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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed with the Securities and Exchange Commission on February 13, 2019.
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, 2019, 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 23.7 million square feet. In total, the real estate projects were 94.2% leased and 92.5% occupied at December 31, 2019. We have paid quarterly dividends to our shareholders continuously since our founding in 1962 and have increased our dividends per common share for 52 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
Policy beginning January 1, 2019, with our adoption of Accounting Standards Codification (ASC) 842, "Leases"
Our leases with our tenants are classified as operating leases. When collection of substantially all lease payments during the lease term is considered probable, the lease qualifies for accrual accounting. Lease payments are recognized on a straight-line basis from when the tenant controls the space through the term of the related lease. Variable lease payments relating to percentage rent are recognized at the end of the lease year or earlier if we have determined the required sales level is achieved. 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.
When collection of substantially all lease payments during the lease term is not considered probable, total lease revenue is limited to the lesser of revenue recognized under accrual accounting or cash received. Determining the probability of collection of substantially all lease payments during lease term requires judgment. This determination is impacted by numerous factors including our assessment of the tenant’s credit worthiness, economic conditions, our historical experience with the tenant and tenants operating in the same industry, and the length of the lease term. If leases currently classified as probable are subsequently reclassified as not probable, any outstanding lease receivables (including straight-line rent receivables) would be written-off with a corresponding decrease in rental income. For example, in the event that our collectability determinations were not accurate and we were required to write off additional receivables equaling 1% of rental income, our rental income and net income would decrease by $9.3 million.
Policy prior to January 1, 2019
Prior to January 1, 2019, management estimates of collectability were considered when reserving for billed and accrued lease receivables and straight-line rent receivables. Full and partial reserves were recorded when determined to be appropriate with a corresponding charge to bad debt expense. The primary impact of the adoption of ASC 842, “Leases,” on our recognition of lease revenue relates to the upfront and ongoing assessment of the collectability of substantially all lease payments required by the new standard.
Other revenue recognition policies
When we enter into a transaction to sell a property or a portion of a property, we evaluate the recognition of the sale under ASC 610-20, "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets." In accordance with ASC 610-20, we apply the guidance in ASC 606, "Revenue from Contracts with Customers," to determine whether and when control transfers and how to measure the associated gain or loss. We determine the transaction price based on the consideration we expect to receive. Variable consideration is included in the transaction price to the extent it is probable that a significant reversal of a gain recognized will not occur. We analyze the risk of a significant gain reversal and if necessary limit the amount of variable consideration recognized in order to mitigate this risk. The estimation of variable consideration requires us to make assumptions and apply significant judgment.
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, and 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 $352 million and $9 million, respectively, for 2019 and $274 million and $8 million, respectively, for 2018. We capitalized external and internal costs related to other property improvements of $80 million and $3 million, respectively, for 2019 and $62 million and $3 million, respectively, for 2018. We capitalized external and internal costs related to leasing activities of $24 million and $2 million, respectively, for 2019 and $20 million and $6 million, respectively, for 2018. 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, $3 million, and $2 million, respectively, for 2019 and $7 million, $3 million, and $6 million, respectively, for 2018. Total capitalized costs were $471 million for 2019 and $373 million for 2018, respectively.
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.
Variable Interest Entities (VIEs) and Consolidation
We have 18 entities that meet the criteria of a VIE and are consolidated. Net real estate assets related to VIEs included in our consolidated balance were approximately $1.5 billion for both December 31, 2019 and 2018, and mortgage payables related to VIEs included in our consolidated balance sheets were approximately $469.2 million and $444.4 million, as of December 31, 2019 and 2018, respectively. In addition, we hold equity method investments in two hotel joint ventures and one shopping center which are considered variable interests in a VIE. VIEs are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE has both the power to direct the activities that most significantly impact economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could be significant to the VIE. The
determination of the power to direct the activities that most significantly impact economic performance requires judgment and is impacted by numerous factors including the purpose of the VIE, contractual rights and obligations of variable interest holders, and mechanisms for the resolution of disputes among the variable interest holders.
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.
2019 Property Acquisitions
| Date Acquired | Property | City/State | Gross Leasable Area (GLA) | Purchase Price | |||||||
| (in square feet) | (in millions) | ||||||||||
| February 8, 2019 | Fairfax Junction | Fairfax, Virginia | 75,000 | $ | 22.5 | ||||||
| September 13, 2019 | San Antonio Center | Mountain View, California | 6,000 | $ | 6.5 | ||||||
| November 15, 2019 | Georgetowne Shopping Center | Brooklyn, New York | 147,000 | $ | 83.7 | ||||||
| Various 2019 | Hoboken (37 mixed-use buildings) | Hoboken, New Jersey | 158,000 | $ | 189.2 | (1) |
(1) These acquisitions were completed through a newly formed joint venture, for which we own a 90% interest. This property includes 123 residential units in addition to the GLA in the table above.
2019 Property Dispositions
On December 11, 2019, we received $154.7 million in net proceeds related to the sale under the threat of condemnation of 11.7 acres of San Antonio Center to a local school district ("the condemning authority"). As part of the transaction, the condemning authority will commence condemnation proceedings in order to terminate all existing leases they assumed at closing. We have indemnified the condemning authority for all costs incurred related to the condemnation proceedings including any payments required to tenants at the property and expect the process will take several years to complete. The consideration in the transaction is considered variable because we have agreed to indemnify the condemning authority for these costs. Consequently, we have recorded a liability of $45.5 million to reflect our estimate of the final consideration, net of estimated condemnation proceeding costs and other transaction related costs. The resulting net gain on sale is approximately $85.1 million.
During the year ended December 31, 2019, we sold three properties and one land parcel for a net sales price of $149.0 million, which resulted in a net gain of $28.3 million.
During the year ended December 31, 2019, we closed on the sale of 43 condominium units at our Assembly Row and Pike & Rose properties (combined), received proceeds net of closing costs of $20.1 million, and recognized a gain of $2.6 million, net of income taxes. The cost basis for the remaining condominium units as of December 31, 2019 is $1.7 million, and is included in "assets held for sale" on our consolidated balance sheets.
2019 Significant Debt and Equity Transactions
On January 31, 2019, we repaid the $20.3 million mortgage loan on Rollingwood Apartments, at par, prior to its original maturity date.
On June 7, 2019, we issued $300.0 million of fixed rate senior unsecured notes that mature on June 15, 2029 and bear interest at 3.20%. The notes were offered at 99.838% of the principal amount with a yield to maturity of 3.219%. On August 21, 2019, we issued an additional $100.0 million senior notes of the same series and with the same terms. The August notes were offered at 103.813% of the principal amount, with a yield to maturity of 2.744%. The combined net proceeds from the note offerings after net issuance premium, underwriting fees, and other costs were $399.9 million, which were primarily used to repay our $275.0 million unsecured term loan, at par, on June 7, 2019 and for general corporate purposes.
On July 25, 2019, we amended our revolving credit facility to increase our borrowing capacity to $1.0 billion and extend the maturity date to January 19, 2024, plus two six-month extensions at our option. Under the amended facility, the spread over LIBOR is 77.5 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.
In connection with our Hoboken, New Jersey acquisitions in 2019, we assumed mortgage loans with a face amount of $41.6 million and a fair value of $42.9 million, and entered into a new mortgage loan with a face amount of $56.5 million. The mortgage loans associated with our Hoboken acquisitions have the following contractual terms:
| Principal | Stated Interest Rate | Maturity Date | |||||||||
| (in millions) | |||||||||||
| September 18, 2019 (date assumed) | $ | 17.0 | 3.75 | % | July 1, 2042 | ||||||
| November 26, 2019 (date originated) | $ | 56.5 | LIBOR + 1.95% | (1) | December 15, 2029 | ||||||
| November 26, 2019 (date assumed) | $ | 5.7 | Various | (2) | Various | (2) | |||||
| December 19, 2019 (date assumed) | $ | 18.9 | Various | (3) | Various | (3) |
| (1) | The interest rate is effectively fixed at 3.67% as a result of two interest rate swap agreements. |
| (2) | The interest rates on these mortgages range from 3.91% to 5.00% and have maturity dates ranging from January 9, 2025 to May 31, 2029. |
| (3) | The interest rates on these mortgages range from 4.00% to 4.38% and have maturity dates ranging from October 1, 2025 to July 1, 2026. |
On August 2, 2019, we acquired the 10.1% redeemable noncontrolling interest in the partnership that owns our Montrose Crossing Shopping Center for $10.0 million, bringing our ownership interest to 100%.
We have an at-the-market (“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 year ended December 31, 2019, we sold 1,069,699 common shares at a weighted average
price per share of $134.71 for net cash proceeds of $142.7 million and paid $1.2 million in commissions and $0.2 million in additional offering expenses related to the sales of these common shares. As of December 31, 2019, we had the capacity to issue up to $128.3 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 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 relatively 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 vacating prior to the end of their lease term 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, 2019, no single tenant accounted for more than 2.6% 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 $315 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 20,000 square feet of retail space and 1,300 parking spaces. The building is expected to cost between $210 million and $220 million, to be delivered in 2020, and the office portion is 100% 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, and we are proceeding with the first phase of construction on this land, which includes an eight story 376,000 square foot office building, with over 1,700 parking spaces. The building is expected to cost between $250 million and $270 million, with openings beginning in 2022. In addition, the land also has approximately 604,000 square feet of remaining commercial space entitlements.
Phase II of Assembly Row 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). As of December 31, 2019, Phase II is substantially complete with expected final costs of $298 million to $302 million. Phase II also included 122 for-sale condominium units, which had a total cost of $81 million and have all have been sold as of December 31, 2019.
Additionally, we are under 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 2021.
Phase II of Pike & Rose includes approximately 219,000 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), and is substantially complete as of December 31, 2019. The total cost for this portion of Phase II was $208 million. As of December 31, 2019, we closed on the sale of 97 of the 99 for-sale condominium units in Phase II. The condominiums had a final 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 2020.
We invested $258 million in Assembly Row, Pike & Rose, and Santana Row in 2019, net of public funding, and expect to invest between $320 million and $350 million in Assembly Row, Pike & Rose, and Santana Row in 2020.
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, 2019, the leasable square feet in our properties was 94.2% leased and 92.5% 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, 2019 and the comparison of 2019 and 2018, all or a portion of 95 properties were considered comparable properties and eight properties were considered non-comparable properties. For the year ended December 31, 2019, seven properties were moved from acquisitions to comparable properties, two properties were removed from comparable properties as they were sold during 2019, one property was moved from acquisitions 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, 2018. 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, 2019 COMPARED TO YEAR ENDED DECEMBER 31, 2018
| Change | ||||||||||||||
| 2019 | 2018 | Dollars | % | |||||||||||
| (Dollar amounts in thousands) | ||||||||||||||
| Rental income | $ | 932,738 | $ | 912,287 | $ | 20,451 | 2.2 | % | ||||||
| Mortgage interest income | 3,050 | 3,149 | (99 | ) | (3.1 | )% | ||||||||
| Total property revenue | 935,788 | 915,436 | 20,352 | 2.2 | % | |||||||||
| Rental expenses | 187,831 | 173,094 | 14,737 | 8.5 | % | |||||||||
| Real estate taxes | 110,927 | 114,776 | (3,849 | ) | (3.4 | )% | ||||||||
| Total property expenses | 298,758 | 287,870 | 10,888 | 3.8 | % | |||||||||
| Property operating income (1) | 637,030 | 627,566 | 9,464 | 1.5 | % | |||||||||
| General and administrative expense | (42,754 | ) | (33,600 | ) | (9,154 | ) | 27.2 | % | ||||||
| Depreciation and amortization | (239,758 | ) | (244,245 | ) | 4,487 | (1.8 | )% | |||||||
| Gain on sale of real estate, net | 116,393 | 11,915 | 104,478 | 876.9 | % | |||||||||
| Operating income | 470,911 | 361,636 | 109,275 | 30.2 | % | |||||||||
| Other interest income | 1,266 | 942 | 324 | 34.4 | % | |||||||||
| Interest expense | (109,623 | ) | (110,154 | ) | 531 | (0.5 | )% | |||||||
| Loss from partnerships | (2,012 | ) | (3,398 | ) | 1,386 | (40.8 | )% | |||||||
| Total other, net | (110,369 | ) | (112,610 | ) | 2,241 | (2.0 | )% | |||||||
| Net income | 360,542 | 249,026 | 111,516 | 44.8 | % | |||||||||
| Net income attributable to noncontrolling interests | (6,676 | ) | (7,119 | ) | 443 | (6.2 | )% | |||||||
| Net income attributable to the Trust | $ | 353,866 | $ | 241,907 | $ | 111,959 | 46.3 | % |
(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 $20.4 million, or 2.2%, to $935.8 million in 2019 compared to $915.4 million in 2018. The percentage occupied at our shopping centers was 92.5% at December 31, 2019 compared to 93.6% at December 31, 2018. 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 $20.5 million, or 2.2%, to $932.7 million in 2019 compared to $912.3 million in 2018 due primarily to the following:
| • | an increase of $14.9 million at comparable properties due primarily to higher rental rates of approximately $11.8 million, higher lease termination fees and legal fee income of $7.6 million, and higher average occupancy of approximately $2.8 million, partially offset by a $4.4 million decrease in real estate tax recoveries primarily due to the requirements of the new lease accounting standard, and $2.5 million related to collectibility adjustments, which are now being presented as a reduction of rental income rather than rental expense (see Note 2 for additional disclosure) |
| • | an increase of $9.2 million at non-comparable properties due primarily to the opening of Phase II at Assembly Row and Pike & Rose partially offset by redevelopment related occupancy decreases at three properties, and |
| • | an increase of $3.9 million from acquisitions, primarily Fairfax Junction in February 2019, Hoboken during the second half of 2019, and Georgetowne Shopping Center in November 2019, |
partially offset by
| • | a decrease of $8.4 million from property sales. |
Property Expenses
Total property expenses increased $10.9 million, or 3.8%, to $298.8 million in 2019 compared to $287.9 million in 2018. Changes in the components of property expenses are discussed below.
Rental Expenses
Rental expenses increased $14.7 million, or 8.5%, to $187.8 million in 2019 compared to $173.1 million in 2018. This increase is primarily due to the following:
| • | an $11.9 million charge in 2019 related to the buyout of a lease at Assembly Square Marketplace, |
| • | an increase of $1.9 million from comparable properties due primarily to a $5.2 million increase in repairs and maintenance costs partially offset by a $4.2 million decrease in bad debt expense due to the new lease accounting standard requirement to record collectibility adjustments as a reduction to revenue rather than rental expense effective at adoption on January 1, 2019, |
| • | an increase of $1.2 million from non-comparable properties due primarily to the opening of Phase II at Assembly Row and Pike & Rose, partially offset by lower expenses at two of our properties, and |
| • | an increase of $0.8 million from acquisitions, |
partially offset by
| • | a decrease of $1.4 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 increased to 20.1% for the year ended December 31, 2019 from 19.0% for the year ended December 31, 2018.
Real Estate Taxes
Real estate tax expense decreased $3.8 million, or 3.4% to $110.9 million in 2019 compared to $114.8 million in 2018 due primarily to the following:
| • | a decrease of $3.2 million from comparable properties due primarily to the new lease accounting standard requirement, which no longer permits the gross up of real estate tax revenue and expense for real estate taxes that our tenants pay directly to the taxing authority (see Note 2 for additional disclosure) of $5.0 million and a tax refund from a multi-year appeal and reassessment for three of our properties, partially offset by higher assessments, and |
| • | a decrease of $1.8 million from property sales, |
partially offset by
| • | an increase of $0.7 million from acquisitions, and |
| • | an increase of $0.5 million at non-comparable properties due primarily to increases in assessments as a result of our redevelopment activities. |
Property Operating Income
Property operating income increased $9.5 million, or 1.5%, to $637.0 million in 2019 compared to $627.6 million in 2018. This increase is primarily due to growth in earnings at comparable properties, the opening of Phase II at Assembly Row and Pike & Rose, and our 2019 acquisitions, partially offset by the charge related to the buyout of a lease at Assembly Square Marketplace, and property sales.
Other Operating
General and Administrative Expense
General and administrative expense increased $9.2 million, or 27.2%, to $42.8 million in 2019 from $33.6 million in 2018. This increase is due primarily to higher leasing related costs as certain costs can no longer be capitalized as a result of the new lease accounting standard (see Note 2 for additional disclosure) and higher personnel costs.
Depreciation and Amortization
Depreciation and amortization expense decreased $4.5 million, or 1.8%, to $239.8 million in 2019 from $244.2 million in 2018. This decrease is primarily due to lower accelerated depreciation related to tenants who vacated in advance of their lease expiration and property sales, partially offset by Phase II of Assembly Row and Pike & Rose being placed in service and our 2019 acquisitions.
Gain on Sale of Real Estate, Net
The $116.4 million gain on sale of real estate, net for the year ended December 31 2019 is primarily due to the following:
| • | $85.1 million related to the sale under the threat of condemnation of 11.7 acres of San Antonio Center, |
| • | $28.3 million related to the sale of three properties and one land parcel, |
| • | $2.6 million net gain related to condominium unit sales that have closed at our Assembly Row and Pike & Rose properties. |
The $11.9 million gain on sale of real estate, net 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, |
| • | $4.7 million gain related to the sale of one property and the residential building at another one of our properties |
Operating Income
Operating income increased $109.3 million, or 30.2%, to $470.9 million in 2019 compared to $361.6 million in 2018. This increase is due primarily to higher gains on the sale of real estate in 2019, growth in earnings at our comparable properties, and the opening of Phase II of Assembly Row and Pike & Rose, partially offset by the charge related to the buyout of a lease at Assembly Square Marketplace, higher leasing and personnel related costs, and property sales.
Other
Interest Expense
Interest expense decreased $0.5 million, or 0.5%, to $109.6 million in 2019 compared to $110.2 million in 2018. This decrease is due primarily to a $1.6 million increase in capitalized interest partially offset by a $1.1 million increase due to a higher weighted average borrowing rate in 2019.
Gross interest costs were $130.1 million and $129.0 million in 2019 and 2018, respectively. Capitalized interest was $20.5 million and $18.8 million in 2019 and 2018, respectively.
Loss from Partnerships
Loss from partnerships decreased to $2.0 million in 2019 compared to $3.4 million in 2018. This decrease is due primarily to improved operating results at our Assembly Row and Pike & Rose hotel joint ventures, which opened in August 2018 and March 2018, respectively.
Discussions of year-to-year comparisons between 2018 and 2017 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed with the Securities and Exchange Commission on February 13, 2019.
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, 2019, we had cash and cash equivalents of $127.4 million and no outstanding balance on our unsecured revolving credit facility. For the year ended 2019, the maximum amount of borrowings outstanding under our revolving credit facility was $116.5 million, the weighted average amount of borrowings outstanding was $26.8 million, and the weighted average interest rate, before amortization of debt fees, was 3.2%.
On June 7, 2019, we issued $300.0 million of fixed rate senior unsecured notes that mature on June 15, 2029 and bear interest at 3.20%. On August 21, 2019, we issued an additional $100.0 million senior notes of the same series and with the same terms.
The combined net proceeds of $399.9 million were primarily used to repay our $275.0 million unsecured term loan, which was scheduled to mature in November 2019. During 2020, we have only $60.6 million of debt maturing.
On July 25, 2019, we amended our revolving credit facility to increase our borrowing capacity from $800.0 million to $1.0 billion, lower our spread over LIBOR from 82.5 basis points to 77.5 basis points, and extend the maturity date to January 19, 2024, plus 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.
During 2019, we raised $142.7 million under our ATM equity program after fees and other costs, and as of December 31, 2019, we had the capacity to issue up to $128.3 million in common shares under the ATM 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 2020 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 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, as we continue to 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, | |||||||
| 2019 | 2018 | ||||||
| (In thousands) | |||||||
| Cash provided by operating activities | $ | 461,919 | $ | 516,688 | |||
| Cash used in investing activities | (316,532 | ) | (192,247 | ) | |||
| Cash used in financing activities | (100,105 | ) | (241,309 | ) | |||
| Increase in cash and cash equivalents | 45,282 | 83,132 | |||||
| Cash, cash equivalents, and restricted cash, beginning of year | 108,332 | 25,200 | |||||
| Cash, cash equivalents, and restricted cash, end of year | $ | 153,614 | $ | 108,332 |
Net cash provided by operating activities decreased $54.8 million to $461.9 million during 2019 from $516.7 million during 2018. The decrease was primarily attributable to the $14.5 million lease buyout payment at Assembly Square Marketplace in August 2019, $12.4 million in net proceeds in 2018 from the Freedom Plaza new market tax credit transaction (see Note 3 to the Consolidated Financial Statements for further discussion), and the timing of cash receipts.
Net cash used in investing activities increased $124.3 million to $316.5 million during 2019 from $192.2 million during 2018. The increase was primarily attributable to:
| • | a $191.0 million increase in acquisitions of real estate, primarily due to the acquisitions of Georgetowne Shopping Center, 37 mixed-use buildings in Hoboken, New Jersey, and Fairfax Junction in 2019, |
| • | a $41.7 million increase in capital expenditures as we continue to invest in Pike & Rose, Assembly Row, Santana Row and other redevelopments, and |
| • | $38.0 million in proceeds from our Assembly Row hotel joint venture formation in 2018, |
partially offset by
| • | a $144.2 million increase in proceeds from sales of real estate, resulting from the sale under the threat of condemnation of a portion of San Antonio Center in December 2019 and the sale of three additional properties in 2019 compared to two properties in 2018, partially offset by a decrease in the sale of condominiums at our Assembly Row and Pike & Rose properties. |
Net cash used in financing activities decreased $141.2 million to $100.1 million during 2019 from $241.3 million during 2018. The decrease was primarily attributable to:
| • | $399.9 million in net proceeds from the issuance of $300.0 million of 3.20% senior unsecured notes in June 2019 and an additional $100.0 million of the same series in August 2019, |
| • | $41.0 million of repayments on our revolving credit facility in 2018 partially offset by $4.0 million of costs related to the July 2019 amendment, and |
| • | a $12.1 million increase in net proceeds from the issuance of 1.1 million common shares under our ATM program at a weighted average price of $134.71 during 2019, as compared to 1.0 million common shares at a weighted average price of $129.19 in 2018, |
partially offset by
| • | a $284.4 million increase in repayment of mortgages, finance leases, and notes payable primarily due to the payoff of our $275.0 million unsecured term loan in June 2019 and the $20.3 million payoff of the mortgage loan on Rollingwood Apartments in January 2019, as compared to the $10.5 million payoff of the mortgage loan on the Grove at Shrewsbury (West) in March 2018, and |
| • | a $12.5 million increase in dividends paid to shareholders due to an increase in the common share dividend rate and an increase in the number of common shares outstanding. |
Contractual Commitments
The following table provides a summary of our fixed, noncancelable obligations as of December 31, 2019:
| 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) | $ | 4,747,178 | $ | 189,669 | $ | 875,132 | $ | 764,264 | $ | 2,918,113 | |||||||||
| Fixed and variable rate debt - our share of unconsolidated real estate partnerships (principal and interest) | 60,492 | 28,453 | 12,356 | 19,683 | — | ||||||||||||||
| Finance lease obligations (principal and interest) | 160,285 | 5,800 | 11,610 | 61,026 | 81,849 | ||||||||||||||
| Variable rate debt (principal only)(2) | — | — | — | — | — | ||||||||||||||
| Operating leases | 204,439 | 4,824 | 9,780 | 9,939 | 179,896 | ||||||||||||||
| Real estate commitments | 67,500 | — | — | 5,000 | 62,500 | ||||||||||||||
| Development, redevelopment, and capital improvement obligations | 572,422 | 300,520 | 271,880 | 22 | — | ||||||||||||||
| Contractual operating obligations | 59,081 | 29,026 | 24,809 | 5,126 | 120 | ||||||||||||||
| Total contractual obligations | $ | 5,871,397 | $ | 558,292 | $ | 1,205,567 | $ | 865,060 | $ | 3,242,478 |
| (1) | Fixed rate debt includes a $56.5 million mortgage loan that has a rate that is effectively fixed by two interest rate swap agreements. |
| (2) | Variable rate debt includes our revolving credit facility, which bears interest at LIBOR + 0.775% and had no balance outstanding at December 31, 2019. |
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, 2019, our estimated liability upon exercise of the put option would range from approximately $79 million to $84 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, 2019, a total of 609,584 operating partnership units are outstanding.
(c) 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, 2019, our estimated maximum liability upon exercise of the put option would range from approximately $30 million to $33 million.
(d) The other member in The Grove at Shrewsbury and Brook 35 has the right to require us to purchase all of its approximately 4.1% interest in The Grove at Shrewsbury and approximately 6.5% 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, 2019, our estimated maximum liability upon exercise of the put option would range from $7 million to $8 million.
(e) Effective September 18, 2023, the other member in Hoboken has the right to require us to purchase all of its 10% ownership interest at the interest's then-current fair market value. Based on management's current estimate of fair market value as of December 31, 2019, our estimated maximum liability upon exercise of the put option would range from $9 million to $10 million.
(f) At December 31, 2019, we had letters of credit outstanding of approximately $4.3 million.
(g) In connection with our sale under the threat of condemnation of a portion of San Antonio Center, we agreed to indemnify the condemning authority for costs including any payments required to be paid to tenants at the property, in connection with the actual condemnation. We expect the condemnation process to take several years and estimate these costs to be approximately $45.5 million.
Off-Balance Sheet Arrangements
At December 31, 2019, we have three real estate related equity method investments with total debt outstanding of $111.1 million, of which our share is $54.0 million. Our investment in these ventures at December 31, 2019 was $23.4 million.
Other than the items disclosed in the Contractual Commitments Table, we have no off-balance sheet arrangements as of December 31, 2019 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, 2019:
| Description of Debt | Original Debt Issued | Principal Balance as of December 31, 2019 | Stated Interest Rate as of December 31, 2019 | Maturity Date | ||||||||
| (Dollars in thousands) | ||||||||||||
| Mortgages payable | ||||||||||||
| Secured fixed rate | ||||||||||||
| The Shops at Sunset Place | Acquired | $ | 61,987 | 5.62 | % | September 1, 2020 | ||||||
| 29th Place | Acquired | 3,878 | 5.91 | % | January 31, 2021 | |||||||
| Sylmar Towne Center | Acquired | 16,630 | 5.39 | % | June 6, 2021 | |||||||
| Plaza Del Sol | Acquired | 8,230 | 5.23 | % | December 1, 2021 | |||||||
| THE AVENUE at White Marsh | 52,705 | 52,705 | 3.35 | % | January 1, 2022 | |||||||
| Montrose Crossing | 80,000 | 67,492 | 4.20 | % | January 10, 2022 | |||||||
| Azalea | Acquired | 40,000 | 3.73 | % | November 1, 2025 | |||||||
| Bell Gardens | Acquired | 12,677 | 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 | |||||||
| Hoboken (24 Buildings) (1) | 56,450 | 56,450 | LIBOR + 1.95% | December 15, 2029 | ||||||||
| Various Hoboken (12 Buildings) | Acquired | 24,627 | Various (3) | Various through 2029 | ||||||||
| Chelsea | Acquired | 5,597 | 5.36 | % | January 15, 2031 | |||||||
| Hoboken (1 Building) (2) | Acquired | 16,874 | 3.75 | % | July 1, 2042 | |||||||
| Subtotal | 547,247 | |||||||||||
| Net unamortized premium and debt issuance costs | (1,568 | ) | ||||||||||
| Total mortgages payable | 545,679 | |||||||||||
| Notes payable | ||||||||||||
| Revolving credit facility (4) | 1,000,000 | — | LIBOR + 0.775% | January 19, 2024 | ||||||||
| Various | 7,239 | 3,843 | 11.31 | % | Various through 2028 | |||||||
| Subtotal | 3,843 | |||||||||||
| Net unamortized debt issuance costs | (62 | ) | ||||||||||
| Total notes payable | 3,781 | |||||||||||
| 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 | |||||||
| 3.20% notes | 400,000 | 400,000 | 3.20 | % | June 15, 2029 | |||||||
| 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 | 2,819,200 | |||||||||||
| Net unamortized discount and debt issuance costs | (12,066 | ) | ||||||||||
| Total senior notes and debentures | 2,807,134 | |||||||||||
| Total debt, net | $ | 3,356,594 |
| 1) | On November 26, 2019, we entered into two interest rate swap agreements that fix the interest rate on the mortgage loan at 3.67%. |
| 2) | This mortgage loan has a fixed interest rate, however, the rate resets every five years until maturity. The current interest rate is fixed until July 1, 2022, and the loan is prepayable at par anytime after this date. |
| 3) | The interest rates on these mortgages range from 3.91% to 5.00%. |
| 4) | The maximum amount drawn under our revolving credit facility during 2019 was $116.5 million and the weighted average effective interest rate on borrowings under our revolving credit facility, before amortization of debt fees, was 3.2%. |
Our revolving credit facility and other debt agreements include financial and other covenants that may limit our operating activities in the future. As of December 31, 2019, we were in compliance with all of the financial and other covenants related to our revolving credit facility and senior notes. Additionally, as of December 31, 2019, 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 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, 2019:
| Unsecured | Secured | Total | ||||||||||
| (In thousands) | ||||||||||||
| 2020 | $ | 613 | $ | 66,252 | $ | 66,865 | ||||||
| 2021 | 250,680 | 31,519 | 282,199 | |||||||||
| 2022 | 250,756 | 119,460 | 370,216 | |||||||||
| 2023 | 275,775 | 3,293 | 279,068 | |||||||||
| 2024 | 300,665 | (1) | 3,421 | 304,086 | ||||||||
| Thereafter | 1,744,554 | 323,302 | 2,067,856 | |||||||||
| $ | 2,823,043 | $ | 547,247 | $ | 3,370,290 | (2) |
| 1) | Our $1.0 billion revolving credit facility matures on January 19, 2024, plus two six-month extensions at our option. As of December 31, 2019, there was no outstanding balance under this credit facility. |
| 2) | 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, 2019. |
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.
During 2019, we entered into two interest rate swap agreements that effectively fix the interest rate on a mortgage payable associated with our Hoboken acquisition at 3.67%. Our Assembly Row hotel joint venture is also a party to two interest rate swap agreements that effectively fix the interest rate on the joint venture's mortgage debt at 5.206%. All swaps were designated and qualify as cash flow hedges. Hedge ineffectiveness has not impacted our earnings in 2019, 2018 and 2017.
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, 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, | |||||||||||
| 2019 | 2018 | 2017 | |||||||||
| (In thousands, except per share data) | |||||||||||
| Net income | $ | 360,542 | $ | 249,026 | $ | 297,870 | |||||
| Net income attributable to noncontrolling interests | (6,676 | ) | (7,119 | ) | (7,956 | ) | |||||
| Gain on sale of real estate and change in control of interests, net | (116,393 | ) | (11,915 | ) | (77,632 | ) | |||||
| Depreciation and amortization of real estate assets | 215,139 | 213,098 | 188,719 | ||||||||
| Amortization of initial direct costs of leases | 19,359 | 24,603 | 19,124 | ||||||||
| Funds from operations | 471,971 | 467,693 | 420,125 | ||||||||
| Dividends on preferred shares | (7,500 | ) | (7,500 | ) | (1,917 | ) | |||||
| Income attributable to operating partnership units | 2,703 | 3,053 | 3,143 | ||||||||
| Income attributable to unvested shares | (1,355 | ) | (1,469 | ) | (1,374 | ) | |||||
| Funds from operations available for common shareholders (1) | $ | 465,819 | $ | 461,777 | $ | 419,977 | |||||
| Weighted average number of common shares, diluted (2) | 75,514 | 74,153 | 73,122 | ||||||||
| Funds from operations available for common shareholders, per diluted share (1) | $ | 6.17 | $ | 6.23 | $ | 5.74 |
| (1) | For the year ended December 31, 2019, FFO available for common shareholders includes an $11.9 million charge relating to the buyout of a lease at Assembly Square Marketplace. If this charge was excluded, our FFO available for common shareholders for 2019 would have been $477.7 million, and FFO available for common shareholders, per diluted share would have been $6.33. For the year ended December 31, 2017, FFO available for common shareholders includes a $12.3 million charge related to early extinguishment of debt. If this charge 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. |
| (2) | 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. |
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