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FSP > SEC Filings for FSP > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for FRANKLIN STREET PROPERTIES CORP /MA/

Form 10-Q for FRANKLIN STREET PROPERTIES CORP /MA/


30-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011. Historical results and percentage relationships set forth in the condensed consolidated financial statements, including trends which might appear, should not be taken as necessarily indicative of future operations. The following discussion and other parts of this Quarterly Report on Form 10-Q may also contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those indicated in such forward-looking statements. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements. Investors are cautioned that our forward-looking statements involve risks and uncertainty, including without limitation, economic conditions in the United States, disruptions in the debt markets, economic conditions in the markets in which we own properties, risks of a lessening of demand for the types of real estate owned by us, uncertainties relating to fiscal policy, changes in government regulations and regulatory uncertainty, geopolitical events, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, additional staffing, insurance increases and real estate tax valuation reassessments. See Item 1A. "Risk Factors" below. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We may not update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform them to actual results or to changes in our expectations that occur after such date, other than as required by law.

Overview

FSP Corp., or we, operate in the real estate operations segment. The real estate operations segment involves real estate rental operations, leasing, secured financing of real estate and services provided for asset management, property management, property acquisitions, dispositions and development.

The main factor that affects our real estate operations is the broad economic market conditions in the United States. These market conditions affect the occupancy levels and the rent levels on both a national and local level. We have no influence on broader economic/market conditions. We look to acquire and/or develop quality properties in good locations in order to lessen the impact of downturns in the market and to take advantage of upturns when they occur.

Critical Accounting Policies

We have certain critical accounting policies that are subject to judgments and estimates by our management and uncertainties of outcome that affect the application of these policies. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. On an on-going basis, we evaluate our estimates. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. The accounting policies that we believe are most critical to the understanding of our financial position and results of operations, and that require significant management estimates and judgments, are discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.

Critical accounting policies are those that have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and assessments are consistently applied and produce financial information that fairly presents our results of operations. No changes to our critical accounting policies have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2011.

Trends and Uncertainties

Economic Conditions

The economy in the United States is continuing to experience a period of limited economic growth, including high levels of unemployment, which directly affects the demand for office space, our primary income producing asset. The broad economic market conditions in the United States are affected by numerous factors, including but not limited to, inflation and employment levels, energy prices, slow economic growth and/or recessionary concerns, uncertainty about government fiscal policy, changes in currency exchange rates, geopolitical events, the regulatory environment and the availability of debt and interest rate fluctuations. We believe that recent economic conditions in the United States have negatively affected our business by, among other factors, contributing to a decline in occupancy and rental rates in our real estate portfolio in 2009 and 2010. Although occupancy levels in our real estate portfolio generally improved in 2011 and the first nine months of 2012, future economic factors may negatively affect real estate values, occupancy levels and property income. At this time, we cannot predict the extent or duration of any negative impact that the current state of the United States economy will have on our business.


Real Estate Operations

Leasing

Our real estate portfolio was approximately 89.9% leased (including an asset held for sale) as of September 30, 2012 and approximately 88.7% leased as of December 31, 2011. During the nine months ended September 30, 2012, we leased 521,574 square feet of office space, of which approximately 395,667square feet were with existing tenants, at a weighted average term of 4.3 years. On average, tenant improvements for such leases were $8.30 per square foot, lease commissions were $3.69 per square foot and rent concessions were approximately two months of free rent. GAAP base rents under such leases were $22.06 per square foot, or 1.4% higher than average rents in the respective properties as applicable compared to the prior period.

As of September 30, 2012, approximately 1.2% of the square footage in our portfolio is scheduled to expire during the remainder of 2012, and approximately 5.9% is scheduled to expire during 2013. Our property portfolio is primarily suburban office assets. Most of the rental/leasing markets where our properties are located remained stable during the third quarter both in terms of occupancy and rental rate levels. Within this environment, we continue to make steady leasing progress and anticipate higher year-end occupancy. Our property portfolio has relatively modest lease expirations over the next two years and, along with our improving occupancy levels, should allow overall tenant improvement expenditures and leasing costs to moderate in relation to the level of rental revenues being achieved.

While we cannot generally predict when existing vacancy in our real estate portfolio will be leased or if existing tenants with expiring leases will renew their leases or what the terms and conditions of the lease renewals will be, we expect to renew or sign new leases at then-current market rates for locations in which the buildings are located, which in many cases may be below the expiring rates. Also, even as the economy recovers, we believe the potential for any of our tenants to default on its lease or to seek the protection of bankruptcy still exists. If any of our tenants defaults on its lease, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. In addition, at any time, a tenant of one of our properties may seek the protection of bankruptcy laws, which could result in the rejection and termination of such tenant's lease and thereby cause a reduction in cash available for distribution to our stockholders.

Real Estate Acquisitions and Investments

On July 5, 2012, we made and funded a Sponsored REIT Loan in the form of a first mortgage loan in the principal amount of $33.0 million to an entity that is a wholly-owned by a subsidiary of a Sponsored REIT, FSP Energy Tower I Corp. On July 31, 2012, we acquired an office property with approximately 387,000 square feet for approximately $52.8 million in Atlanta, Georgia. We also made one additional real estate investment in the first quarter of 2012 for a total capital contribution of $30 million. The investment was made as an additional funding amount to our original $76.2 million two-year bridge loan on a CBD office/retail property located in Minneapolis, Minnesota. The total loan provided to this property was $106.2 million and was secured by a first mortgage. On July 27, 2012 this loan was repaid in its entirety and we received an exit fee in the amount of $0.5 million. The property is owned by FSP 50 South Tenth Street Corp., which is one of our Sponsored REITs. During 2011, we acquired five properties directly into our portfolio with an aggregate of approximately 994,000 rentable square feet at an aggregate purchase price of approximately $214 million. The results of operations for each of the acquired properties are included in our operating results as of their respective purchase dates. Increases in revenues and expenses for the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011 are primarily a result of the timing of these property acquisitions and subsequent contribution of these acquired properties as well as our mortgage investments. On October 10, 2012, we announced entering into an agreement to purchase a property. The property is located at 10370 and 10350 Richmond Avenue, Houston, Texas and consists of two, 14-story, multi-tenant office buildings containing an aggregate of approximately 629,000 rentable square feet of space and a parking garage located on approximately 6.5 acres of land. The purchase price is approximately $154.8 million and is subject to customary conditions and termination rights for transactions of this type. We anticipate that the closing will take place on or about November 1, 2012. Additional potential real estate investment opportunities are actively being explored and we would anticipate further real estate investments in the coming months.


Discontinued Operations and Property Dispositions

We include investment banking activities and properties sold or held for sale as discontinued operations.

Investment Banking

Previously we operated in the investment banking segment, and in December 2011, we discontinued those activities. The investment banking segment involved the structuring of real estate investments and broker/dealer services that included the organization of Sponsored REITs, the acquisition and development of real estate on behalf of Sponsored REITs and the raising of capital to equitize the Sponsored REITs through sale of preferred stock in private placements. On December 15, 2011, we announced that our broker/dealer subsidiary, FSP Investments LLC, would no longer sponsor the syndication of shares of preferred stock in newly-formed Sponsored REITs.

FSP Investments LLC will, however, continue to provide investor services to existing Sponsored REITs, which are not a significant activity, and has the capability to sponsor the syndication of any additional shares of preferred stock in existing Sponsored REITs. Our decision to no longer sponsor the syndication of shares of preferred stock in newly-formed Sponsored REITs was made after judging the potential for meaningful future profit contribution to our earnings from such syndications to be limited. Our investment banking segment had been marginal in its profit contribution over the last four years and we believed time and resources would be more productively deployed elsewhere.

Property Dispositions and Asset Held For Sale

During the three months ended September 30, 2012, we reached a decision to classify its office property located in Southfield, Michigan as an asset held for sale. In evaluating the Southfield, Michigan property, management considered various subjective factors, including the time, cost and likelihood of successfully leasing the property, the affect of the property's results on its unencumbered asset value, which is part of the leverage ratio used to calculate interest rates in the 2012 Credit Facility and future capital costs to upgrade and reposition the multi-tenant property and to lease up the building, recent leasing and economic activity in the local area, and offers to purchase the property. We concluded that selling the property was the more prudent decision and outweighed the potential future benefit of continuing to hold the property. The property is expected to sell within one year at a loss, which was recorded as a provision for loss on a property held for sale of $14.3 million net of applicable income taxes and was classified as an asset held for sale at September 30, 2012.

We sold an industrial property located in Savage, Maryland on June 24, 2011 and in 2010 reached an agreement to sell an office property, located in Falls Church, Virginia, which was sold on January 21, 2011. Both properties were sold at gains and were classified as discontinued for all periods presented.

We will continue to evaluate our portfolio, and in the future may decide to dispose of additional properties from time to time in the ordinary course of business. We believe that the current property sales environment remains challenged relative to both liquidity and pricing. However, we also believe that we are witnessing improving pricing and liquidity in certain markets, extending a trend that we believe began in the second half of 2009. We believe that both improving office property fundamentals as well as plentiful and attractive financing availability will likely be required to broadly improve the marketplace for property dispositions. As an important part of our total return strategy, we intend to be active in property dispositions when we believe that market conditions warrant such activity and, as a consequence, we continue to consider some of our properties for possible disposition.


The following table shows results for the three months ended September 30, 2012 and 2011:

(in thousands)
                                                 Three months ended September 30,
Revenue:                                      2012             2011            Change
Rental                                    $      38,251    $      33,398    $      4,853
Related party revenue:
Management fees and interest income
from loans                                        3,485            1,037           2,448
Other                                                39                7              32
Total revenue                                    41,775           34,442           7,333

Expenses:
Real estate operating expenses                    9,639            8,889             750
Real estate taxes and insurance                   5,764            4,950             814
Depreciation and amortization                    13,572           12,183           1,389
Selling, general and administrative               3,141            1,654           1,487
Interest                                          4,187            3,419             768
Total expenses                                   36,303           31,095           5,208

Income before interest income, equity
in earnings of non-consolidated REITs
and taxes                                         5,472            3,347           2,125
Interest income                                       5                3               2
Equity in earnings of non-consolidated
REITs                                               176              573            (397 )

Income before taxes on income                     5,653            3,923           1,730
Taxes on income                                      80               67              13

Income from continuing operations                 5,573            3,856           1,717

Discontinued operations:
Income (loss) from discontinued
operations, net of income tax                      (271 )           (542 )           271
Provision for loss on property held for
sale of $14,300 less applicable income
tax                                             (14,300 )            -           (14,300 )
Total discontinued operations                   (14,571 )           (542 )       (14,029 )

Net income (loss)                         $      (8,998 )  $       3,314    $    (12,312 )

Comparison of the three months ended September 30, 2012 to the three months ended September 30, 2011

Revenues

Total revenues increased by $7.3 million to $41.8 million for the quarter ended September 30, 2012, as compared to the quarter ended September 30, 2011. The increase was primarily a result of:

o An increase in rental revenue of approximately $4.9 million arising primarily from the acquisition of a property in September 2011, a property acquired in October 2011 and a property acquired in July 2012, which were included in the quarter ended September 30, 2012; and to a lesser extent, leasing, which raised occupancy approximately 1.7% in the continuing real estate portfolio at September 30, 2012 compared to September 30, 2011.

o A $2.4 million increase in interest income from loans to Sponsored REITs, which was primarily a result of a larger average loan receivable balance and a higher interest rate charged during the three months ended September 30, 2012, as compared to the three months ended September 30, 2011.

Expenses

Total expenses increased by $5.2 million to $36.3 million for the quarter ended September 30, 2012, as compared to $31.1 million for the quarter ended September 30, 2011. The increase was primarily a result of:


o An increase in real estate operating expenses and real estate taxes and insurance of approximately $1.5 million, and depreciation and amortization of $1.4 million, which were primarily from the acquisition of a property in late September 2011, a property acquired in October 2011 and a property acquired in July 2012, which were included in the quarter ended September 30, 2012.

o An increase to interest expense of approximately $0.8 million to $4.2 million during the three months ended September 30, 2012 compared to the same period in 2011. The increase was attributable to a higher amount of debt outstanding for the second quarter of 2012 compared to the second quarter of 2011, and to a lesser extent the acceleration of some amortization of deferred financing costs related to the 2012 Credit Facility.

o An increase in selling, general and administrative expenses of $1.5 million, which was primarily the result of a $0.8 million increase in compensation accruals in the third quarter of 2012 compared to the same period in 2011, and realignment of personnel and resources in our real estate business following a decision to discontinue our investment banking activities in December 2011. We had 35 and 44 employees as of September 30, 2012 and 2011, respectively, at our headquarters in Wakefield, Massachusetts.

Equity in earnings of non-consolidated REITs

Equity in earnings from non-consolidated REITs decreased approximately $0.4 million to $0.2 million during the three months ended September 30, 2012 compared to $0.6 million for the same period in 2011. The decrease was primarily because our equity in income of our investment in East Wacker decreased $0.2 million during the three months ended September 30, 2012 compared to the same period in 2011; and we had no syndications in process during the three months ended September 30, 2012 from which equity in income of syndications is derived, compared to one syndication in process during the third quarter of 2011.

Taxes on income

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties that increased $13,000 for the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Income from continuing operations

Income from continuing operations for the three months ended September 30, 2012 was $5.6 million compared to $3.9 million for the three months ended September 30, 2011, for the reasons described above.

Discontinued operations and provision for sale of property

The sale of properties from our portfolio results in a reclassification of real estate income from those properties for all periods presented to discontinued operations. Gains or losses on those sales or provisions for losses on sales are included in discontinued operations.

During the three months ended September 30, 2012, we reached a decision to classify its office property located in Southfield, Michigan as an asset held for sale. In evaluating the Southfield, Michigan property, management considered various subjective factors, including the time, cost and likelihood of successfully leasing the property, the affect of the property's results on its unencumbered asset value, which is part of the leverage ratio used to calculate interest rates in the 2012 Credit Facility and future capital costs to upgrade and reposition the multi-tenant property and to lease up the building, recent leasing and economic activity in the local area, and offers to purchase the property. We concluded that selling the property was the more prudent decision and outweighed the potential future benefit of continuing to hold the property. The property is expected to sell within one year at a loss, which was recorded as a provision for loss on a property held for sale of $14.3 million net of applicable income taxes and was classified as an asset held for sale at September 30, 2012. The operations of the property generated losses, which are included in income (loss) from discontinued operations of $0.3 million during the three months ended September 30, 2012 and $0.4 million during the three months ended September 30, 2011. In addition, in December 2011, we discontinued our investment banking segment. The loss derived from the investment bank was $0.1 million for the three months ended September 30, 2011.

Net income (loss)

Net loss for the three months ended September 30, 2012 was $9.0 million compared to net income of $3.3 million for the three months ended September 30, 2011, for the reasons described above.


The following table shows results for the nine months ended September 30, 2012 and 2011:

(in thousands)
                                                 Nine months ended September 30,
Revenue:                                      2012             2011            Change
Rental                                    $     110,124    $      97,494    $     12,630
Related party revenue:
Management fees and interest income
from loans                                        9,146            2,995           6,151
Other                                               112               20              92
Total revenue                                   119,382          100,509          18,873

Expenses:
Real estate operating expenses                   26,940           25,590           1,350
Real estate taxes and insurance                  16,952           14,757           2,195
Depreciation and amortization                    39,647           34,671           4,976
Selling, general and administrative               7,454            4,901           2,553
Interest                                         11,901            9,405           2,496
Total expenses                                  102,894           89,324          13,570

Income before interest income, equity
in earnings of non-consolidated REITs
and taxes                                        16,488           11,185           5,303
Interest income                                      17               19              (2 )
Equity in earnings of non-consolidated
REITs                                             1,061            2,707          (1,646 )

Income before taxes on income                    17,566           13,911           3,655
Taxes on income                                     236              185              51

Income from continuing operations                17,330           13,726           3,604

Discontinued operations:
Income (loss) from discontinued
operations, net of income tax                      (856 )          2,797          (3,653 )
Gain on sale of properties and
provision for loss on property held for
sale of $14,300 less applicable income
tax                                             (14,300 )         21,939         (36,239 )
Total discontinued operations                   (15,156 )         24,736         (39,892 )

Net income                                $       2,174    $      38,462    $    (36,288 )

Comparison of the nine months ended September 30, 2012 to the nine months ended September 30, 2011

Revenues

Total revenues increased by $18.9 million to $119.4 million for the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011. The increase was primarily a result of:

o An increase in rental revenue of approximately $12.7 million arising primarily from the acquisitions of three properties in March 2011, a property in September 2011, a property in October 2011 and a property in July 2012, which were included in the nine months ended September 30, 2012, as compared to a partial period for the three properties acquired in March 2011 and a property acquired in September 2011 that were included in the nine months ended September 30, 2011; and to a lesser extent, leasing, which raised occupancy approximately 1.7% in the continuing real estate portfolio at September 30, 2012 compared to September 30, 2011.

o A $6.2 million increase in interest income from loans to Sponsored REITs, which was primarily a result of a larger average loan receivable balance and a higher interest rate charged during the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011.


Expenses

Total expenses increased by approximately $13.6 million to $102.9 million for the nine months ended September 30, 2012, as compared to $89.3 million for the nine months ended September 30, 2011. The increase was primarily a result of:

o An increase in real estate operating expenses and real estate taxes and insurance of approximately $3.5 million, and depreciation and amortization of $5.0 million, which were primarily from the acquisitions of three properties in March 2011, a property in September 2011, a property in October 2011 and a property in July 2012, which were included in the nine months ended September 30, 2012, as compared to a partial period for the three properties acquired in March 2011 and a property acquired in September 2011 that were included in the nine months ended September 30, 2011.

o An increase to interest expense of approximately $2.5 million to $11.9 million during the nine months ended September 30, 2012 compared to $9.4 million for the same period in 2011. The increase was attributable to a higher amount of debt outstanding, and to a lesser extent the acceleration of some amortization of deferred financing costs related to the 2012 Credit Facility.

o An increase in selling, general and administrative expenses of $2.6 million, which was primarily the result of a $0.9 million increase in compensation accruals during the nine months ended September 30, 2012 compared . . .

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