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| PSB > SEC Filings for PSB > Form 10-Q on 4-Nov-2008 | All Recent SEC Filings |
4-Nov-2008
Quarterly Report
In determining the fair value of the tangible assets of the acquired properties,
management considers the value of the properties as if vacant as of the
acquisition date. Management must make significant assumptions in determining
the value of assets acquired and liabilities assumed. Using different
assumptions in the allocation of the purchase cost of the acquired properties
would affect the timing of recognition of the related revenue and expenses.
Amounts allocated to land are derived from comparable sales of land within the
same region. Amounts allocated to buildings and improvements, tenant
improvements and unamortized lease commissions are based on current market
replacement costs and other market rate information.
The value allocable to the above-market or below-market in-place lease values of
acquired properties is determined based upon the present value (using a discount
rate which reflects the risks associated with the acquired leases) of the
difference between (i) the contractual rents to be paid pursuant to the in-place
leases, and (ii) management's estimate of fair market lease rates for the
corresponding in-place leases, measured over a period equal to the remaining
non-cancelable term of the lease. The amounts allocated to above-market or
below-market leases are included in other assets or other liabilities in the
accompanying consolidated balance sheets and are amortized on a straight-line
basis as an increase or reduction of rental income over the remaining
non-cancelable term of the respective leases.
Allowance for Doubtful Accounts: Rental revenue from our tenants is our
principal source of revenue. We monitor the collectibility of our receivable
balances including the deferred rent receivable on an ongoing basis. Based on
these reviews, we maintain an allowance for doubtful accounts for estimated
losses resulting from the possible inability of our tenants to make required
rent payments to us. Tenant receivables and deferred rent receivables are
carried net of the allowances for uncollectible tenant receivables and deferred
rent. As discussed below, determination of the adequacy of these allowances
requires significant judgments and estimates. Our estimate of the required
allowance is subject to revision as the factors discussed below change and is
sensitive to the effect of economic and market conditions on our tenants.
Tenant receivables consist primarily of amounts due for contractual lease
payments, reimbursements of common area maintenance expenses, property taxes and
other expenses recoverable from tenants. Determination of the adequacy of the
allowance for uncollectible current tenant receivables is performed using a
methodology that incorporates specific identification, aging analysis, an
overall evaluation of the historical loss trends and the current economic and
business environment. The specific identification methodology relies on factors
such as the age and nature of the receivables, the payment history and financial
condition of the tenant, the assessment of the tenant's ability to meet its
lease obligations, and the status of negotiations of any disputes with the
tenant. The allowance also includes a reserve based on historical loss trends
not associated with any specific tenant. This reserve as well as the specific
identification reserve is reevaluated quarterly based on economic conditions and
the current business environment.
Deferred rent receivable represents the amount that the cumulative straight-line
rental income recorded to date exceeds cash rents billed to date under the lease
agreement. Given the long-term nature of these types of receivables,
determination of the adequacy of the allowance for unbilled deferred rent
receivable is based primarily on historical loss experience. Management
evaluates the allowance for unbilled deferred rent receivable using a specific
identification methodology for significant tenants designed to assess their
financial condition and ability to meet their lease obligations.
Impairment of Long-Lived Assets: The Company evaluates a property for potential
impairment whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable. On a quarterly basis, we evaluate our
whole portfolio for impairment based on current operating information. In the
event that these periodic assessments reflect that the carrying amount of a
property exceeds the sum of the undiscounted cash flows (excluding interest)
that are expected to result from the use and eventual disposition of the
property, the Company would recognize an impairment loss to the extent the
carrying amount exceeded the estimated fair value of the property. The
estimation of expected future net cash flows is inherently uncertain and relies
on subjective assumptions dependent upon future and current market conditions
and events that affect the ultimate value of the property. Management must make
assumptions related to the property such as future rental rates, tenant
allowances, operating expenditures, property taxes, capital improvements,
occupancy levels and the estimated proceeds generated from the future sale of
the property. These assumptions could differ materially from actual results in
future periods. Since SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," provides that the future cash flows used in this analysis
be considered on an undiscounted basis, our intent to hold properties over the
long-term directly decreases the likelihood of recording an impairment loss. If
our strategy changes or if market conditions otherwise dictate an earlier sale
date, an impairment loss could be recognized, and such loss could be material.
Depreciation: We compute depreciation on our buildings and equipment using the
straight-line method based on estimated useful lives of generally 30 and five
years, respectively. A significant portion of the acquisition cost of each
property is allocated to building and building components. The allocation of the
acquisition cost to building and building components, as well as the
determination of their useful lives are based on estimates. If we do not
appropriately allocate to these components or we incorrectly estimate the useful
lives of these components, our computation of depreciation expense may not
appropriately reflect the actual impact of these costs over future periods,
which will affect net income. In addition, the net book value of real estate
assets could be overstated or understated. The statement of cash flows, however,
would not be affected.
Accruals of Operating Expenses: The Company accrues for property tax expenses,
performance bonuses and other operating expenses each quarter based on
historical trends and anticipated disbursements. If these estimates are
incorrect, the timing and amount of expense recognized will be affected.
Accruals for Contingencies: The Company is exposed to business and legal
liability risks with respect to events that may have occurred, but in accordance
with U.S. generally accepted accounting principles ("GAAP") has not accrued for
such potential liabilities because the loss is either not probable or not
estimable. Future events and the result of pending litigation could result in
such potential losses becoming probable and estimable, which could have a
material adverse impact on our financial condition or results of operations.
Effect of Economic Conditions on the Company's Operations:
During the first nine months of 2008, the weakening economic conditions were
reflected in commercial real estate as the Company experienced a decrease in new
rental rates over expiring rents. It is uncertain what impact a recession or
similar economic conditions may have on the Company's ability to maintain high
occupancy levels and increase rents. While the Company has not experienced a
significant impact from the slowed economy, conditions may change and the
Company may be impacted by lower occupancy and a reduced ability to raise rents.
While the Company historically has experienced a low level of write-offs due to
bankruptcy, there is inherent uncertainty in a tenant's ability to continue
paying rent when in bankruptcy. As of September 30, 2008, the Company had
approximately 18,000 square feet occupied by tenants that are protected by
Chapter 11 of the U.S. Bankruptcy Code. Given the historical uncertainty of
these tenants' ability to meet their lease obligations, we will continue to
reserve any income that would have been realized on a straight-line basis.
Several other tenants have contacted us, requesting early termination of their
lease, reduction in space under lease, rent deferment or abatement. At this
time, the Company cannot anticipate what impact, if any, the ultimate outcome of
these discussions will have on our operating results.
Company Performance and Effect of Economic Conditions on Primary Markets:
The Company's operations are substantially concentrated in 10 regions. Current
market conditions for each region are summarized below. During the nine months
ended September 30, 2008, rental rates on new and renewed leases within the
Company's overall portfolio decreased 0.1% over expiring rents. Excluding a
45,000 square foot lease executed during the third quarter of 2008 on a space in
Northern California, rental rates on new and renewed leases would have increased
1.5%. The Company has compiled the market occupancy information set forth below
using third party reports for each respective market. The Company considers
these sources to be reliable, but there can be no assurance that the information
in these reports is accurate.
The Company owns approximately 4.0 million square feet in Southern California.
Market vacancies have increased primarily due to the number of sub-prime
lenders, mortgage brokers and other related businesses that have vacated office
space, creating significantly more competition for tenants. These vacancies have
had less of an impact on flex space, which comprises approximately 63.7% of the
Company's Southern California portfolio. Vacancy rates in Southern California
range from 2.5% to 15.9%. The Company's vacancy rate in this region at
September 30, 2008 was 7.2%. For the nine months ended September 30, 2008, the
overall market experienced negative net absorption of 0.4% attributed to the
mortgage and housing-related companies as well as newly constructed space
completed during 2008. The Company's weighted average occupancy for the region
decreased from 94.8% for the first nine months in 2007 to 93.5% for the first
nine months in 2008. Annualized realized rent per square foot increased 2.6%
from $16.98 per square foot for the first nine months in 2007 to $17.42 per
square foot for the first nine months in 2008. Although these markets continue
to experience increasing rental rates, the Company has seen signs of easing
rental rate growth and modestly increasing concessions due to higher vacancies
in the office market. Additionally, construction of Class A buildings, primarily
in Orange County, could have an impact on the Company's ability to maintain
occupancy and generate rental rate growth within the office portfolio.
The Company owns approximately 1.8 million square feet in Northern California
with concentrations in Sacramento, the East Bay (Hayward and San Ramon) and
Silicon Valley (San Jose). Vacancy rates in these submarkets are 16.9%, 20.7%
and 14.3%, respectively. The Company's vacancy rate in its Northern California
portfolio at September 30, 2008 was 8.6%. Demand in these submarkets has slowed
measurably in the second half of 2008. Lease renewals and short term leases were
the most common leasing activity in the market during this quarter as firms are
seeking ways of reducing costs and curbing expansion. For the nine months ended
September 30, 2008, the combined submarkets experienced positive net absorption
of 0.6%, however, the time necessary to execute a transaction has lengthened as
tenants weigh their options and negotiate on concessions. The Company's weighted
average occupancy in this region increased from 90.7% for the first nine months
in 2007 to 92.3% for the first nine months in 2008. Annualized realized rent per
square foot increased 3.3% from $13.81 per square foot for the first nine months
in 2007 to $14.27 per square foot for the first nine months in 2008.
The Company owns approximately 1.2 million square feet in Southern Texas,
specifically in the Austin and Houston markets. Market vacancy rates are 11.0%
in the Austin market and 11.8% in the Houston market. The Company's vacancy rate
for these combined markets at September 30, 2008 was 6.9%. During the first half
of 2008, job growth in both the Austin and Houston markets along with the strong
oil and gas industry in the Houston market have increased leasing activity.
However, during the third quarter of 2008 demand has softened in these markets
as evidenced by increased tenant incentives such as free rent or higher
improvement allowances. For the nine months ended September 30, 2008, the
combined markets experienced positive net absorption of 0.7%. The Company's
weighted average occupancy in this region decreased from 95.3% for the first
nine months in 2007 to 95.0% for the first nine months in 2008. Annualized
realized rent per square foot increased 4.5% from $10.82 per square foot for the
first nine months in 2007 to $11.31 per square foot for the first nine months in
2008. Texas leads the nation in scheduled construction projects, and as
construction outweighs demand, it could have an impact on the Company's ability
to maintain occupancy and generate rental rate growth within the Company's
portfolio.
The Company owns approximately 1.7 million square feet in Northern Texas,
primarily located in the Dallas Metroplex market. The market vacancy rate in Las
Colinas, where a significant concentration of the Company's properties are
located, is 10.6%. The Company's vacancy rate at September 30, 2008 in this
market was 6.8%. For the nine months ended September 30, 2008, the market
experienced positive net absorption of 0.8% as the result of continued job
growth. During 2008, modest new construction continued, which included both
speculative construction, as well as owner-user construction. Despite the new
construction, the Company has experienced a modest level of leasing activity
during the first nine months of 2008 generating rental rate growth and higher
occupancy. The Company's weighted average occupancy for the region increased
from 86.7% for the first nine months in 2007 to 92.9% for the first nine months
in 2008. Annualized realized rent per square foot increased 3.4% from $10.34 per
square foot for the first nine months in 2007 to $10.69 per square foot for the
first nine months in 2008 as rental rates have increased modestly over expiring
leases. However, new construction completed during the year could have an impact
on the Company's ability to maintain occupancy and generate rental rate growth
within the Company's portfolio.
The Company owns approximately 3.6 million square feet in South Florida. The
Company owns Miami International Commerce Center ("MICC") located in the Airport
West submarket of Miami-Dade County. While the saturation of the condominium and
housing markets in Miami has negatively impacted its overall economy, it has had
little impact on international trade-based assets, such as industrial and flex
space, which constitutes the majority of the Company's South Florida portfolio.
MICC is located less than one mile from the cargo entrance of the Miami
International Airport, which is one of the most active ports in the United
States. The Company acquired two assets in Palm Beach County at the end of 2006,
comprising 398,000 square feet. The downturn in the housing market and slowing
economy have adversely affected Palm Beach County. Market vacancy rates for
Miami-Dade County and Palm Beach County are 6.9% and 8.4%, respectively,
compared with the Company's South Florida vacancy rate of 3.9% at September 30,
2008. For the nine months ended September 30, 2008, the combined markets
experienced negative net absorption of 0.4%. The Company's weighted average
occupancy in this region outperformed the market and remained strong, decreasing
slightly from 97.0% for the first nine months in 2007 to 96.8% for the first
nine months in 2008. Annualized realized rent per square foot increased 5.4%
from $8.82 per square foot for the first nine months in 2007 to $9.30 per square
foot for the first nine months in 2008.
The Company owns approximately 3.0 million square feet in the Northern Virginia
submarket of Washington D.C., where the average market vacancy rate is 12.3%.
Vacancy rates in this market increased as new supply continues to outpace the
demand coupled with tenants downsizing their existing space. Despite the
increase in the market's vacancy rate, the Company's vacancy rate at
September 30, 2008 was 2.7%. For the nine months ended September 30, 2008, the
market experienced positive net absorption of 1.0%. The increase in sublease
space and decrease in demand has lengthened the time of lease negotiation as
tenants weigh their options and negotiate on tenant improvements. Higher
concessions are more prevalent as landlords entice prospective tenants, while
they struggle to keep rents steady. These factors could limit the Company's
ability to generate rental rate growth and place pressure on occupancy. The
Company's annualized realized rent per square foot increased 3.4% from $19.43
per square foot for the first nine months in 2007 to $20.10 per square foot for
the first nine months in 2008. The Company's weighted average occupancy
increased from 94.9% for the first nine months in 2007 to 97.5% for the first
nine months in 2008.
The Company owns approximately 1.8 million square feet in the Maryland submarket
of Washington D.C. The Company's vacancy rate in the region at September 30,
2008 was 7.4% compared to 11.8% for the market as a whole. The market vacancy
rate increased as new developments are completed with limited preleasing
activities combined with more companies contracting and reorganizing business
operations. Rather than dropping rental rates, landlords are offering higher
concessions to prospective tenants. For the nine months ended September 30,
2008, the market experienced negative net absorption of 0.4%, which is
attributed to a decrease in demand for large blocks of space due to the slowing
economy. The Company's weighted average occupancy decreased from 94.5% for the
first nine months in 2007 to 92.5% for the first nine months in 2008, modestly
outperforming the market. The decrease in occupancy was primarily related to a
67,000 square foot tenant vacating its space at the end of 2007. Annualized
realized rent per square foot increased 0.5% from $23.18 per square foot for the
first nine months in 2007 to $23.29 per square foot for the first nine months in
2008.
The Company owns approximately 1.3 million square feet in the Beaverton
submarket of Portland, Oregon. The market vacancy rate in this region is 18.6%.
The Company's vacancy rate in the market was 15.8% at September 30, 2008. Recent
economic trends and slowdown have resulted in increases in both vacancy rates
and rent concessions in the market. For the nine months ended September 30,
2008, the market experienced negative net absorption of 3.3%. The Company's
weighted average occupancy decreased from 86.9% for the first nine months in
2007 to 84.0% for the first nine months in 2008 primarily related to a 120,000
square foot tenant vacating its space during the second quarter of 2008. Despite
the recent trends and slowdown, annualized realized rent per square foot
increased 6.5% from $15.76 per square foot for the first nine months in 2007 to
$16.79 per square foot for the first nine months in 2008. The increase was
primarily the result of the impact from write-offs related to business failures
during the nine months ended September 30, 2007.
The Company owns approximately 679,000 square feet in the Phoenix and Tempe
submarkets of Arizona. Market vacancies increased significantly due in part to
the number of housing-related tenants who have vacated space combined with
companies contracting and reorganizing business operations, creating
significantly more competition for tenants. During 2007 and continuing into
2008, significant construction of buildings has impacted the Company's portfolio
and may result in higher lease concessions while limiting the Company's ability
to generate rental rate growth. The market vacancy rate is 11.5% compared to the
Company's vacancy rate of 13.6% at September 30, 2008. For the nine months ended
September 30, 2008, despite the decrease in demand, the market experienced
positive net absorption of 0.6%. Although demand for space has subsided,
annualized realized rent per square foot increased 3.9% from $11.40 per square
foot for the first nine months in 2007 to $11.85 per square foot for the first
nine months in 2008. The Company's weighted average occupancy in the region
decreased from 87.3% for the first nine months in 2007 to 86.8% for the first
nine months in 2008.
The Company owns approximately 521,000 square feet in the state of Washington.
On February 16, 2007, the Company acquired Overlake Business Center, a 493,000
square foot multi-tenant office and flex business park located in Redmond,
Washington. The technology industry continues to drive the market. The market
experienced positive net absorption of 1.2% for the nine months ended September
30, 2008. The Company's vacancy rate in this region at September 30, 2008 was
6.5% compared to 8.5% for the market as a whole. The Company's weighted average
occupancy increased from 88.8% for the first nine months in 2007 to 94.7% for
the first nine months in 2008. Annualized realized rent per square foot
increased 9.5% from $17.52 per square foot for the first nine months in 2007 to
$19.18 per square foot for the first nine months in 2008.
Growth of the Company's Operations and Acquisitions and Dispositions of
Properties:
The Company is focused on maximizing cash flow from its existing portfolio of
properties by expanding its presence in existing and new markets through
strategic acquisitions and the disposition of non-strategic assets. The Company
has historically maintained a low-leverage-level approach intended to provide
the Company with the flexibility for future growth.
In 2007, the Company acquired 870,000 square feet for an aggregate cost of
$140.6 million. The Company acquired Overlake Business Center, a 493,000 square
foot multi-tenant office and flex business park located in Redmond, Washington,
for $76.0 million; Commerce Campus, a 252,000 square foot multi-tenant office
and flex business park located in Santa Clara, California, for $39.2 million;
and Fair Oaks Corporate Center, a 125,000 square foot multi-tenant office park
located in Fairfax, Virginia, for $25.4 million.
Scheduled Lease Expirations:
In addition to the 1.3 million square feet, or 6.7%, of currently available
space in our total portfolio, leases representing approximately 4.6% of the
leased square footage of our total portfolio are scheduled to expire during the
remainder of 2008. Leases comprising approximately 203,000 square feet of
currently vacant space have been executed as of the date of this report and are
expected to commence during the fourth quarter of 2008 and first quarter of
2009. Our ability to re-lease available space depends upon the market conditions
in the specific submarkets in which our properties are located.
. . .
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