 | ||||||||||||||
| Development, redevelopment, and capital improvement obligations | 429,246 | 351,972 | 77,274 | — | — | ||||||||||||||
| Contractual operating obligations | 47,769 | 18,382 | 19,839 | 9,488 | 60 | ||||||||||||||
| Hotel joint venture obligations (3) | 16,092 | 12,873 | 3,219 | — | — | ||||||||||||||
| Total contractual obligations | $ | 4,878,766 | $ | 722,498 | $ | 616,245 | $ | 650,017 | $ | 2,890,006 |
| (1) | Fixed rate debt includes our $275.0 million term loan as the rate is effectively fixed by two interest rate swap agreements. |
| (2) | Variable rate debt includes our revolving credit facility, which currently has no balance outstanding and bears interest at LIBOR plus 0.825%. |
| (3) | Amounts include our share of our hotel joint venture construction related obligations. |
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, a minority partner 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, 2016, our estimated liability upon exercise of the put option would range from approximately $89 million to $93 million.
(b) 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, 2016, a total of 763,797 operating partnership units are outstanding.
(c) 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, 2016, our estimated maximum liability upon exercise of the put option would range from approximately $9 million to $10 million.
(d) 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, 2016, our estimated maximum liability upon exercise of the put option would range from approximately $21 million to $24 million. Also, we exercised our option to acquire the preferred interest of a member in our Plaza El Segundo partnership for $4.9 million. The transaction is expected to close in 2018.
(e) 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. Based on management's current estimate of fair market value as of December 31, 2016, our estimated maximum liability upon exercise of the put option would range from $10 million to $11 million.
(f) At December 31, 2016, we had letters of credit outstanding of approximately $1.3 million.
Off-Balance Sheet Arrangements
Other than the items disclosed in the Contractual Commitments Table, we have no off-balance sheet arrangements as of December 31, 2016 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, 2016:
| Description of Debt | Original Debt Issued | Principal Balance as of December 31, 2016 | Stated Interest Rate as of December 31, 2016 | Maturity Date | ||||||||
| (Dollars in thousands) | ||||||||||||
| Mortgages payable | ||||||||||||
| Secured fixed rate | ||||||||||||
| Plaza El Segundo | Acquired | $ | 175,000 | 6.33 | % | August 5, 2017 | ||||||
| The Grove at Shrewsbury (East) | Acquired | 42,536 | 5.82 | % | October 1, 2017 | |||||||
| The Grove at Shrewsbury (West) | Acquired | 10,792 | 6.38 | % | March 1, 2018 | |||||||
| Rollingwood Apartments | 24,050 | 21,283 | 5.54 | % | May 1, 2019 | |||||||
| The Shops at Sunset Place | Acquired | 68,634 | 5.62 | % | September 1, 2020 | |||||||
| 29th Place | Acquired | 4,553 | 5.91 | % | January 31, 2021 | |||||||
| THE AVENUE at White Marsh | 52,705 | 52,705 | 3.35 | % | January 1, 2022 | |||||||
| Montrose Crossing | 80,000 | 72,726 | 4.20 | % | January 10, 2022 | |||||||
| Brook 35 | 11,500 | 11,500 | 4.65 | % | July 1, 2029 | |||||||
| Chelsea | Acquired | 6,576 | 5.36 | % | January 15, 2031 | |||||||
| Subtotal | 466,305 | |||||||||||
| Net unamortized premium and debt issuance costs | 4,812 | |||||||||||
| Total mortgages payable | 471,117 | |||||||||||
| Notes payable | ||||||||||||
| Unsecured fixed rate | ||||||||||||
| Term Loan (1) | 275,000 | 275,000 | LIBOR + 0.90% | November 21, 2018 | ||||||||
| Various | 7,239 | 5,247 | 11.31 | % | Various through 2028 | |||||||
| Unsecured variable rate | ||||||||||||
| Revolving credit facility (2) | 800,000 | — | LIBOR + 0.825% | April 20, 2020 | ||||||||
| Subtotal | 280,247 | |||||||||||
| Net unamortized debt issuance cost | (1,096 | ) | ||||||||||
| Total notes payable | 279,151 | |||||||||||
| Senior notes and debentures | ||||||||||||
| Unsecured fixed rate | ||||||||||||
| 5.90% notes | 150,000 | 150,000 | 5.90 | % | April 1, 2020 | |||||||
| 2.55% notes | 250,000 | 250,000 | 2.55 | % | January 15, 2021 | |||||||
| 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 | 450,000 | 450,000 | 4.50 | % | December 1, 2044 | |||||||
| 3.625% notes | 250,000 | 250,000 | 3.625 | % | August 1, 2046 | |||||||
| Subtotal | 1,994,200 | |||||||||||
| Net unamortized (discount)/premium and debt issuance costs | (17,606 | ) | ||||||||||
| Total senior notes and debentures | 1,976,594 | |||||||||||
| Capital lease obligations | ||||||||||||
| Various | 71,590 | Various | Various through 2106 | |||||||||
| Total debt and capital lease obligations | $ | 2,798,452 |
| 1) | 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 is 90 basis points resulting in a fixed rate of 2.62%. |
| 2) | The maximum amount drawn under our revolving credit facility during 2016 was $251.5 million and the weighted average effective interest rate on borrowings under our revolving credit facility, before amortization of debt fees, was 1.30%. |
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, 2016, 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, 2016:
| Unsecured | Secured | Capital Lease | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| 2017 | $ | 462 | $ | 222,445 | $ | 38 | $ | 222,945 | ||||||||
| 2018 | 275,513 | (1) | 15,477 | 37 | 291,027 | |||||||||||
| 2019 | 567 | 25,006 | 42 | 25,615 | ||||||||||||
| 2020 | 150,629 | (2) | 64,687 | 46 | 215,362 | |||||||||||
| 2021 | 250,700 | 5,984 | 51 | 256,735 | ||||||||||||
| Thereafter | 1,596,576 | 132,706 | 71,376 | 1,800,658 | ||||||||||||
| $ | 2,274,447 | $ | 466,305 | $ | 71,590 | $ | 2,812,342 | (3) |
| 1) | Our $275.0 million unsecured term loan matures on November 21, 2018, subject to a one-year extension at our option. |
| 2) | Our $800.0 million revolving credit facility matures on April 20, 2020, subject to two six-month extensions at our option. As of December 31, 2016, there was no outstanding balance under this credit facility. |
| 3) | The total debt maturities differs from the total reported on the consolidated balance sheet due to the unamortized net premium/(discount) and debt issuance costs on certain mortgage loans, notes payable, and senior notes as of December 31, 2016. |
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, 2016, 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 2016, 2015 and 2014, 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 U.S. GAAP, plus real estate related depreciation and amortization and excluding extraordinary items and gains and losses on the sale of real estate, and impairment write-downs of depreciable 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, | |||||||||||
| 2016 | 2015 | 2014 | |||||||||
| (In thousands, except per share data) | |||||||||||
| Net income | $ | 258,883 | $ | 218,424 | $ | 172,289 | |||||
| Net income attributable to noncontrolling interests | (8,973 | ) | (8,205 | ) | (7,754 | ) | |||||
| Gain on sale of real estate and change in control of interests, net | (31,133 | ) | (28,330 | ) | (4,401 | ) | |||||
| Depreciation and amortization of real estate assets | 169,198 | 154,232 | 154,060 | ||||||||
| Amortization of initial direct costs of leases | 16,875 | 15,026 | 12,391 | ||||||||
| Funds from operations | 404,850 | 351,147 | 326,585 | ||||||||
| Dividends on preferred shares | (541 | ) | (541 | ) | (541 | ) | |||||
| Income attributable to operating partnership units | 3,145 | 3,398 | 3,027 | ||||||||
| Income attributable to unvested shares | (1,095 | ) | (1,147 | ) | (1,474 | ) | |||||
| Funds from operations available for common shareholders (1) | $ | 406,359 | $ | 352,857 | $ | 327,597 | |||||
| Weighted average number of common shares, diluted (2) | 71,869 | 69,920 | 68,410 | ||||||||
| Funds from operations available for common shareholders, per diluted share (1) | $ | 5.65 | $ | 5.05 | $ | 4.79 |
| (1) | If the $19.1 million and the $10.5 million early extinguishment of debt charge incurred in 2015 and 2014, respectively, was excluded, our FFO available for common shareholders for 2015 and 2014 would have been $371.9 million and $338.1 million, respectively, and FFO available for common shareholders, per diluted share would have been $5.32 and $4.94, respectively. |
| (2) | 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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