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DEI > SEC Filings for DEI > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for DOUGLAS EMMETT INC

Form 10-Q for DOUGLAS EMMETT INC


7-Nov-2012

Quarterly Report


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

Forward Looking Statements

This Quarterly Report on Form 10-Q (Report) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). You can find many (but not all) of these statements by looking for words such as "approximates," "believes," "expects," "anticipates," "estimates," "intends," "plans," "would," "could", "may" or other similar expressions in this Report. We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements presented in this Report, or those that we may make orally or in writing from time to time, are based on our beliefs and assumptions. The actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our actual future results can be expected to differ from our expectations, and those differences may be material. Accordingly, investors should use caution in relying on previously reported forward-looking statements, which were based on results and trends at the time they were made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following: adverse economic or real estate developments in Southern California and Honolulu, Hawaii; a general downturn in the economy, such as the recent global financial crisis; decreased rental rates or increased tenant incentive and vacancy rates; defaults on, early termination of, or non-renewal of leases by tenants; increased interest rates and operating costs; failure to generate sufficient cash flows to service our outstanding indebtedness; difficulties in raising capital for our institutional funds; difficulties in identifying properties to acquire and completing acquisitions; failure to successfully operate acquired properties and operations; failure to maintain our status as a Real Estate Investment Trust (REIT) under the Internal Revenue Code of 1986, as amended; possible adverse changes in rent control laws and regulations; environmental uncertainties; risks related to natural disasters; lack or insufficient amount of insurance, or changes to the cost of maintaining existing insurance coverage; inability to successfully expand into new markets and submarkets; risks associated with property development; conflicts of interest with our officers; changes in real estate zoning laws and increases in real property tax rates; the negative results of litigation or governmental proceedings; and the consequences of any possible future terrorist attacks. For further discussion of these and other factors, see "Item 1A. Risk Factors" in our 2011 Annual Report on Form 10-K.

This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report.

Executive Summary

Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii. We focus on owning and acquiring a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities.

Through our interest in Douglas Emmett Properties, LP (our operating partnership) and its subsidiaries, including our investments in unconsolidated Funds, we own or partially own, manage, lease, acquire and develop real estate, consisting primarily of office and multifamily properties. As of September 30, 2012:

Our consolidated portfolio of properties included 50 Class A office properties (including ancillary retail space) totaling approximately 12.9 million rentable square feet and 9 multifamily properties containing 2,868 apartment units, as well as the fee interests in 2 parcels of land subject to ground leases.

Our total office portfolio of 58 office properties aggregating approximately 14.7 million rentable square feet, consisting of both our consolidated office properties and 8 Class A office properties owned by our Funds (in which we held an average of 44% of the capital interests).


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Our consolidated office portfolio was 90.7% leased and 89.0% occupied, our total office portfolio was 90.4% leased and 88.2% occupied, and our multifamily properties were 99.8% leased and 98.7% occupied.

Approximately 85.9% of the annualized rent of our consolidated portfolio was derived from our office properties and the remaining 14.1% from our multifamily properties.

Approximately 85.8% of the annualized rent of our consolidated portfolio was derived from our Los Angeles County office and multifamily properties and the remaining 14.2% from our Honolulu, Hawaii office and multifamily properties.

Current Year Acquisitions, Dispositions and Financings

Acquisitions: During the first quarter of 2012 we acquired an additional 16.3% interest in Douglas Emmett Fund X, LLC for approximately $33.4 million from an existing Fund investor that was rebalancing its portfolio. The acquisition also included the assumption of approximately $3.2 million in undrawn commitments. Douglas Emmett Fund X, LLC owns six properties, totaling 1.4 million square feet of office space in our core submarkets, as well as an interest of approximately 10% in our second Fund.

Dispositions: We had no property dispositions during the first nine months of 2012.

Financings: Since the beginning of 2012, we have completed the following transactions:

         During the first quarter of 2012, we closed a secured non-recourse
          $155.0 million term loan maturing on February 1, 2019, with fixed
          interest at 4% per annum.



         During the first quarter of 2012, we sold an aggregate of approximately
          6.9 million shares of our common stock under our "at the market" (ATM)
          program (which completed that $250.0 million program), in exchange for
          aggregate gross proceeds of approximately $130.2 million. During the
          third quarter of 2012, we instituted a new ATM program to sell up to an
          additional $300.0 million of stock, none of which was sold during the
          quarter.



         During the first quarter of 2012, we used the proceeds from the debt
          and ATM financings, together with a portion of our cash on hand, to
          fully repay a $522.0 million loan, our last with a 2012 maturity date.



         During the third quarter of 2012, we obtained a secured, non-recourse
          $285.0 million term loan maturing on June 5, 2019, with fixed interest
          of 3.85% per annum. Monthly payments are interest-only until February
          5, 2017, with principal amortization thereafter based upon a 30-year
          amortization table. We used $100.0 million of the proceeds to prepay
          existing debt and retained the remaining proceeds for acquisitions and
          other working capital needs. See "Liquidity and Capital Resources"
          below, and Note 7 to our consolidated financial statements in Item 1 of
          this Report.

Rental Rate Trends

Office Rental Rates: The following table sets forth the average effective annual
rental rate per leased square foot and the annualized lease transaction costs
for leases executed in our total office portfolio during the specified periods:
                        Nine Months Ended           Twelve Months Ended December 31,
Historical
straight-line rents:(1) September 30, 2012     2011         2010        2009        2008
Average rental rate(2)        $33.40          $32.76       $32.33      $35.11      $41.90
Annualized lease
transaction costs(3)          $3.97            $3.64        $3.68       $3.33       $3.23

(1) Because straight-line rent takes into account the full economic value of each lease, including accommodations and rent escalations, we believe that it may provide a better comparison than ending cash rents, which include the impact of the annual escalations over the entire term of the lease. However, care should be taken in any comparison, as the averages can be affected in each period by factors such as the buildings, submarkets, types of space and term involved in the leases executed during the period.

(2) Represents the weighted average straight-line annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot for leases entered into within our total office portfolio. For our triple net Burbank and Honolulu office properties, annualized rent is calculated by adding expense reimbursements to base rent.

(3) Represents the weighted average leasing commissions and tenant improvement allowances under all office leases within our total office portfolio that were entered into during the applicable period, divided by the number of years of the lease.


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Office rental rates in our markets generally peaked in 2007 and early 2008, so that rental rates on new leases since that period have generally been less than the rental rates on the expiring leases for the same space. During the third quarter of 2012, the average straight-line rent under new and renewal leases we signed was 5.2% lower than the average straight-line rent under the expiring leases for the same space. However, net changes in our office rental rates have not had a significant impact on our revenues in recent periods, as the negative effect of rent roll downs, which affect approximately 11% to 14% of our office portfolio each year, have been essentially offset by the positive impact of the annual 3% to 5% rent escalations contained in virtually all of our continuing in-place office leases.

Over the next four quarters, we expect to see expiring cash rents as set forth in the following table:

                                                       Three Months Ended
Expiring cash rents:   December 31, 2012       March 31, 2013       June 30, 2013       September 30, 2013
Expiring square feet
(1)                              471,437              264,589              320,283                 707,864
Expiring rent per
square foot (2)      $             33.63     $          35.15     $          38.27     $             39.19

(1) Includes scheduled expirations for our total office portfolio, including our consolidated portfolio of 50 properties totaling 12.9 million square feet, as well as 8 properties totaling 1.8 million square feet owned by our Funds. Expiring square footage reflects all existing leases that are scheduled to expire in the respective quarter shown above, excluding the square footage under leases where the existing tenant has renewed the lease prior to September 30, 2012. These numbers (i) include leases for space where someone other than the existing tenant (for example, a subtenant) had executed a lease for the space prior to September 30, 2012 but that had not commenced as of that date but (ii) do not include exercises of early termination options (unless exercised prior to September 30, 2012) or defaults occurring after September 30, 2012. All month-to-month tenants are included in the expiring leases in the first quarter listed.

(2) Represents annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot at expiration. The amount reflects total cash base rent before abatements. For our Burbank and Honolulu office properties, we calculate annualized base rent for triple net leases by adding expense reimbursements to base rent. Expiring rent per square foot on a quarterly basis is impacted by a number of variables, including variations in the submarkets or buildings involved.

Multifamily Rental Rates. With respect to our residential properties, our average rent on leases to new tenants during the third quarter of 2012 was 6.4% higher than the rent for the same unit at the time it became vacant. The following table sets forth the average effective annual rental rate per leased unit for leases executed in our residential portfolio during the specified periods:

             Nine Months Ended            Twelve Months Ended December 31,
             September 30, 2012       2011        2010        2009        2008
Rental rate $            25,966    $  24,502    $ 22,497    $ 22,776    $ 23,427

Occupancy Rates

Occupancy Rates: The following tables set forth the occupancy rates for our total office portfolio and multifamily portfolio as of the specified periods:
December 31, Occupancy Rates as of: September 30, 2012 2011 2010 2009 2008 Total Office Portfolio 88.2 % 87.5 % 86.9 % 89.0 % 92.4 % Multifamily Portfolio 98.7 % 98.4 % 98.4 % 98.0 % 97.9 %

                        Nine Months Ended               Twelve Months Ended December 31,
Average Occupancy
Rates for: (1)          September 30, 2012       2011           2010           2009         2008
Total Office Portfolio            88.0 %          87.0 %         88.0 %         90.3 %       93.6 %
Multifamily Portfolio             98.5 %          98.2 %         98.3 %         97.9 %       98.2 %

(1) Average occupancy rates are calculated by averaging the occupancy on the last day of the quarter with the occupancy on the last day of the prior quarter, and for periods longer than a quarter, by taking the average of the rates at the quarter-end immediately before, and each quarter-end contained in, such period.


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Funds From Operations

Many investors use Funds From Operations (FFO) as a performance yardstick to compare our operating performance with that of other REITs. FFO represents net income (loss), computed in accordance with GAAP, excluding gains (or losses) from sales of depreciable operating property, impairments of depreciable operating property and investments, real estate depreciation and amortization (other than amortization of deferred financing costs) and after adjustments for unconsolidated partnerships and joint ventures. We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts (NAREIT), adjusted to treat debt interest rate swaps as terminated for all purposes in the quarter of termination.

Like any metric, FFO is not perfect as a measure of our performance, because it excludes depreciation and amortization and captures neither the changes in the value of our properties that result from use or market conditions nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results from operations. Other REITs may not calculate FFO in accordance with the NAREIT definition or may not adjust that definition to treat debt interest rate swaps as terminated for all purposes in the quarter of termination and, accordingly, our FFO may not be comparable to those other REITs' FFO. Accordingly, FFO should be considered only as a supplement to net income as a measure of our performance. FFO should not be used as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends. FFO should not be used as a supplement to or substitute measure for cash flow from operating activities computed in accordance with GAAP.

For the reasons described below, our FFO (adjusted for our terminated swaps) for the three months ended September 30, 2012 increased by $2.7 million, or 4.9%, to $57.3 million compared to $54.6 million for the three months ended September 30, 2011, which is primarily attributable to increased office and multifamily revenue, as well as a decrease in our interest expense resulting from lower debt balances. FFO (adjusted for our terminated swaps) for the nine months ended September 30, 2012 increased by $1.6 million, or 0.9%, to $178.8 million compared to $177.3 million for the nine months ended September 30, 2011, which is primarily attributable to increased multifamily revenue offset by an increase in our interest expense resulting from the refinancing of maturing floating-rate debt with long-term fixed-rate debt and a larger share of losses from Funds as a result of our acquisition of additional ownership interests.

The following table (in thousands) sets forth a reconciliation of our FFO to net income (loss) computed in accordance with GAAP:

                                               Three Months Ended            Nine Months Ended
                                                  September 30,                September 30,
                                                2012          2011           2012          2011
Funds From Operations (FFO)
Net income (loss) attributable to common
stockholders                                $    5,055     $  3,397      $   16,968     $  (1,968 )
Depreciation and amortization of real
estate assets                                   46,546       45,872         139,071       160,139
Net income (loss) attributable to
noncontrolling interests                         1,173        1,007           4,037          (182 )
Less: adjustments attributable to
consolidated joint venture and
unconsolidated investment in real estate
funds                                            3,387        2,837           9,910         8,841
FFO (before adjustments for terminated
swaps)                                          56,161       53,113         169,986       166,830
Amortization of accumulated other
comprehensive income as a result of
terminated swaps (1)                             1,148        1,526           8,855        10,436
FFO (after adjustments for terminated
swaps)                                      $   57,309     $ 54,639      $  178,841     $ 177,266

(1) We terminated certain interest rate swaps in November 2010 and December 2011 in connection with the refinancing of related loans. As noted above, in calculating FFO, we make an adjustment to treat debt interest rate swaps as terminated for all purposes in the quarter of termination. In contrast, under GAAP, terminated swaps can continue to impact net income over their original lives as if they were still outstanding. In the three and nine months ended September 30, 2011, GAAP net income was reduced by amortization expense as a result of certain swaps terminated in November 2010. However, in calculating FFO, we recognize the full expense in the period the swaps are terminated and offset the subsequent amortization expense contained in GAAP net income by an equivalent amount in this table, leaving a net zero impact as a result of terminated swaps on our 2011 FFO. Similarly, in the three and nine months ended September 30, 2012, GAAP net income was reduced by amortization expense as a result of certain swaps terminated in December 2011, and we offset that expense by an equivalent amount in calculating our 2012 FFO.


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Historical Results of Operations

Overview

Our results of operations for the three and nine months ended September 30, 2012 and 2011 consist of the rental operations for our 50 consolidated office properties and 9 consolidated multifamily properties. Our share of results from our unconsolidated Funds, which owned an additional 8 office properties at September 30, 2012, is included through Loss, Including Depreciation, from Unconsolidated Real Estate Funds.

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

Revenues

Office Rental Revenue: Rental revenue includes rental revenues from our office properties, percentage rent on the retail space contained within office properties and lease termination income. Total office rental revenue increased by $688 thousand, or 0.7%, to $98.4 million for the three months ended September 30, 2012, compared to $97.7 million for the three months ended September 30, 2011. The increase primarily reflects higher cash revenues partly offset by lower non-cash revenue from straight line and below-market leases. Net accretion from above- and below-market leases declined by $417 thousand to $3.8 million for the three months ended September 30, 2012, compared to $4.2 million for the three months ended September 30, 2011, largely as the result of the ongoing expiration of leases in place at the time of our initial public offering (IPO).

Tenant Recoveries: Total office tenant recoveries decreased by $264 thousand, or 2.3%, to $11.3 million for the three months ended September 30, 2012, compared to $11.6 million for the three months ended September 30, 2011. The decrease is primarily due to lower common area maintenance (CAM) recoveries related to both the current year and the prior year reconciliations.

Total Multifamily Revenue: Total multifamily revenue consists of rent, parking income and other income. Total multifamily revenue increased by $952 thousand, or 5.4%, to $18.6 million for the three months ended September 30, 2012, compared to $17.6 million for the three months ended September 30, 2011. The increase is primarily due to increases in rental rates.

Operating Expenses

Office Rental Expenses: Total office rental expenses were essentially unchanged at $44.3 million for the three months ended September 30, 2012, compared to $44.3 million for the three months ended September 30, 2011 as a result of modest increases in employee and insurance costs largely offset by lower costs for utilities and other expense reductions. .

Multifamily Rental Expenses: Total multifamily rental expense increased by $167 thousand, or 3.5%, to $5.0 million for the three months ended September 30, 2012, compared to $4.8 million for the three months ended September 30, 2011. The increase is primarily due to increases in utilities expense.

General and Administrative Expenses: General and administrative expenses decreased by $344 thousand or 4.9% to $6.6 million for the three months ended September 30, 2012, compared to $7.0 million for the three months ended September 30, 2011. The decrease is primarily due to decreases in employee equity compensation expense resulting from certain tranches of our 2010 multi-year equity grants becoming fully vested.

Depreciation and Amortization: Depreciation and amortization expense increased by $674 thousand, or 1.5%, to $46.5 million for the three months ended September 30, 2012, compared to $45.9 million for the three months ended September 30, 2011. The increase is primarily due to higher tenant improvement and lease intangible balances.


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Non-Operating Income and Expenses

Loss, Including Depreciation, from Unconsolidated Real Estate Funds: The loss, including depreciation, from unconsolidated real estate funds represents our equity interest in the operating results of our Funds, including the operating income net of historical cost-basis depreciation. Our share of the loss, including depreciation, from our Funds increased by $378 thousand, or 132.6%, to $663 thousand for the three months ended September 30, 2012, compared to $285 thousand for the three months ended September 30, 2011, which was primarily due to our increased ownership in the Funds as a result of our acquisition of an additional 16.3% interest in Douglas Emmett Fund X, LLC during the first quarter.

Interest Expense: Interest expense decreased by $873 thousand, or 2.3%, to $36.8 million for the three months ended September 30, 2012, compared to $37.7 million for the three months ended September 30, 2011. The decrease primarily reflects lower debt balances and market interest rates, as well as non-cash market value adjustments related to interest rate swaps not designated as hedges, partly offset by decreased amortization of non-cash loan premium. See Notes 7 and 8 to our consolidated financial statements in Item 1 of this Report.

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

Revenues

Office Rental Revenue: Total office rental revenue was essentially unchanged at $295.0 million for the nine months ended September 30, 2012, compared to $295.1 million for the nine months ended September 30, 2011. The decrease primarily reflects lower non-cash revenue from straight line and below-market leases, almost entirely offset by higher cash revenues. Net accretion from above- and below- market leases declined by $1.7 million to $11.4 million for the nine months ended September 30, 2012, compared to $13.1 million for the nine months ended September 30, 2011, largely as the result of the ongoing expiration of leases in place at the time of our IPO.

Tenant Recoveries: Total office tenant recoveries decreased by $571 thousand, or 1.7%, to $33.1 million for the nine months ended September 30, 2012, compared to $33.7 million for the nine months ended September 30, 2011. The decrease is primarily due to lower common area maintenance (CAM) recoveries related to both the current year and the prior year reconciliations.

Total Multifamily Revenue: Total multifamily revenue increased by $2.6 million, or 5.0%, to $55.0 million for the nine months ended September 30, 2012, compared to $52.3 million for the nine months ended September 30, 2011. The increase is primarily due to increases in rental rates.

Operating Expenses

Office Rental Expenses: Total office rental expense increased by $603 thousand, or 0.5%, to $127.7 million for the nine months ended September 30, 2012, compared to $127.1 million for the nine months ended September 30, 2011. The increase is primarily due to modest increases in utilities expense and payroll, partly offset by lower property taxes.

Multifamily Rental Expenses: Total multifamily rental expense increased by $543 thousand, or 3.8%, to $14.9 million for the nine months ended September 30, 2012, compared to $14.3 million for the nine months ended September 30, 2011. The increase is primarily due to increases in scheduled services and utilities expense.

General and Administrative Expenses: General and administrative expenses decreased by $1.2 million, or 5.7%, to $20.1 million for the nine months ended September 30, 2012, compared to $21.3 million for the nine months ended September 30, 2011. The decrease is primarily due to decreases in employee equity compensation expense resulting from certain tranches of our 2010 multi-year equity grants becoming fully vested.

Depreciation and Amortization: Depreciation and amortization expense decreased . . .

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