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| WRE > SEC Filings for WRE > Form 10-Q on 7-Aug-2009 | All Recent SEC Filings |
7-Aug-2009
Quarterly Report
The following discussion should be read in conjunction with our Consolidated Financial Statements and the notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on March 2, 2009, as well as our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 10, 2009 .
We refer to the three months ended June 30, 2009 and June 30, 2008 as the "2009 Quarter" and the "2008 Quarter", respectively, and the six months ended June 30, 2009 and June 30, 2008 as the "2009 Period" and the "2008 Period", respectively.
Forward-Looking Statements
We claim the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995 for the
foregoing statements. The following important factors, in addition to those
discussed elsewhere in our 2008 Annual Report on Form 10-K under the caption
"Risk Factors" and elsewhere in that report, could affect our future results and
could cause those results to differ materially from those expressed in the
forward-looking statements: (a) the effect of the current credit and financial
market conditions; (b) the availability and cost of capital; (c) fluctuations in
interest rates; (d) the economic health of our tenants; (e) the timing and
pricing of lease transactions; (f) the economic health of the greater Washington
metro region, or other markets we may enter; (g) the effects of changes in
Federal government spending; (h) the supply of competing properties;
(i) consumer confidence; (j) unemployment rates; (k) consumer tastes and
preferences; (l) our future capital requirements; (m) inflation; (n) compliance
with applicable laws, including those concerning the environment and access by
persons with disabilities; (o) governmental or regulatory actions and
initiatives; (p) changes in general economic and business conditions;
(q) terrorist attacks or actions; (r) acts of war; (s) weather conditions;
(t) the effects of changes in capital available to the technology and
biotechnology sectors of the economy; (u) the impact of newly adopted accounting
principles; and (v) other factors discussed under the caption "Risk Factors." We
undertake no obligation to update our forward-looking statements or risk factors
to reflect new information, future events, or otherwise.
Overview
Our revenues are derived primarily from the ownership and operation of income-producing properties in the greater Washington metro region. As of June 30, 2009, we owned a diversified portfolio of 92 properties, consisting of 28 office properties, 22 industrial/flex properties, 17 medical office properties, 14 retail centers, and 11 multifamily properties, encompassing in the aggregate 13.3 million net rentable square feet, and land for development. Subsequent to the end of the 2009 Quarter, we completed the sales of Tech 100, a 166,000 square foot industrial property, and Brandywine Center, a 35,000 square foot office property. We have a fundamental strategy of regional focus, diversification by property type and conservative capital management.
When evaluating our financial condition and operating performance, we focus on the following financial and non-financial indicators, discussed in further detail herein:
• Net operating income ("NOI") by segment, calculated as real estate rental revenue less real estate expenses excluding depreciation and amortization and general and administrative expenses. NOI is a non-GAAP supplemental measure to net income.
• Funds from operations ("FFO"), calculated as set forth below under the caption "Funds from Operations." FFO is a non-GAAP supplemental measure to net income.
• Economic occupancy ("occupancy"), calculated as actual real estate rental revenue recognized for the period indicated as a percentage of gross potential real estate rental revenue for that period. Percentage rents and expense reimbursements are not considered in computing economic occupancy percentages.
• Leased percentage, calculated as the percentage of available physical net rentable area leased for our commercial segments and percentage of apartments leased for our multifamily segment.
• Rental rates.
Our results of operations in the 2009 Quarter were primarily impacted by acquisitions in 2008, development properties placed into service, dispositions and the performance of our core portfolio. We completed acquisitions and dispositions totaling $257.4 million and $41.1 million, respectively, during 2008. We placed into service from development at the end of 2007 and during 2008 two multifamily properties and one office property. The performance of our core portfolio, consisting of properties owned for the entirety of the 2009 and 2008 Quarters, declined compared to the 2008 Quarter, primarily due to lower occupancy and higher bad debt expense.
We summarize below our significant transactions during the 2009 and 2008 Periods:
2009 Period
• The completion of a public offering of 5.25 million common shares priced at $21.40 per share, raising $107.5 million in net proceeds.
• The disposition of one multifamily property, Avondale, for a contract sales price of $19.75 million and a gain on sale of $6.7 million.
• The execution of an agreement to modify our $100.0 million unsecured term loan with Wells Fargo Bank, National Association to extend the maturity date from February 19, 2010 to November 1, 2011. This agreement also increased the interest rate on the term loan from LIBOR plus 150 basis points to LIBOR plus 275 basis points.
• The issuance of 0.6 million common shares at a weighted average price of $26.47 under our sales agency financing agreement, raising $14.6 million in net proceeds.
• The execution of one mortgage note of approximately $37.5 million at a fixed rate of 5.37%, secured by the Kenmore Apartments.
• The repurchase of $89.4 million of our 3.875% convertible notes at 80% to 92% of par, resulting in a gain on extinguishment of debt of $7.1 million.
• The execution of new leases for 793,800 square feet of commercial space, with an average rental rate increase of 13.2% over expiring leases.
2008 Period
• The acquisition of one medical office building for $6.5 million, adding approximately 36,000 square feet which was 100% leased at the end of the 2008 Period. The sellers of this property agreed to lease 37% of the building's space for a period of 12 to 18 months.
• The sale of two industrial properties for a contract sales price of $41.1 million, resulting in a gain on sale of $15.3 million.
• The completion of a public offering of 2.6 million common shares priced at $34.80 per share, raising $86.7 million in net proceeds.
• The execution of three mortgage loans totaling approximately $81 million at a fixed rate of 5.71%, secured by three multifamily properties.
• The repayment of the $60 million outstanding principal balance under 6.74% 10-year Mandatory Par Put Remarketed Securities ("MOPPRS") notes. The total aggregate consideration paid to repurchase the notes was $70.8 million, which amount included the $8.7 million remarketing option value paid to the remarketing dealer and accrued interest paid to the holders. The loss on extinguishment of debt was $8.4 million, net of unamortized loan premium costs, upon settlement of these securities. WRIT refinanced the repurchase of these notes, and refinanced a portion of line outstandings, by issuing a $100 million 2-year term loan.
• The execution of new leases for 470,000 square feet of commercial space, with an average rental rate increase of 18.0% over expiring leases.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate these estimates, including those related to estimated useful lives of real estate assets, estimated fair value of acquired leases, cost reimbursement income, bad debts, contingencies and litigation. We base the estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates.
We believe the following critical accounting policies reflect the significant judgments and estimates used in the preparation of our consolidated financial statements. Our significant accounting policies are also described in Note 2 to the consolidated financial statements contained in this Form 10-Q.
Revenue Recognition
Residential properties (our multifamily segment) are leased under operating leases with terms of generally one year or less, and commercial properties (our office, medical office, retail and industrial segments) are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13, Accounting for Leases. Recognition of rental income commences when control of the facility has been given to the tenant. We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of our receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants' sales exceed specified thresholds.
In accordance with SFAS No. 66, Accounting for Sales of Real Estate, sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement.
We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable primarily represents amounts accrued and unpaid from tenants in accordance with the terms of the respective leases, subject to our revenue recognition policy. Receivables are reviewed monthly and reserves are established when, in the opinion of management, collection of the receivable is doubtful. Reserves are established for tenants whose rent payment history or financial condition casts doubt upon the tenant's ability to perform under its lease obligation. When the collection of a receivable is deemed doubtful in the same quarter that the receivable was established, then the allowance for that receivable is recognized as an offset to real estate revenues. When a receivable that was initially established in a prior quarter is deemed doubtful, then the allowance is recognized as an operating expense. In addition to rents due currently, accounts receivable include amounts representing minimal rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.
Included in our accounts receivable balance as of June 30, 2009 and December 31, 2008, are notes receivable balances of $8.3 million and $8.6 million, respectively.
Real Estate and Depreciation
We depreciate buildings on a straight-line basis over estimated useful lives ranging from 28 to 50 years. We capitalize all capital improvement expenditures associated with replacements, improvements or major repairs to real property that extend its useful life and depreciate them using the straight-line method over their estimated useful lives ranging from 3 to 30 years. We also capitalize costs incurred in connection with our development projects, including capitalizing interest and other internal costs during periods in which qualifying expenditures have been made and activities necessary to get the development projects ready for their intended use are in progress. In addition, we capitalize tenant leasehold improvements when certain criteria are met, including when we supervise construction and will own the improvements. We depreciate all tenant improvements over the shorter of the useful life of the improvements or the term of the related tenant lease. Real estate depreciation expense from continuing operations was $19.0 million and $37.8 million for the 2009 Quarter and Period, respectively, and $17.0 million and $33.6 million for the 2008 Quarter and Period, respectively. Maintenance and repair costs that do not extend an asset's life are charged to expense as incurred.
We capitalize interest costs incurred on borrowing obligations while qualifying assets are being readied for their intended use in accordance with SFAS No. 34, Capitalization of Interest Cost. Total interest expense capitalized to real estate assets related to development and major renovation activities was $0.3 million and $0.7 million for the 2009 Quarter and Period, respectively, and $0.7 million and $1.6 million for the 2008 Quarter and Period, respectively. Interest capitalized is amortized over the useful life of the related underlying assets upon those assets being placed into service.
We recognize impairment losses on long-lived assets used in operations and held for sale, development assets or land held for future development, if indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount and estimated undiscounted cash flows associated with future development expenditures. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair value. The estimated fair value would be calculated in accordance with FAS 157. There were no property impairments recognized during the 2009 and 2008 Quarters and Periods.
Effective January 1, 2009, we record real estate acquisitions as business combinations in accordance with SFAS No. 141(R), Business Combinations. Acquired or assumed assets, including physical assets and in-place leases, and liabilities are recorded based on their fair values. Goodwill is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired. The estimated fair values of the assets and liabilities are determined in accordance with FAS 157. The fair values of acquired buildings are determined on an "as-if-vacant" basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The "as-if-vacant" fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.
The fair value of in-place leases consists of the following components - (a) the
estimated cost to us to replace the leases, including foregone rents during the
period of finding a new tenant and foregone recovery of tenant pass-throughs
(referred to as "absorption cost"), (b) the estimated cost of tenant
improvements, and other direct costs associated with obtaining a new tenant
(referred to as "tenant origination cost"); (c) estimated leasing commissions
associated with obtaining a new tenant (referred to as "leasing commissions");
(d) the above/at/below market cash flow of the leases, determined by comparing
the projected cash flows of the leases in place to projected cash flows of
comparable market-rate leases (referred to as "net lease intangible"); and
(e) the value, if any, of customer relationships, determined based on our
evaluation of the specific characteristics of each tenant's lease and our
overall relationship with the tenant (referred to as "customer relationship
value"). We have attributed no value to customer relationship value as of
June 30, 2009 or December 31, 2008.
The amounts used to calculate net lease intangibles are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant origination costs are included in income producing property on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing commissions and absorption costs are classified as other assets and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. Net lease intangible assets are classified as other assets and are amortized on a straight-line basis as a decrease to real estate rental revenue over the remaining term of the underlying leases. Net lease intangible liabilities are classified as other liabilities and are amortized on a straight-line basis as an increase to real estate rental revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, the unamortized portion of the tenant origination cost, leasing commissions, absorption costs and net lease intangible associated with that lease are written off.
Federal Income Taxes
We believe that we qualify as a real estate investment trust ("REIT") under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (a) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (b) paying out capital gains to the shareholders with no tax to WRIT or (c) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. In June 2008, two industrial properties, Sullyfield Center and The Earhart Building, were sold for a gain of $15.3 million. The proceeds from the sale were treated as a distribution to shareholders. In May 2009, a multifamily property, Avondale, was sold for a gain of $6.7 million. It is anticipated that the proceeds from the gain will be treated as a distribution to shareholders. Generally, no provisions for income taxes are necessary except for taxes on undistributed REIT taxable income and taxes on the income generated by our taxable REIT subsidiaries ("TRS"). A TRS is subject to corporate federal and state income tax on its taxable income at regular statutory rates. There were no income tax provisions or material deferred income tax items for our TRS for the six month periods ended June 30, 2009 and 2008.
Results of Operations
The discussion that follows is based on our consolidated results of operations for the 2009 and 2008 Quarters. The ability to compare one period to another may be significantly affected by acquisitions completed and dispositions made during those periods.
For purposes of evaluating comparative operating performance, we categorize our properties as "core", "non-core" or discontinued operations. A "core" property is one that was owned for the entirety of the periods being evaluated and is included in continuing operations. A "non-core" property is one that was acquired or placed into service during either of the periods being evaluated and is included in continuing operations. Results for properties sold or held for sale during any of the periods evaluated are classified as discontinued operations. No properties were acquired during the 2009 Period, and four properties were acquired during or subsequent to the 2008 Period. Also classified as non-core are three development properties placed into service in 2008 and 2007. One property was sold and one property was classified as held for sale during the 2009 Period, and two properties were sold during 2008. These held for sale and sold properties are classified as discontinued operations for the 2009 and 2008 Quarters and Periods.
To provide more insight into our operating results, our discussion is divided
into two main sections: (a) the consolidated results of operations section, in
which we provide an overview analysis of results on a consolidated basis, and
(b) the net operating income ("NOI") section, in which we provide a detailed
analysis of core versus non-core NOI results by segment.
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