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| PSB > SEC Filings for PSB > Form 10-Q on 4-Nov-2009 | All Recent SEC Filings |
4-Nov-2009
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 collectability 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
entire 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. 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 2009, the severe recession and weak economic
conditions continued to impact commercial real estate as the Company experienced
a decrease in new rental rates over expiring rental rates on executed leases as
well as declining occupancy. Although it is uncertain what impact the current
recession will have on the Company's ability to maintain current occupancy
levels and rental rates, management expects that the decrease in rental rates on
new and renewal transactions combined with further reductions in occupancy will
result in a decrease in rental income for the fourth quarter of 2009 when
compared to the same period of 2008. A continued deepening economic recession
may have a significant impact on the Company, potentially resulting in further
reductions in occupancy and rental rates.
While the Company historically has experienced a moderate level of write-offs
due to business failures and bankruptcy filing, there is inherent uncertainty in
a tenant's ability to continue paying rent when in bankruptcy. As of October 31,
2009, the Company had approximately 31,000 square feet of leased space that is
occupied by tenants that are protected by Chapter 11 of the U.S. Bankruptcy
Code. In addition, the Company had tenants occupying approximately 713,000
square feet who vacated their space during the nine months ended September 30,
2009 as a result of business failures. As of September 30, 2009, 320,000 square
feet has been re-leased. During the nine months ended September 30, 2009 and
2008, write-offs of unpaid rents were $733,000 and $485,000, respectively. A
number of other tenants have contacted us, requesting a reduction in space under
lease, or 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 future 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, 2009, rental rates on new and renewed leases within the
Company's overall portfolio decreased 14.5% over expiring rents. The Company's
overall vacancy rate at September 30, 2009 was 9.5%. Below is a summary of the
general market conditions as well as the Company's operating statistics for each
of the 10 regions in which the Company operates. The Company has compiled the
market 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
located in Los Angeles, Orange and San Diego Counties. Market vacancies have
increased due to the continued weakness in the economy and the resulting job
losses combined with the lack of credit availability and its effect on small
businesses. These factors have also created significantly more competition for
tenants, which in turn has placed pressure on occupancy and rental rates.
Vacancy rates in Southern California range from 4.2% to 18.8%. The Company's
vacancy rate in this region at September 30, 2009 was 7.2%. For the nine months
ended September 30, 2009, the overall market experienced negative net absorption
of 0.6% for the reasons noted above as well as the completion of newly
constructed space in 2008. The Company's weighted average occupancy for the
region decreased from 94.3% for the first nine months of 2008 to 90.8% for the
first nine months of 2009. Annualized realized rent per square foot decreased
1.6% from $17.42 per square foot for the first nine months of 2008 to $17.14 per
square foot for the first nine months of 2009.
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 and Santa Clara). Vacancy rates in these submarkets are
23.8%, 21.2% and 18.4%, respectively. The Company's vacancy rate in its Northern
California portfolio at September 30, 2009 was 16.0%. Demand in these submarkets
slowed measurably in the second half of 2008 and has continued to slow in the
first nine months of 2009. The time necessary to execute a transaction has
lengthened as tenants weigh various options. For the nine months ended
September 30, 2009, the combined submarkets experienced negative net absorption
of 4.4%. The Company's weighted average occupancy in this region decreased from
92.1% for the first nine months of 2008 to 85.5% for the first nine months of
2009 due in part to two tenant defaults comprising 134,000 square feet.
Annualized realized rent per square foot decreased 6.4% from $14.28 per square
foot for the first nine months of 2008 to $13.36 per square foot for the first
nine months of 2009.
The Company owns approximately 1.2 million square feet in Southern Texas,
specifically in the Austin and Houston markets. Market vacancy rates are 14.4%
in the Austin market and 15.3% in the Houston market. The Company's vacancy rate
for these combined markets at September 30, 2009 was 9.8%. During the second
half of 2008 and continuing into 2009, demand eased in these markets due to the
slowdown in the oil and gas industry as a result of declining oil prices. For
the nine months ended September 30, 2009, the combined markets experienced
negative net absorption of 1.2%. The Company's weighted average occupancy in
this region decreased from 95.4% for the first nine months of 2008 to 86.8% for
the first nine months of 2009 due in part to large tenant defaults comprising
61,000 square feet. Annualized realized rent per square foot increased 8.2% from
$11.30 per square foot for the first nine months of 2008 to $12.23 per square
foot for the first nine months of 2009 primarily due to the decrease in
occupancy.
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 significant concentrations of the Company's properties are
located, is 10.7%. The Company's vacancy rate at September 30, 2009 in this
market was 9.5%. In late 2008 and continuing into 2009, this market began to
show signs of softening in fundamentals as a result of the impact of the
national recession. Vacancy is on the rise due to a high volume of construction
completed in 2008 and minimal job growth. The market's net absorption was flat
for the nine months ended September 30, 2009. The Company's weighted average
occupancy for the region decreased from 93.0% for the first nine months of 2008
to 91.1% for the first nine months of 2009. Annualized realized rent per square
foot increased 0.7% from $10.69 per square foot for the first nine months of
2008 to $10.76 per square foot for the first nine months of 2009.
The Company owns approximately 3.6 million square feet in South Florida, which
consists of Miami International Commerce Center ("MICC") business park located
in the Airport West submarket of Miami-Dade County and two multi-tenant flex
parks located in Palm Beach County. 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 effect of the current economic recession
on the import/export business has had a measurable negative impact on demand in
Miami. Market vacancy rates for Miami-Dade County and Palm Beach County are
11.6% and 11.3%, respectively, compared with the Company's South Florida vacancy
rate of 6.4% at September 30, 2009. For the nine months ended September 30,
2009, the combined markets experienced negative net absorption of 2.4%. The
Company's weighted average occupancy in this region outperformed the market,
decreasing from 96.5% for the first nine months of 2008 to 94.4% for the first
nine months of 2009. Annualized realized rent per square foot increased 0.4%
from $9.30 per square foot for the first nine months of 2008 to $9.34 per square
foot for the first nine months of 2009.
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 14.2%.
The Company's vacancy rate at September 30, 2009 was 5.8%. Vacancy rates in this
market increased as tenants downsize their existing space due to the economic
recession. The increase in sublease space and decrease in demand have lengthened
the time of lease negotiations. For the nine months ended September 30, 2009,
the market experienced negative net absorption of 0.4%. The Company's annualized
realized rent per square foot increased 3.9% from $20.09 per square foot for the
first nine months of 2008 to $20.87 per square foot for the first nine months of
2009. The Company's weighted average occupancy decreased from 97.3% for the
first nine months of 2008 to 93.3% for the first nine months of 2009.
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,
2009 was 7.8% compared to 14.9% for the market as a whole. For the nine months
ended September 30, 2009, the market experienced negative net absorption of
0.9%, which is attributed to a decrease in demand for large blocks of space due
to the slowing economy. The Company's weighted average occupancy increased from
91.3% for the first nine months of 2008 to 91.7% for the first nine months of
2009. Annualized realized rent per square foot increased 2.6% from $23.29 per
square foot for the first nine months of 2008 to $23.90 per square foot for the
first nine months of 2009.
The Company owns approximately 1.3 million square feet in the Beaverton
submarket of Portland, Oregon. The market vacancy rate in this region is 24.9%.
The Company's vacancy rate in the market was 21.1% at September 30, 2009. The
economic recession has resulted in increases in higher vacancy rates and
increased rent concessions in the market. For the nine months ended
September 30, 2009, the market experienced negative net absorption of 1.9%. The
Company's weighted average occupancy decreased from 84.3% for the first nine
months of 2008 to 79.7% for the first nine months of 2009. The decrease was
primarily related to a 120,000 square foot tenant vacating its space during the
second quarter of 2008 and a 28,000 square foot tenant defaulting during the
second quarter of 2009. Annualized realized rent per square foot decreased 2.4%
from $16.79 per square foot for the first nine months of 2008 to $16.38 per
square foot for the first nine months of 2009.
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. These factors have
also created significantly more competition for tenants, which may result in
higher lease concessions while limiting the Company's ability to generate rental
rate growth. The market vacancy rate is 15.8% compared to the Company's vacancy
rate of 15.5% at September 30, 2009. For the nine months ended September 30,
2009, the market experienced negative net absorption of 1.5%. Annualized
realized rent per square foot decreased 6.8% from $11.85 per square foot for the
first nine months of 2008 to $11.04 per square foot for the first nine months of
2009. The Company's weighted average occupancy in the region decreased from
87.0% for the first nine months of 2008 to 86.3% for the first nine months of
2009.
The Company owns approximately 521,000 square feet in the state of Washington
which mostly consists of Overlake Business Center, a 493,000 square foot
multi-tenant office and flex business park located in Redmond. The weakened
aerospace manufacturing industry and global economic slowdown has resulted in a
softened demand in this market. The market vacancy rate is 13.6%. For the nine
months ended September 30, 2009, this market experienced negative net absorption
of 2.9%. The Company's vacancy rate in this region at September 30, 2009 was
15.0%. The Company's weighted average occupancy decreased from 94.5% for the
first nine months of 2008 to 89.0% for the first nine months of 2009. Annualized
realized rent per square foot increased 1.9% from $19.17 per square foot for the
first nine months of 2008 to $19.53 per square foot for the first nine months of
2009.
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.
The Company made no acquisitions during the nine months ended September 30, 2009
and 2008.
During May, 2009, the Company sold 3.4 acres of land held for development in
Portland, Oregon, for a gross sales price of $2.7 million, resulting in a net
gain of $1.5 million. The Company made no dispositions during the nine months
ended September 30, 2008.
Scheduled Lease Expirations:
In addition to the 1.8 million square feet, or 9.5%, of space available in our
total portfolio as of September 30, 2009, leases representing approximately 5.0%
of the leased square footage of our total portfolio are scheduled to expire
during the remainder of 2009. Our ability to re-lease available space depends
upon the market conditions in the specific submarkets in which our properties
are located.
Impact of Inflation:
Although inflation has not been significant in recent years, it remains a factor
in our economy, and the Company continues to seek ways to mitigate its potential
impact. A substantial portion of the Company's leases require tenants to pay
operating expenses, including real estate taxes, utilities, and insurance, as
well as increases in common area expenses, partially reducing the Company's
exposure to inflation.
Concentration of Portfolio by Region:
Rental income, cost of operations and rental income less cost of operations,
excluding depreciation and amortization, or net operating income prior to
depreciation and amortization (defined as "NOI" for purposes of the following
tables), are summarized for the three and nine months ended September 30, 2009
by major geographic region below. The Company uses NOI and its components as a
measurement of the performance of its commercial real estate. Management
believes that these financial measures provide them as well as the investor the
most consistent measurement on a comparative basis of the performance of the
commercial real estate and its contribution to the value of the Company.
Depreciation and amortization has been excluded from these financial measures as
they are generally not used in determining the value of commercial real estate
by management or the investment community. Depreciation and amortization is
generally not used in determining value as they consider the historical costs of
an asset compared to its current value; therefore, to understand the effect of
the assets' historical cost on the Company's results, investors should look at
GAAP financial measures, such as total operating costs including depreciation
and amortization. The Company's calculation of NOI may not be comparable to
those of other companies and should not be used as an alternative to measures of
performance calculated in accordance with GAAP. The tables below reflect rental
income, operating expenses and NOI for the three and nine months ended
September 30, 2009 based on geographical concentration. The total of all regions
is equal to the amount of rental income and cost of operations recorded by the
Company in accordance with GAAP. As part of the tables below, we have shown the
effect of depreciation and amortization on NOI. We have reconciled NOI to net
income in the table under "Results of Operations" below. The percent of total by
region reflects the actual contribution to rental income, cost of operations and
NOI during the period (in thousands):
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