filings.toolsItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
87K characters. Original on sec.gov · Markdown
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, 2018, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use properties which are operated as 104 predominantly retail real estate projects comprising approximately 24.1 million square feet. In total, the real estate projects were 94.6% leased and 93.6% occupied at December 31, 2018. We have paid quarterly dividends to our shareholders continuously since our founding in 1962 and have increased our dividends per common share for 51 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, 2018 and 2017, our allowance for doubtful accounts was $12.7 million and $11.8 million, respectively. Historically, we have recognized bad debt expense between 0.3% and 1.3% of rental income and it was 0.5% in 2018. 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 $9.0 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, 2018 and 2017, accounts receivable includes approximately $97.4 million and $93.1 million, respectively, related to straight-line rents. Correspondingly, these estimates of collectability have a direct impact on our net income.
We completed construction on 221 condominium units at our Assembly Row and Pike & Rose properties. Beginning on January 1, 2018, with the adoption of ASU 2014-09, "Revenue from Contracts with Customers," (see "Recent Accounting Pronouncements" for discussion of change in timing of revenue recognition), gains or losses on the sale of these condominium units are recognized as the condominium units are legally sold. However, in 2017, we accounted for contracted condominium sales under the percentage-of completion method, based on an evaluation of the criteria specified in ASC Topic 360-20, “Property, Plant and Equipment – Real Estate Sales,” including: the legal commitment of the purchaser in the real estate contract, whether the construction of the project was beyond a preliminary phase, whether sufficient units had been contracted to ensure the project would not revert to a rental project, the ability to reasonably estimate the aggregate project sale proceeds and aggregate project costs, and the determination that the buyer had made an adequate initial and continuing cash investment under the contract. When the percentage-of-completion criteria had not been met, no profit was recognized. The application of these criteria can be complex and required us to make assumptions.
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 $274 million and $8 million, respectively, for 2018 and $410 million and $8 million, respectively, for 2017. We capitalized external and internal costs related to other property improvements of $62 million and $3 million, respectively, for 2018 and $74 million and $3 million, respectively, for 2017. We capitalized external and internal costs related to leasing activities of $20 million and $6 million, respectively, for 2018 and $11 million and $6 million, respectively, for 2017. 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, $3 million, and $6 million, for both 2018 and 2017. Total capitalized costs were $373 million and $512 million for 2018 and 2017, 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.
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.
2018 Property Acquisitions and Dispositions
On June 15, 2018, we formed a new joint venture to develop Jordan Downs Plaza which, when completed, will be an approximately 113,000 square foot grocery anchored shopping center located in Los Angeles County, California. We initially invested $34.4 million as a result of a pre-funding requirement for equity to be advanced prior to the start of construction. We own approximately 91% of the venture, and control the 9.4 acre land parcel on which the shopping center will be constructed under a long-term ground lease that expires June 15, 2093 (including two 10-year option periods which may be exercised at our option). The Jordan Downs Plaza development is expected to generate income tax credits under the New Market Tax Credit Program ("NMTC") which was provided for in the Community Renewal Tax Relief Act of 2000 ("the Act") and is intended to induce investment in underserved areas of the United States. The Act permits taxpayers to claim credits against their Federal income taxes for qualified investments. A third party bank contributed $13.9 million to the development, and is entitled to the related tax credit benefits, but they do not have an interest in the underlying economics of the property. The transaction also includes a put/call provision whereby we may be obligated or entitled to purchase the third party bank’s interest. We believe the put will be exercised at its $1,000 strike price. Based on our assessment of control, we concluded that the project and certain
other transaction related entities should be consolidated. The $13.9 million in proceeds received in exchange for the transfer of the tax credits has been deferred and will be recognized when the tax benefits are delivered to the third party bank without risk of recapture. Direct and incremental costs of $1.6 million incurred in structuring the NMTC transaction have also been deferred. The Trust anticipates recognizing the net cash received as revenue upon completion of the seven-year NMTC compliance period. Cash in escrow at December 31, 2018 of $32.2 million reflects cash that will ultimately be used for the development of the shopping center, and is included in "prepaid expenses and other assets" on our consolidated balance sheet. The cash is held in escrow pursuant to the new market tax credit transaction documents and will be released as qualified development expenditures are incurred.
In August 2018, we contributed hotel related assets valued at $44.0 million to our Assembly Row hotel joint venture, and received a cash distribution of $38.0 million. At December 31, 2018, our investment in the venture was $5.6 million. The joint venture is considered a variable interest entity controlled by our partner, and as a result, we are using the equity method to account for our investment.
On August 16, 2018, we sold the residential building at our Chelsea Commons property in Chelsea, Massachusetts for a sales price of $15.0 million, resulting in a gain of $3.1 million.
On November 9, 2018, we sold our Atlantic Plaza property in North Reading, Massachusetts for a sales price of $27.2 million, resulting in a gain of $1.6 million.
On November 29, 2018, we acquired a 40,000 square foot building adjacent to our Bell Gardens property for $9.6 million.
During the year ended December 31, 2018, we closed on the sale of 176 condominium units at our Assembly Row and Pike & Rose properties (combined) and received proceeds net of closing costs of $133.5 million, For the year ended December 31, 2018, we recognized a gain of $7.2 million, net of $1.6 million of income taxes. The cost basis for remaining condominium units that are ready for their intended use as of December 31, 2018 is $16.6 million, and is included in "assets held for sale" on our consolidated balance sheets.
2018 and 2019 Significant Debt and Equity Transactions
On March 1, 2018, we repaid the $10.5 million mortgage loan on The Grove at Shrewsbury (West) at par.
On August 10, 2018, we exercised our option to extend the maturity date of our $275.0 million unsecured term loan by one year to November 21, 2019.
On May 7, 2018, we replaced our existing at-the-market (“ATM”) equity program with a new ATM 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, 2018, we sold 374,725 common shares at a weighted average price per share of $131.36 for net cash proceeds of $48.7 million and paid $0.5 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, 2018, we issued 987,383 common shares at a weighted average price per share of $129.19 for net cash proceeds of $126.1 million and paid $1.3 million in commissions and $0.2 million in additional offering expenses related to the sales of these common shares. As of December 31, 2018, we had the capacity to issue up to $272.4 million in common shares under our ATM equity program.
On January 31, 2019, we repaid the $20.3 million mortgage loan on Rollingwood Apartments, at par, prior to its original maturity date.
Outlook
We seek growth in earnings, funds from operations, and cash flows primarily through a combination of the following:
| • | growth in our comparable property portfolio, |
| • | growth in our portfolio from property development and redevelopments, and |
| • | expansion of our portfolio through property acquisitions. |
Our comparable property growth is primarily driven by increases in rental rates on new leases and lease renewals, changes in portfolio occupancy, and the redevelopment of those assets. 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 generally increase rental rates. We continue 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 the number of tenants available to fill anchor spaces, and have seen an uptick in the number of retail tenants closing early and/or filing for bankruptcy. We believe the locations and nature of our centers and diverse tenant base partially mitigates any potential 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, 2018, no single tenant accounted for more than 2.7% 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 $210 million that we expect to stabilize in the next several years.
We continue our ongoing redevelopment efforts at Santana Row and are under construction on an eight story 301,000 square foot office building which will include an additional 18,000 square feet of retail space and 1,300 parking spaces. The building is expected to cost between $205 and $215 million, to be delivered in 2019, and the office portion is 100% pre-leased. 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 across from Santana Row, which has approximately 1 million square feet of commercial space entitlements.
Construction continues on Phase II of Assembly Row which includes approximately 161,000 square feet of retail space, 447 residential units, and a 158 room boutique hotel (owned and operated by a joint venture in which we are a partner). Total expected costs range from $290 million to $305 million and remaining delivery is expected in 2019. As of December 31, 2018, approximately 120,000 square feet of retail space and the 158 room hotel have opened, and all of the residential units have been completed. Phase II also includes 122 for-sale condominium units, of which 107 have closed as of December 31, 2018. The remaining 15 units are expected to close in 2019. The condominium units have an expected total cost of $81 million. Additionally, Partners HealthCare built a 741,500 square foot office building as part of Phase II.
Additionally, we commenced construction on Phase III of Assembly Row, which will include 277,000 square feet of office space (of which, 150,000 square feet is pre-leased), 56,000 square feet of retail space, 500 residential units, and over 800 additional parking spaces. The expected costs for Phase III are between $465 million and $485 million and is projected to open beginning in 2022.
Construction also continues on Phase II of Pike & Rose which includes approximately 216,000 square feet of retail space, 272 residential units, and a 177 room boutique hotel (owned and operated by a joint venture in which we are a partner). As of December 31, 2018, approximately 190,000 square feet of retail space and the 177 room hotel have opened, and all of the residential units have been completed. Total expected costs range from $200 million to $207 million and remaining delivery is expected in 2019. As of December 31, 2018, we closed on the sale of 69 of the 99 for-sale condominium units in Phase II. The condominiums have an expected total cost of $62 million.
Additionally, at Pike & Rose, we commenced construction on a 212,000 square foot office building (which includes 4,000 square feet of ground floor retail space), and will include over 600 additional parking spaces. The building is expected to cost between $128 million and $135 million and is projected to open beginning in 2021.
We invested $82 million in Assembly Row and Pike & Rose in 2018 and expect to invest between $175 million and $200 million in Assembly Row and Pike & Rose in 2019.
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 assumed mortgages and property sales.
At December 31, 2018, the leasable square feet in our properties was 94.6% leased and 93.6% occupied. 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 closings and bankruptcies.
Comparable Properties
Throughout this section, we have provided certain information on a “comparable property” basis. Information provided on a comparable property basis includes the results of properties that we owned and operated for the entirety of both periods being compared except for properties that are currently under development or are being repositioned for significant redevelopment and investment. For the year ended December 31, 2018 and the comparison of 2018 and 2017, all or a portion of 90 properties were considered comparable properties and eight properties were considered non-comparable properties. For the year ended December 31, 2018, five properties were moved from acquisitions to comparable properties, one portion of a property was removed from comparable properties as it was sold during 2018, one portion of a property was moved from comparable properties to non-comparable properties, and one portion of a property was moved from non-comparable properties to comparable properties, compared to the designations as of December 31, 2017. For the year ended December 31, 2017 and the comparison of 2017 and 2016, all or a portion of 85 properties were considered comparable properties and 7 properties were considered non-comparable properties. For the year ended December 31, 2017, one property was moved from acquisitions to comparable properties and two properties were removed from comparable properties as they were sold during 2017, compared to the designations as of December 31, 2016. While there is judgment surrounding changes in designations, we typically move non-comparable properties to comparable properties once they have stabilized, which is typically considered 90% physical occupancy or when the growth expected from the redevelopment has been included in the comparable periods. We typically remove properties from comparable properties when the repositioning of the asset has commenced and has or is expected to have a significant impact to property operating income within the calendar year. Acquisitions are moved to comparable properties once we have owned the property for the entirety of comparable periods and the property is not under development or being repositioned for significant redevelopment and investment. Comparable property information replaces our previous same center designations.
YEAR ENDED DECEMBER 31, 2018 COMPARED TO YEAR ENDED DECEMBER 31, 2017
| Change | ||||||||||||||
| 2018 | 2017 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 895,698 | $ | 841,461 | $ | 54,237 | 6.4 | % | ||||||
| Other property income | 16,589 | 12,825 | 3,764 | 29.3 | % | |||||||||
| Mortgage interest income | 3,149 | 3,062 | 87 | 2.8 | % | |||||||||
| Total property revenue | 915,436 | 857,348 | 58,088 | 6.8 | % | |||||||||
| Rental expenses | 173,094 | 164,890 | 8,204 | 5.0 | % | |||||||||
| Real estate taxes | 114,776 | 107,839 | 6,937 | 6.4 | % | |||||||||
| Total property expenses | 287,870 | 272,729 | 15,141 | 5.6 | % | |||||||||
| Property operating income (1) | 627,566 | 584,619 | 42,947 | 7.3 | % | |||||||||
| General and administrative expense | (33,600 | ) | (36,281 | ) | 2,681 | (7.4 | )% | |||||||
| Depreciation and amortization | (244,245 | ) | (216,050 | ) | (28,195 | ) | 13.1 | % | ||||||
| Operating income | 349,721 | 332,288 | 17,433 | 5.2 | % | |||||||||
| Other interest income | 942 | 475 | 467 | 98.3 | % | |||||||||
| Interest expense | (110,154 | ) | (100,125 | ) | (10,029 | ) | 10.0 | % | ||||||
| Early extinguishment of debt | — | (12,273 | ) | 12,273 | (100.0 | )% | ||||||||
| Loss from real estate partnerships | (3,398 | ) | (417 | ) | (2,981 | ) | 714.9 | % | ||||||
| Total other, net | (112,610 | ) | (112,340 | ) | (270 | ) | 0.2 | % | ||||||
| Income from continuing operations | 237,111 | 219,948 | 17,163 | 7.8 | % | |||||||||
| Gain on sale of real estate, net | 11,915 | 77,922 | (66,007 | ) | (84.7 | )% | ||||||||
| Net income | 249,026 | 297,870 | (48,844 | ) | (16.4 | )% | ||||||||
| Net income attributable to noncontrolling interests | (7,119 | ) | (7,956 | ) | 837 | (10.5 | )% | |||||||
| Net income attributable to the Trust | $ | 241,907 | $ | 289,914 | $ | (48,007 | ) | (16.6 | )% |
(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 $58.1 million, or 6.8%, to $915.4 million in 2018 compared to $857.3 million in 2017. The percentage occupied at our shopping centers was 93.6% at December 31, 2018 compared to 93.9% at December 31, 2017. 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 $54.2 million, or 6.4%, to $895.7 million in 2018 compared to $841.5 million in 2017 due primarily to the following:
| • | an increase of $25.0 million from acquisitions, primarily related to the six shopping centers acquired in Los Angeles County, California in August 2017 and Riverpoint Center in March 2017, |
| • | an increase of $20.2 million at non-comparable properties due primarily to the opening of Phase II at Assembly Row and Pike & Rose during the second half of 2017 into 2018 and the lease-up of two other redevelopments, partially offset by lower occupancy at two of our Florida properties in the beginning stages of redevelopment, and |
| • | an increase of $15.3 million at comparable properties due primarily to higher rental rates of approximately $10.2 million and higher average occupancy of approximately $4.7 million, |
partially offset by
| • | a decrease of $5.8 million from property sales. |
Other Property Income
Other property income increased $3.8 million, or 29.3%, to $16.6 million in 2018 compared to $12.8 million in 2017. 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 related to higher lease termination fees.
Property Expenses
Total property expenses increased $15.1 million, or 5.6%, to $287.9 million in 2018 compared to $272.7 million in 2017. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $8.2 million, or 5.0%, to $173.1 million in 2018 compared to $164.9 million in 2017. This increase is primarily due to the following:
| • | an increase of $6.5 million from acquisitions, primarily related to our acquisition of six shopping centers in Los Angeles County, California in August 2017, |
| • | an increase of $2.7 million from non-comparable properties, due primarily to the opening of Phase II at Assembly Row and Pike & Rose during the second half of 2017 into 2018, partially offset by lower expenses at two of our Florida properties in the beginning stages of redevelopment, and |
| • | an increase of $0.9 million from comparable properties, primarily related to higher bad debt expense partially offset by lower operating costs, |
partially offset by
| • | a decrease of $1.3 million from property sales. |
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 to 19.0% for the year ended December 31, 2018 from 19.3% for the year ended December 31, 2017.
Real Estate Taxes
Real estate tax expense increased $6.9 million, or 6.4% to $114.8 million in 2018 compared to $107.8 million in 2017 due primarily to the following:
| • | an increase of $3.9 million from acquisitions, primarily related to our acquisition of six shopping centers in Los Angeles County, California in August 2017 and Riverpoint Center in March 2017, |
| • | an increase of $3.1 million at non-comparable properties due primarily to increases in assessments as a result of our redevelopment activities, |
| • | an increase of $1.0 million at comparable properties primarily due to higher assessments, |
partially offset by
| • | a decrease of $1.1 million million from property sales. |
Property Operating Income
Property operating income increased $42.9 million, or 7.3%, to $627.6 million in 2018 compared to $584.6 million in 2017. This increase is primarily due to growth in earnings at comparable properties, our acquisition of six shopping centers in Los Angeles County, California in August 2017 and Riverpoint Center in March 2017, and the opening of Phase II at Assembly Row and Pike & Rose, partially offset by property sales.
Other Operating Expenses
General and Administrative Expense
General and administrative expense decreased $2.7 million, or 7.4%, to $33.6 million in 2018 from $36.3 million in 2017. The decrease is primarily due to lower costs from acquisitions and other transactions.
Depreciation and Amortization
Depreciation and amortization expense increased $28.2 million, or 13.1%, to $244.2 million in 2018 from $216.1 million in 2017. This increase is primarily due to our investment in comparable properties, Phase II of Assembly Row and Pike & Rose being placed in service, our acquisition of six shopping centers in Los Angeles County, California in August 2017, and accelerated depreciation related to tenants who vacated in advance of their lease expiration.
Operating Income
Operating income increased $17.4 million, or 5.2%, to $349.7 million in 2018 compared to $332.3 million in 2017. This increase is primarily due to the opening of Phase II at Assembly Row and Pike & Rose, higher lease termination fees, lower general and administrative costs, our acquisition of six shopping centers in Los Angeles County, California in August 2017 and Riverpoint Center in March 2017, and growth in earnings at comparable properties, partially offset by property sales.
Other
Interest Expense
Interest expense increased $10.0 million, or 10.0%, to $110.2 million in 2018 compared to $100.1 million in 2017. This increase is due primarily to the following:
| • | a decrease of $6.7 million in capitalized interest, and |
| • | an increase of $6.1 million due to higher borrowings primarily attributable to the $475 million issuance of 3.25% senior notes ($300 million issued in June 2017 and $175 million issued in December 2017) and the $100 million reopening in June 2017 of the 4.50% senior notes, partially offset by the early redemption of our $150 million 5.90% senior notes in December 2017, |
partially offset by
| • | a decrease of $2.8 million due to a lower overall weighted average borrowing rate. |
Gross interest costs were $129.0 million and $125.7 million in 2018 and 2017, respectively. Capitalized interest was $18.8 million and $25.6 million in 2018 and 2017, respectively.
Loss from Real Estate Partnerships
Loss from real estate partnerships increased to $3.4 million in 2018 compared to $0.4 million in 2017. This increase is due primarily to our share of losses related to the hotel joint ventures at Assembly Row (hotel opened in August 2018) and Pike & Rose (hotel opened in March 2018).
Early Extinguishment of Debt
The $12.3 million early extinguishment of debt charge in 2017 relates to the make-whole premium paid as part of the early redemption of our 5.90% senior notes on December 31, 2017 and the related write-off of the unamortized discount and debt fees.
Gain on Sale of Real Estate, Net
The $11.9 million gain on sale of real estate for the year ended December 31, 2018 is primarily due to the following:
| • | $7.2 million net gain related to condominium unit sales that have closed at our Assembly Row and Pike & Rose properties, and |
| • | $3.1 million gain related to the sale of the residential building at our Chelsea Commons property in August 2018, and |
| • | $1.6 million gain related to the sale of our Atlantic Plaza property in November 2018, |
The $77.9 million gain on sale of real estate for the year ended December 31, 2017 is primarily due to the following:
| • | $45.2 million gain related to the sale of our 150 Post Street property in August 2017, |
| • | $15.4 million gain related to the sale of three ground lease parcels at our Assembly Row property in Somerville, Massachusetts, |
| • | $6.5 million gain related to the sale of a parcel of land at our Bethesda Row property in December 2017, |
| • | $5.4 million net percentage-of-completion gain, related to residential condominium units under binding contract at our Assembly Row property, and |
| • | $4.9 million gain related to the sale of our North Lake Commons property in September 2017. |
YEAR ENDED DECEMBER 31, 2017 COMPARED TO YEAR ENDED DECEMBER 31, 2016
| Change | ||||||||||||||
| 2017 | 2016 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 841,461 | $ | 786,583 | $ | 54,878 | 7.0 | % | ||||||
| Other property income | 12,825 | 11,015 | 1,810 | 16.4 | % | |||||||||
| Mortgage interest income | 3,062 | 3,993 | (931 | ) | (23.3 | )% | ||||||||
| Total property revenue | 857,348 | 801,591 | 55,757 | 7.0 | % | |||||||||
| Rental expenses | 164,890 | 158,326 | 6,564 | 4.1 | % | |||||||||
| Real estate taxes | 107,839 | 95,286 | 12,553 | 13.2 | % | |||||||||
| Total property expenses | 272,729 | 253,612 | 19,117 | 7.5 | % | |||||||||
| Property operating income (1) | 584,619 | 547,979 | 36,640 | 6.7 | % | |||||||||
| General and administrative expenses | (36,281 | ) | (33,399 | ) | (2,882 | ) | 8.6 | % | ||||||
| Depreciation and amortization | (216,050 | ) | (193,585 | ) | (22,465 | ) | 11.6 | % | ||||||
| Operating income | 332,288 | 320,995 | 11,293 | 3.5 | % | |||||||||
| Other interest income | 475 | 374 | 101 | 27.0 | % | |||||||||
| Interest expense | (100,125 | ) | (94,994 | ) | (5,131 | ) | 5.4 | % | ||||||
| Early extinguishment of debt | (12,273 | ) | — | (12,273 | ) | 100.0 | % | |||||||
| Income from real estate partnerships | (417 | ) | 50 | (467 | ) | (934.0 | )% | |||||||
| Total other, net | (112,340 | ) | (94,570 | ) | (17,770 | ) | 18.8 | % | ||||||
| Income from continuing operations | 219,948 | 226,425 | (6,477 | ) | (2.9 | )% | ||||||||
| Gain on sale of real estate and change in control of interests, net | 77,922 | 32,458 | 45,464 | 140.1 | % | |||||||||
| Net income | 297,870 | 258,883 | 38,987 | 15.1 | % | |||||||||
| Net income attributable to noncontrolling interests | (7,956 | ) | (8,973 | ) | 1,017 | (11.3 | )% | |||||||
| Net income attributable to the Trust | $ | 289,914 | $ | 249,910 | $ | 40,004 | 16.0 | % |
(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 $55.8 million, or 7.0%, to $857.3 million in 2017 compared to $801.6 million in 2016. The percentage occupied at our shopping centers was 93.9% at December 31, 2017 compared to 93.3% at December 31, 2016. 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 $54.9 million, or 7.0%, to $841.5 million in 2017 compared to $786.6 million in 2016 due primarily to the following:
| • | an increase of $25.2 million from acquisitions, primarily related to the six shopping centers acquired in Los Angeles County, California in August 2017, Riverpoint Center in March 2017, Hastings Ranch Plaza in February 2017, and the acquisition of six previously unconsolidated Clarion joint venture properties in January 2016, |
| • | an increase of $20.1 million from non-comparable properties, due primarily to the opening of our new office building at Santana Row in late 2016 and the lease-up of residential units and the opening of Phase II at Assembly Row and Pike & Rose during the second half of 2017, partially offset by lower occupancy at two of our retail properties in Florida in the beginning stages of redevelopment, and |
| • | an increase of $11.8 million from comparable properties due primarily to higher rental rates of approximately $6.9 million, higher recoveries of $4.3 million primarily the result of higher real estate tax assessments, and higher average occupancy of approximately $1.2 million, |
partially offset by
| • | a decrease of $0.9 million from the sale of our 150 Post Street and North Lake Commons properties in August and September 2017, respectively. |
Other Property Income
Other property income decreased $1.8 million, or 16.4%, to $12.8 million in 2017 compared to $11.0 million in 2016. 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 related to higher lease termination fees.
Mortgage Interest Income
Mortgage interest income decreased $0.9 million, or 23.3%, to $3.1 million in 2017 compared to $4.0 million in 2016. This decrease is primarily related to a mortgage note receivable that was repaid in 2016.
Property Expenses
Total property expenses increased $19.1 million, or 7.5%, to $272.7 million in 2017 compared to $253.6 million in 2016. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $6.6 million, or 4.1%, to $164.9 million in 2017 compared to $158.3 million in 2016. This increase is primarily due to the following:
| • | an increase of $5.0 million from acquisitions, primarily related to six shopping centers in Los Angeles County, California, Hastings Ranch Plaza, and Riverpoint Center, and |
| • | an increase of $3.9 million from non-comparable properties, due primarily to the opening of Phase II residential units during the second half of 2017 and the opening of our new office building at Santana Row in late 2016, |
partially offset by,
| • | a decrease of $1.9 million from comparable properties, primarily related to lower operating costs. |
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 to 19.3% for the year ended December 31, 2017 from 19.9% for the year ended December 31, 2016.
Real Estate Taxes
Real estate tax expense increased $12.6 million, or 13.2% to $107.8 million in 2017 compared to $95.3 million in 2016 due primarily to the following:
| • | an increase of $5.0 million from comparable properties primarily due to higher assessments, |
| • | an increase of $4.6 million from acquisitions, primarily related to six shopping centers in Los Angeles County, California, Riverpoint Center, Hastings Ranch Plaza, and the acquisition of six previously unconsolidated Clarion joint venture properties in January 2016, and |
| • | an increase of $3.9 million from non-comparable properties, primarily related to our new office building at Santana Row, Assembly Row and Pike & Rose, and other reassessments on our redevelopments. |
Property Operating Income
Property operating income increased $36.6 million, or 6.7%, to $584.6 million in 2017 compared to $548.0 million in 2016. This increase is primarily due to non-comparable properties, largely the new office building at Santana Row and Assembly Row and Pike & Rose (primarily the lease-up of residential units at Pike & Rose, the opening of the second phase of retail at
Pike & Rose, and higher lease termination fees), 2017 acquisitions, growth in earnings at comparable properties, and the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016.
Other Operating Expense
General and Administrative Expense
General and administrative expense increased $2.9 million, or 8.6%, to $36.3 million in 2017 from $33.4 million in 2016. This increase is primarily due to higher personnel related costs.
Depreciation and Amortization
Depreciation and amortization expense increased $22.5 million, or 11.6%, to $216.1 million in 2017 from $193.6 million in 2016. This increase is primarily due to 2017 acquisitions, non-comparable properties (largely the new office building at Santana Row), and comparable properties.
Operating Income
Operating income increased $11.3 million, or 3.5%, to $332.3 million in 2017 compared to $321.0 million in 2016. This increase is primarily due to the new office building at Santana Row and Assembly Row and Pike & Rose, our 2017 acquisitions and the acquisition of the six previously unconsolidated Clarion joint venture properties in January 2016, and growth in earnings at comparable properties, partially offset by higher personnel related costs.
Other
Interest Expense
Interest expense increased $5.1 million, or 5.4%, to $100.1 million in 2017 compared to $95.0 million in 2016. This increase is due primarily to the following:
| • | an increase of $16.1 million due to higher borrowings primarily attributable to the $300 million 3.25% senior notes and the $100 million reopening of the 4.5% senior notes both issued in June 2017, the 3.625% senior notes issued in July 2016, and higher weighted average borrowings on our revolving credit facility, |
partially offset by
| • | an increase of $7.5 million in capitalized interest, and |
| • | a decrease of $3.5 million due to a lower overall weighted average borrowing rate. |
Gross interest costs were $125.7 million and $113.0 million in 2017 and 2016, respectively. Capitalized interest was $25.6 million and $18.0 million in 2017 and 2016, respectively.
Early Extinguishment of Debt
The $12.3 million early extinguishment of debt in 2017 relates to the make-whole premium paid as part of the early redemption of our 5.90% senior notes on December 31, 2017 and the related write-off of the unamortized discount and debt fees.
Gain on sale of Real Estate and Change in Control of Interests, Net
The $77.9 million net gain on sale of real estate for the year ended December 31, 2017 is primarily due to the following:
| • | $45.2 million gain related to the sale of our 150 Post Street property in August 2017, |
| • | $15.4 million gain related to the sale of three ground lease parcels at our Assembly Row property in Somerville, Massachusetts, |
| • | $6.5 million gain related to the sale of a parcel of land at our Bethesda Row property in December 2017, |
| • | $5.4 million net percentage-of-completion gain, related to residential condominium units under binding contract at our Assembly Row property, and |
| • | $4.9 million gain related to the sale of our North Lake Commons property in September 2017. |
The $32.5 million gain on sale of real estate and change in control of interests for the year ended December 31, 2016 is primarily due to the following:
| • | $25.7 million gain related to our obtaining control of six properties when we acquired Clarion’s 70% interest in the partnership that owned those properties. 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 on obtaining the controlling interest, |
| • | $4.9 million gain related to the reversal of the unused portion of the warranty reserve for condominium units at Santana Row, as the statutorily mandated latent construction defect period ended in third quarter 2016, and |
| • | $1.8 million gain related to the sale of a building in Coconut Grove, Florida. Our share of the gain, net of noncontrolling interests, was $0.5 million. |
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, 2018, we had cash and cash equivalents of $64.1 million and no outstanding balance on our $800.0 million unsecured revolving credit facility which matures on 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. For the year ended 2018, the maximum amount of borrowings outstanding under our revolving credit facility was $177.0 million the weighted average amount of borrowings outstanding was $83.1 million and the weighted average interest rate, before amortization of debt fees, was 2.7%. During 2019, we have only $295.3 million of debt maturing (of which $20.3 million was repaid on January 31, 2019). As of December 31, 2018, we had the capacity to issue up to $272.4 million in common shares under our ATM equity program. We currently believe that cash flows from operations, cash on hand, our ATM 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 2019 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 see higher levels of capital investments in our properties under development and redevelopment compared to 2018, as we invest in the next phase of these projects. With respect to other capital investments related to our existing properties, we expect to incur levels consistent with prior years. Our capital investments will be funded on a short-term basis with cash flow from operations, cash on hand and/or our revolving credit facility, and on a long-term basis, with long-term debt or equity including shares issued under our ATM equity program. If necessary, we may access the debt or equity capital markets to finance significant acquisitions. Given our past ability to access the capital markets, we expect debt or equity to be available to us. Although there is no intent at this time, if market conditions deteriorate, we may also delay the timing of certain development and redevelopment projects as well as limit future acquisitions, reduce our operating expenditures, or re-evaluate our dividend policy.
In addition to conditions in the capital markets which could affect our ability to access those markets, the following factors could affect our ability to meet our liquidity requirements:
| • | restrictions in our debt instruments or preferred shares may limit us from incurring debt or issuing equity at all, or on acceptable terms under then-prevailing market conditions; and |
| • | we may be unable to service additional or replacement debt due to increases in interest rates or a decline in our operating performance. |
Summary of Cash Flows
| Year Ended December 31, | |||||||
| 2018 | 2017 | ||||||
| (In thousands) | |||||||
| Cash provided by operating activities | $ | 516,688 | $ | 458,828 | |||
| Cash used in investing activities | (192,247 | ) | (837,922 | ) | |||
| Cash (used in) provided by financing activities | (241,309 | ) | 369,445 | ||||
| Increase (decrease) in cash and cash equivalents | 83,132 | (9,649 | ) | ||||
| Cash, cash equivalents, and restricted cash, beginning of year | 25,200 | 34,849 | |||||
| Cash, cash equivalents, and restricted cash, end of year | $ | 108,332 | $ | 25,200 |
Net cash provided by operating activities increased $57.9 million to $516.7 million during 2018 from $458.8 million during 2017. The increase was primarily attributable to higher net income before certain non-cash items, $12.4 million in net proceeds from the Jordan Downs Plaza new market tax credit transaction (see Note 3 to the Consolidated Financial Statements for further discussion) and timing of cash receipts, partially offset by timing of interest payments on our senior notes.
Net cash used in investing activities decreased $645.7 million to $192.2 million during 2018 from $837.9 million during 2017. The decrease was primarily attributable to:
| • | a $424.3 million decrease in acquisitions of real estate, primarily due to the 2017 acquisitions of six shopping centers in Los Angeles County, California and our Riverpoint Center, Hastings Ranch, and Fourth Street properties, |
| • | an $141.9 million decrease in capital expenditures and leasing costs primarily due to the completion of portions of Phase II of both our Assembly Row and Pike & Rose projects, |
| • | a $41.7 million increase in proceeds from sale of real estate primarily due to the sale of condominiums at our Assembly Row and Pike & Rose properties in 2018, and |
| • | $38.0 million in proceeds from our Assembly Row hotel joint venture formation (see Note 3 to the Consolidated Financial Statements for further discussion). |
Net cash used in financing activities increased $610.8 million to $241.3 million during 2018 from $369.4 million provided by financing activities during 2017. The increase was primarily attributable to:
| • | $572.1 million net proceeds from the June 2017 issuance of $300.0 million and the December 2017 issuance of $175.0 million of 3.25% senior unsecured notes and $100.0 million of 4.50% notes, |
| • | $145.0 million in net proceeds from the September 2017 issuance of 6,000 Series C Preferred Shares, |
| • | $41.0 million of repayments on our revolving credit facility in 2018, as compared to $41.0 million of borrowings in 2017, |
| • | an $18.2 million increase in dividends paid to shareholders due to an increase in the common share dividend rate, an increase in the number of common shares outstanding, and preferred dividends related to the issuance of our Series C Preferred Shares in September 2017, and |
| • | a $10.6 million decrease in contributions from noncontrolling interests primarily due to contributions to fund the $50.0 million repayment of the Plaza El Segundo mortgage loan in June 2017, |
partially offset by
| • | the December 2017 redemption of $150.0 million of senior notes with a make-whole premium of $11.9 million, |
| • | a $39.7 million decrease in repayment of mortgages and capital leases due to the $10.5 million payoff of the mortgage loan on the Grove at Shrewsbury (West) in March 2018, as compared to the $50.0 million paydown of the Plaza El Segundo mortgage loan in June 2017, and |
| • | a $12.3 million increase in net proceeds from the issuance of 1.0 million common shares under our ATM program at a weighted average price of $129.19 during 2018, as compared to 0.8 million common shares at a weighted average price of $132.56 in 2017, partially offset by lower option exercises in 2018. |
Contractual Commitments
The following table provides a summary of our fixed, noncancelable obligations as of December 31, 2018:
| 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) | $ | 4,225,465 | $ | 133,939 | $ | 552,103 | $ | 814,370 | $ | 2,725,053 | |||||||||
| Fixed and variable rate debt - our share of unconsolidated real estate partnerships (principal and interest) | 62,481 | 28,527 | 12,835 | 21,119 | — | ||||||||||||||
| Capital lease obligations (principal and interest) | 166,085 | 5,800 | 11,600 | 65,823 | 82,862 | ||||||||||||||
| Variable rate debt (principal only)(1) | 275,000 | 275,000 | — | — | — | ||||||||||||||
| Operating leases | 209,121 | 4,794 | 9,622 | 9,902 | 184,803 | ||||||||||||||
| Real estate commitments | 67,500 | — | — | 5,000 | 62,500 | ||||||||||||||
| Development, redevelopment, and capital improvement obligations | 568,226 | 428,061 | 140,165 | — | — | ||||||||||||||
| Contractual operating obligations | 76,709 | 34,053 | 28,195 | 14,461 | — | ||||||||||||||
| Total contractual obligations | $ | 5,650,587 | $ | 910,174 | $ | 754,520 | $ | 930,675 | $ | 3,055,218 |
| (1) | Variable rate debt includes our $275.0 million term loan that bears interest at LIBOR plus 0.90%, and our revolving credit facility, which bears interest at LIBOR plus 0.825% and had no balance outstanding at December 31, 2018. |
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 26.63% 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, 2018, our estimated liability upon exercise of the put option would range from approximately $78 million to $83 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, 2018, a total of 738,423 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, 2018, our estimated maximum liability upon exercise of the put option would range from approximately $13 million to $14 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, 2018, our estimated maximum liability upon exercise of the put option would range from approximately $23 million to $26 million.
(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, 2018, our estimated maximum liability upon exercise of the put option would range from $9 million to $10 million. On January 4, 2019, we acquired a portion of the noncontrolling interest in Brook 35 for $0.8 million, bringing the noncontrolling ownership interest down to 6.5%.
(f) At December 31, 2018, we had letters of credit outstanding of approximately $1.3 million.
Off-Balance Sheet Arrangements
At December 31, 2018, we have three real estate related equity method investments with total debt outstanding of $112.6 million, of which our share is $54.1 million. Our investment in these ventures at December 31, 2018 was $26.9 million.
Other than the items disclosed in the Contractual Commitments Table, we have no off-balance sheet arrangements as of December 31, 2018 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, 2018:
| Description of Debt | Original Debt Issued | Principal Balance as of December 31, 2018 | Stated Interest Rate as of December 31, 2018 | Maturity Date | ||||||||
| (Dollars in thousands) | ||||||||||||
| Mortgages payable | ||||||||||||
| Secured fixed rate | ||||||||||||
| Rollingwood Apartments | 24,050 | $ | 20,331 | 5.54 | % | May 1, 2019 | ||||||
| The Shops at Sunset Place | Acquired | 64,453 | 5.62 | % | September 1, 2020 | |||||||
| 29th Place | Acquired | 4,117 | 5.91 | % | January 31, 2021 | |||||||
| Sylmar Towne Center | Acquired | 17,006 | 5.39 | % | June 6, 2021 | |||||||
| Plaza Del Sol | Acquired | 8,409 | 5.23 | % | December 1, 2021 | |||||||
| THE AVENUE at White Marsh | 52,705 | 52,705 | 3.35 | % | January 1, 2022 | |||||||
| Montrose Crossing | 80,000 | 69,310 | 4.20 | % | January 10, 2022 | |||||||
| Azalea | Acquired | 40,000 | 3.73 | % | November 1, 2025 | |||||||
| Bell Gardens | Acquired | 12,936 | 4.06 | % | August 1, 2026 | |||||||
| Plaza El Segundo | 125,000 | 125,000 | 3.83 | % | June 5, 2027 | |||||||
| The Grove at Shrewsbury (East) | 43,600 | 43,600 | 3.77 | % | September 1, 2027 | |||||||
| Brook 35 | 11,500 | 11,500 | 4.65 | % | July 1, 2029 | |||||||
| Chelsea | Acquired | 5,941 | 5.36 | % | January 15, 2031 | |||||||
| Subtotal | 475,308 | |||||||||||
| Net unamortized premium and debt issuance costs | (929 | ) | ||||||||||
| Total mortgages payable | 474,379 | |||||||||||
| Notes payable | ||||||||||||
| Term Loan | 275,000 | 275,000 | LIBOR + 0.90% | November 21, 2019 | ||||||||
| Revolving credit facility (1) | 800,000 | — | LIBOR + 0.825% | April 20, 2020 | ||||||||
| Various | 7,239 | 4,392 | 11.31 | % | Various through 2028 | |||||||
| Subtotal | 279,392 | |||||||||||
| Net unamortized debt issuance costs | (365 | ) | ||||||||||
| Total notes payable | 279,027 | |||||||||||
| Senior notes and debentures | ||||||||||||
| Unsecured fixed rate | ||||||||||||
| 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 | |||||||
| 3.25% notes | 475,000 | 475,000 | 3.25 | % | July 15, 2027 | |||||||
| 6.82% medium term notes | 40,000 | 40,000 | 6.82 | % | August 1, 2027 | |||||||
| 4.50% notes | 550,000 | 550,000 | 4.50 | % | December 1, 2044 | |||||||
| 3.625% notes | 250,000 | 250,000 | 3.625 | % | August 1, 2046 | |||||||
| Subtotal | 2,419,200 | |||||||||||
| Net unamortized discount and debt issuance costs | (14,921 | ) | ||||||||||
| Total senior notes and debentures | 2,404,279 | |||||||||||
| Capital lease obligations | ||||||||||||
| Various | 71,519 | Various | Various through 2106 | |||||||||
| Total debt and capital lease obligations | $ | 3,229,204 |
| 1) | The maximum amount drawn under our revolving credit facility during 2018 was $177.0 million and the weighted average effective interest rate on borrowings under our revolving credit facility, before amortization of debt fees, was 2.7%. |
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, 2018, we were in compliance with all of the financial and other covenants related to our revolving credit facility, term loan, and senior notes. Additionally, as of December 31, 2018, we were in compliance with all of the financial and other covenants that could trigger loan default on our mortgage loans. If we were to breach any of these financial and other 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, 2018:
| Unsecured | Secured | Capital Lease | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| 2019 | $ | 275,551 | $ | 25,795 | (1) | $ | 46 | $ | 301,392 | |||||||
| 2020 | 613 | (2) | 65,539 | 46 | 66,198 | |||||||||||
| 2021 | 250,682 | 30,541 | 51 | 281,274 | ||||||||||||
| 2022 | 250,758 | 117,018 | 56 | 367,832 | ||||||||||||
| 2023 | 275,787 | 730 | 55,043 | 331,560 | ||||||||||||
| Thereafter | 1,645,201 | 235,685 | 16,277 | 1,897,163 | ||||||||||||
| $ | 2,698,592 | $ | 475,308 | $ | 71,519 | $ | 3,245,419 | (3) |
| 1) | 2019 maturities include a $20.3 million mortgage loan, which was paid off at par on January 31, 2019, prior to its original maturity date. |
| 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, 2018, there was no outstanding balance under this credit facility. |
| 3) | The total debt maturities differ from the total reported on the consolidated balance sheet due to the unamortized net premium/discount and debt issuance costs on mortgage loans, notes payable, and senior notes as of December 31, 2018. |
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.
Interest rate swaps associated with cash flow hedges are recorded at fair value on a recurring basis. Effectiveness of cash flow hedges is assessed both at inception and on an ongoing basis. The effective portion of changes in fair value of the interest rate swaps associated with cash flow hedges is recorded in other comprehensive income (loss) which is included in accumulated other comprehensive income (loss) on the balance sheet and statement of shareholders' equity. 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, the default risk of the counterparty is evaluated by monitoring the credit worthiness of the counterparty which includes reviewing debt ratings and financial performance. If a cash flow hedge is deemed ineffective, the ineffective portion of changes in fair value of the interest rate swaps associated with cash flow hedges is recognized in earnings in the period affected.
Prior to November 1, 2018, we were 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. As of December 31, 2018, our Assembly Row hotel joint venture is a party to two interest rate swap agreements that effectively fix their debt at 5.206%. Both swaps were designated and qualify for cash flow hedge accounting. Hedge ineffectiveness has not impacted earnings in 2018, 2017 and 2016.
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, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| (In thousands, except per share data) | |||||||||||
| Net income | $ | 249,026 | $ | 297,870 | $ | 258,883 | |||||
| Net income attributable to noncontrolling interests | (7,119 | ) | (7,956 | ) | (8,973 | ) | |||||
| Gain on sale of real estate and change in control of interests, net | (11,915 | ) | (77,632 | ) | (31,133 | ) | |||||
| Depreciation and amortization of real estate assets | 213,098 | 188,719 | 169,198 | ||||||||
| Amortization of initial direct costs of leases | 24,603 | 19,124 | 16,875 | ||||||||
| Funds from operations | 467,693 | 420,125 | 404,850 | ||||||||
| Dividends on preferred shares (1) | (7,500 | ) | (1,917 | ) | (541 | ) | |||||
| Income attributable to operating partnership units | 3,053 | 3,143 | 3,145 | ||||||||
| Income attributable to unvested shares | (1,469 | ) | (1,374 | ) | (1,095 | ) | |||||
| Funds from operations available for common shareholders (2) | $ | 461,777 | $ | 419,977 | $ | 406,359 | |||||
| Weighted average number of common shares, diluted (1) | 74,153 | 73,122 | 71,869 | ||||||||
| Funds from operations available for common shareholders, per diluted share (2) | $ | 6.23 | $ | 5.74 | $ | 5.65 |
| (1) | For the year ended December 31, 2018 and 2017, dividends on our Series 1 preferred stock are not deducted in the calculation of FFO available to common shareholders, as the related shares are dilutive and included in "weighted average common shares, diluted." The weighted average common shares used to compute FFO per diluted common share also 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. |
| (2) | If the $12.3 million early extinguishment of debt charge incurred in 2017 was excluded, our FFO available for common shareholders for 2017 would have been $432.2 million, and FFO available for common shareholders, per diluted share would have been $5.91. |
Previous: Item 6. SELECTED FINANCIAL DATA · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK