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BDN > SEC Filings for BDN > Form 10-Q on 6-Aug-2013All Recent SEC Filings

Show all filings for BRANDYWINE REALTY TRUST



Quarterly Report

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

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Quarterly Report on Form 10-Q and other materials filed by us with the SEC (as well as information included in oral or other written statements made by us) contain statements that are forward-looking, including statements relating to business and real estate development activities, acquisitions, dispositions, future capital expenditures, financing sources, governmental regulation (including environmental regulation) and competition. We intend such forward-looking statements to be covered by the safe-harbor provisions of the 1995 Act. The words "anticipate," "believe," "estimate," "expect," "intend," "will," "should" and similar expressions, as they relate to us, are intended to identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be achieved. As forward-looking statements, these statements involve important risks, uncertainties and other factors that could cause actual results to differ materially from the expected results and, accordingly, such results may differ from those expressed in any forward-looking statements made by us or on our behalf. Factors that could cause actual results to differ materially from our expectations include, but are not limited to:
the continuing impact of modest global economic growth, which is having and may continue to have a negative effect on the following, among other things:

         the fundamentals of our business, including overall market occupancy,
          demand for office space and rental rates;

         the financial condition of our tenants, many of which are financial,
          legal and other professional firms, our lenders, counterparties to our
          derivative financial instruments and institutions that hold our cash
          balances and short-term investments, which may expose us to increased
          risks of default by these parties;

         the availability of financing on attractive terms or at all, which may
          adversely impact our future interest expense and our ability to pursue
          acquisition and development opportunities and refinance existing debt;

         a decline in real estate asset valuations, which may limit our ability
          to dispose of assets at attractive prices or obtain or maintain debt
          financing secured by our properties or on an unsecured basis.

       changes in local real estate conditions (including changes in rental
        rates and the number of properties that compete with our properties);

       changes in the economic conditions affecting industries in which our
        principal tenants compete;

the unavailability of equity and debt financing;

our failure to lease unoccupied space in accordance with our projections;

our failure to re-lease occupied space upon expiration of leases;

tenant defaults and the bankruptcy of major tenants;

increases in interest rates;

failure of interest rate hedging contracts to perform as expected and the effectiveness of such arrangements;

failure of acquisitions to perform as expected;

unanticipated costs associated with the acquisition, integration and operation of our acquisitions;

unanticipated costs to complete, lease-up and operate our developments and redevelopments;

unanticipated costs associated with land development, including building moratoriums and inability to obtain necessary zoning, land-use, building, occupancy and other required governmental approvals, construction cost increases or overruns and construction delays;

impairment losses;

increased costs for, or lack of availability of, adequate insurance, including for terrorist acts;

actual or threatened terrorist attacks;

demand for tenant services beyond those traditionally provided by landlords;

liability under environmental or other laws;

failure or bankruptcy of real estate venture partners;

inability of real estate venture partners to fund venture obligations;

failure of dispositions to close in a timely manner;

failure of buyers of our properties to comply with the terms of their financing agreements to us;

earthquakes and other natural disasters;

the unforeseen impact of climate change and compliance costs relating to laws and regulations governing climate change;

risks associated with federal, state and local tax audits;

complex regulations relating to our status as a REIT and the adverse consequences of the Parent Company's failure to qualify as a REIT; and

the impact of newly adopted accounting principles on our accounting policies and on period-to-period comparisons of financial results.

Given these uncertainties, and the other risks identified in the "Risk Factors" section of our 2012 Annual Report on Form 10-K, we caution readers not to place undue reliance on forward-looking statements. We assume no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.
The discussion that follows is based primarily on our consolidated financial statements as of June 30, 2013 and December 31, 2012 and for the three and six-month periods ended June 30, 2013 and 2012 and should be read along with the consolidated financial statements and related notes appearing elsewhere in this report. The ability to compare one period to another may be significantly affected by acquisitions completed, development properties placed in service and dispositions made during those periods.
As of June 30, 2013, our 210 property portfolio consisted of 182 office properties, 19 industrial facilities, five mixed-use properties (206 core properties), one development property, two redevelopment properties and one re-entitlement property that contain an aggregate of approximately 24.2 million net rentable square feet. As of June 30, 2013, we also held economic interests in 17 unconsolidated real estate ventures that we formed with third parties to develop or own commercial properties. The properties owned by these Real Estate Ventures contain approximately 6.2 million net rentable square feet. As of June 30, 2013, we managed our portfolio within seven geographic segments:
(1) Pennsylvania, (2) Philadelphia CBD, (3) Metropolitan Washington, D.C.,
(4) New Jersey/Delaware, (5) Richmond, Virginia, (6) Austin, Texas and
(7) California. The Pennsylvania segment includes properties in Chester, Delaware, and Montgomery counties in the Philadelphia suburbs. The Philadelphia CBD segment includes properties located in the City of Philadelphia in Pennsylvania. The Metropolitan Washington, D.C. segment includes properties in Northern Virginia and southern Maryland. The New Jersey/Delaware segment includes properties in Burlington, Camden, and Mercer counties in New Jersey and New Castle county in the state of Delaware. The Richmond, Virginia segment includes properties primarily in Albemarle, Chesterfield, Goochland and Henrico counties and one property in Durham, North Carolina. The Austin, Texas segment includes properties in Austin. The California segment includes properties in Oakland, Concord, and Carlsbad, California. We generate cash and revenue from leases of space at our properties and, to a lesser extent, from the management of properties owned by third parties and from investments in the Real Estate Ventures. Factors that we evaluate when leasing space include rental rates, costs of tenant improvements, tenant creditworthiness, current and expected operating costs, the length of the lease, vacancy levels and demand for office and industrial space. We also generate cash through sales of assets, including assets that we do not view as core to our portfolio, either because of location or expected growth potential, and assets that are commanding premium prices from third party investors. Our financial and operating performance is dependent upon the demand for office, industrial and other commercial space in our markets, our leasing results, our acquisition, disposition and development activity, our financing activity, our cash requirements and economic and market conditions, including prevailing interest rates. Challenging economic conditions could result in a reduction of the availability of financing and potentially in higher borrowing costs. These factors, coupled with ongoing economic recovery, have reduced the volume of real estate transactions and created credit stresses on most businesses. Vacancy rates may increase through 2013 and possibly beyond as the current economic climate continues to negatively impact tenants. We expect that the impact of the current state of the economy, including continued high unemployment and the continued volatility in the financial and credit markets, could continue to have a dampening effect on the fundamentals of our business, including

potential increases in past due accounts, tenant defaults, lower occupancy and reduced effective rents. These conditions would negatively affect our future net income and cash flows and could have a material adverse effect on our financial condition. We believe that the quality of our assets and our strong balance sheet will enable us to raise debt capital, if necessary, in various forms and from different sources, including traditional term or secured loans from banks, pension funds and life insurance companies. However, there can be no assurance that we will be able to borrow funds on terms that are economically attractive or at all.
We seek revenue growth throughout our portfolio by increasing occupancy and rental rates. Occupancy at our wholly owned properties at June 30, 2013 was 87.9%.
The table below summarizes the key operating and leasing statistics of our wholly owned operating properties for the three months ended June 30, 2013:

                                                  Three-month period       Six-month period
                                                         ended                   ended
                                                     June 30, 2013           June 30, 2013
Leasing Activity:
Core portfolio net rentable square feet owned
(1)                                                     23,373,550              23,373,550
Occupancy percentage (end of period)                          87.9 %                  87.9 %
Average occupancy percentage                                  88.0 %                  87.9 %
New leases and expansions commenced (square
feet)                                                      460,960                 780,204
Leases renewed (square feet)                               434,240                 807,113
Net absorption (square feet) (2)                            20,216                (103,724 )
Percentage change in rental rates per square
feet (3):
New and expansion rental rates                                13.2 %                  10.8 %
Renewal rental rates                                           9.1 %                   9.9 %
Combined rental rates                                         10.6 %                  10.2 %
Capital Costs Committed (4):
Leasing commissions (per square feet)            $            2.68       $            3.74
Tenant Improvements (per square feet)            $            7.00       $            9.17

(1) Includes all properties in the core portfolio (i.e. not under development or redevelopment or a re-entitlement property), including properties that were sold during these periods.

(2) Includes leasing related to completed developments and redevelopments, as well as properties sold during the six month period ended June 30, 2013.

(3) Rental rates include base rent plus reimbursement for operating expenses and real estate taxes.

(4) Calculated on an average basis.

In seeking to increase revenue through our operating, financing and investment activities, we also seek to minimize operating risks, including (i) tenant rollover risk, (ii) tenant credit risk and (iii) development risk. Tenant Rollover Risk:
We are subject to the risk that tenant leases, upon expiration, will not be renewed, that space may not be relet, or that the terms of renewal or reletting (including the cost of renovations) may be less favorable to us than the current lease terms. Leases accounting for approximately 2.7% of our aggregate final annualized base rents as of June 30, 2013 (representing approximately 2.8% of the net rentable square feet of the Properties) expire without penalty in 2013. As of June 30, 2013, the annualized rent per square foot of these expiring leases amounted to $22.10, and although we can provide no assurance, we currently expect that the annualized market rent per square foot will increase by 5% to 7% through a combination of new leases and renewals throughout the year. We maintain an active dialogue with our tenants in an effort to maximize lease renewals. During the six months ended June 30, 2013, we achieved a 66.2% retention rate in our core portfolio, which was primarily attributable to a former tenant in our Austin, Texas region vacating approximately 0.1 million net rentable square feet. We have leased the majority of this vacated space and new tenants will commence occupancy over the remainder of 2013. If we are unable to renew leases or relet space under expiring leases, at anticipated rental rates, or if tenants terminate their leases early, our cash flow would be adversely impacted.

Tenant Credit Risk:
In the event of a tenant default, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment. Our management regularly evaluates our accounts receivable reserve policy in light of our tenant base and general and local economic conditions. Our accounts receivable allowance was $17.0 million or 11.1% of total receivables (including accrued rent receivables) as of June 30, 2013 compared to $16.6 million or 10.9% of total receivables (including accrued rent receivables) as of December 31, 2012.
If economic conditions persist or deteriorate further, we may experience increases in past due accounts, defaults, lower occupancy and reduced effective rents. This condition would negatively affect our future net income and cash flows and could have a material adverse effect on our financial condition. Development Risk:
As of June 30, 2013, we owned approximately 435 acres of undeveloped land, and held options to purchase approximately 51 additional acres of undeveloped land. As market conditions warrant, we will seek to opportunistically dispose of those parcels that we do not anticipate developing. For parcels of land that we ultimately develop, we will be subject to risks and costs associated with land development, including building moratoriums and inability to obtain necessary zoning, land-use, building, occupancy and other required governmental approvals, construction cost increases or overruns and construction delays, and insufficient occupancy rates and rental rates. As of June 30, 2013, the total potential development that these land parcels could support amounted to 6.2 million square feet.
We are a party to a development agreement and related ground leases covering two adjacent parcels of land. As described below under "Recent Property Transactions
- The Grove Venture" and in Note 4 above, on January 25, 2013, we contributed our development rights in one of the land parcels to the Grove Venture, and during the three months ended March 31, 2013 the Grove Venture commenced construction of a student housing tower. As to the other parcel, we have the right, on terms and conditions in the development agreement and applicable ground lease, to commence development of such other parcel by December 31, 2015. If we determine that we will not be able to commence development of the other parcel by December 31, 2015, or if we determine that development is not in our best interests and we are unable to obtain an additional extension of the development period, then we will be required to write-off all costs that we have incurred in preparing this parcel for development, amounting to $6.0 million as of June 30, 2013.
Real Estate Acquisitions/Dispositions
On April 25, 2013, we exercised our purchase option under the long term ground lease agreement we held through our acquisition of Three Logan Square on August 5, 2010 and acquired the 1.8 acre land parcel underlying Three Logan Square in Philadelphia, Pennsylvania for $20.8 million. We have accounted for the transaction as an asset acquisition. A portion of the original purchase price of Three Logan Square was allocated to the below market ground lease intangible asset, and the sum of the purchase price of the land and the$4.3 million remaining balance for the intangible asset approximates the fair value of the land as an unencumbered ground lease. The remaining intangible asset balance was reclassified to land upon exercise of the purchase option. We funded the cost of the acquisition with available corporate funds and capitalized $0.1 million of acquisition related costs as part of the basis in the operating land. On June 28, 2013, we sold 16870 West Bernardo Drive, a 67,909 net rentable square feet office property located in San Diego, California, for a sales price of $18.0 million. The property was 98.8% occupied as of the date of sale. On June 28, 2013, we sold 100 Arrandale Boulevard, a 34,931 net rentable square feet office property located in Exton, Pennsylvania, for a sales price of $3.5 million. The property was vacant at the date of sale.
On June 19, 2013, the Company sold 1700 Paoli Pike, a 28,000 net rentable square feet office property located in Malvern, Pennsylvania, for a sales price of $2.7 million. The property was vacant at the date of sale.
On June 14, 2013, we sold Pacific View Plaza, a 51,695 net rentable square feet office property located in Carlsbad, California, for a sales price of $10.3 million. The property was 90.5% occupied as of the date of sale.
On February 25, 2013, we sold a portfolio of eight office properties containing 800,546 square feet in Lawrenceville, New Jersey for an aggregate sales price of $121.0 million. These properties, collectively known as "Princeton Pike Corporate Center," were 86.9% occupied as of the date of sale.

Two and Six Tower Bridge Exchange Transaction

On June 19, 2013, we acquired the outside ownership interest in Six Tower Bridge real estate venture, through a nonmonetary exchange with an unaffiliated party for our ownership interest in the Two Tower Bridge real estate venture. We previously accounted for our noncontrolling interest in Six Tower Bridge using the equity method. As a result of this transaction we obtained control of the Six Tower Bridge property and our existing equity interest was remeasured at fair value based on the fair value of the underlying property and the distribution provisions of the real estate venture agreement. Accordingly, during 2013, we recorded a gain approximately $7.8 million which is reflected in "Gain on remeasurement of investment in real estate venture" on the accompanying statements of operations. Following the acquisition, the Class A office property in Conshohocken, PA is wholly owned by us with an unencumbered fair value of $24.5 million. We accounted for this acquisition as a business combination and allocated the fair value as follows: $14.8 million to building, $6.9 million to land, $3.3 million to intangible assets and $0.5 million to below market lease liabilities assumed.

As mentioned above, we exchanged our investment in Two Tower Bridge real estate venture in an nonmonetary transaction with an unaffiliated party to acquire the outside investor interest Six Tower Bridge real estate venture. The investment in Two Tower Bridge had a fair value of $3.6 million on the date of the exchange transaction based on the fair value of the venture's equity and distribution provisions of the real estate venture agreement. Based on the fair value and the carrying value for our investment of $(0.1) million, during 2013 we recognized a gain on exchange of interests in real estate ventures of $3.7 million. The Grove Venture
On January 25, 2013, we formed the Grove Venture, a joint venture among the Company and two unaffiliated parties: Campus Crest Properties, LLC ("Campus Crest") and HSRE-Campus Crest IXA, LLC ("HSRE"). The Grove Venture has commenced construction of a 33-story, 850-bed student housing tower located in the University City submarket of Philadelphia, Pennsylvania to be called The Grove at Cira Centre South (the "Grove"). We and Campus Crest each own a 30% interest in the Grove Venture and HSRE owns a 40% interest. The Grove Venture is developing the project on a one-acre land parcel held under a long-term ground lease with a third party lessor. We contributed to the Grove Venture our tenancy rights under a long-term ground lease, together with associated development rights, at an agreed-upon value of $8.5 million. The total estimated project costs are $158.5 million, which will be financed through partner capital contributions totaling $60.7 million, with the remaining $97.8 million being financed through a construction facility by PNC Bank, Capital One, and First Niagara Bank. Construction has already commenced, with a targeted project completion in 2014.
In connection with our development of the Grove project through the Grove Venture (as described in Note 4 to the consolidated financial statements), we and Campus Crest have provided, in addition to customary non-recourse carve-out guarantees, a completion and cost overrun guaranty, as well as a payment guaranty, on the construction financing (with our share of the payment guaranty being approximately $23.0 million).
BDN Beacon Venture
On March 26, 2013, we sold our entire 20% ownership interest in an unconsolidated real estate venture known as BDN Beacon Venture LLC (the "Beacon Venture"). The carrying amount of our investment in the Beacon Venture amounted to $17.0 million at the sale date, with our proceeds effectively matching the carrying amount.
We continually assess our portfolio in light of our strategic and economic considerations to determine whether to sell properties in the portfolio. Sales of properties, and determinations to hold properties for sale, may result in an impairment or other loss, and such loss could be material to our statement of operations.
Management's Discussion and Analysis of Financial Condition and Results of Operations discuss our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Certain accounting policies are considered to be critical accounting policies, as they require management to make assumptions about matters that are highly uncertain at the time the estimate is made and changes in accounting policies are reasonably likely to occur from period to period. Management bases its estimates and assumptions on historical experience and current economic conditions. On an on-going basis, management evaluates its estimates and assumptions including those related to revenue, impairment of long-lived assets and the allowance for doubtful accounts. Actual results may differ from those estimates and assumptions.

Our Annual Report on Form 10-K for the year ended December 31, 2012 contains a discussion of our critical accounting policies. There have been no significant changes in our critical accounting policies since December 31, 2012. See also Note 2 in our unaudited consolidated financial statements for the three and six-month periods ended June 30, 2013 set forth herein. Management discusses our critical accounting policies and management's judgments and estimates with our Audit Committee.
The following discussion is based on our Consolidated Financial Statements for the three and six-month periods ended June 30, 2013 and 2012. We believe that presentation of our consolidated financial information, without a breakdown by segment, will effectively present important information useful to our investors. Net operating income ("NOI"), as presented in the comparative analysis below is defined as total revenue less property operating expenses, real estate taxes and third party management expenses. Property operating expenses that are included in determining NOI consist of costs that are necessary and allocable to our operating properties such as utilities, property-level salaries, repairs and maintenance, property insurance, management fees and bad debt expense. General and administrative expenses that are not reflected in NOI primarily consist of corporate-level salaries, amortization of share based awards to our executives and employees and professional fees that we incur as part of corporate office management. NOI is a non-GAAP financial measure that we use internally to evaluate the operating performance of our real estate assets by segment, as presented in Note 16 to the consolidated financial statements, and of our business as a whole. We believe NOI provides useful information to investors regarding our financial condition and results of operations because it reflects only those income and expense items that are incurred at the property level. While NOI is a relevant and widely used measure of operating performance of real estate investment trusts, it does not represent cash flow from operations or net income as defined by GAAP and should not be considered as an alternative to those measures in evaluating our liquidity or operating performance. NOI also does not reflect general and administrative expenses, interest expenses, real estate impairment losses, depreciation and amortization costs, capital expenditures and leasing costs. Trends in development and construction activities that could materially impact our results from operations are also not included in NOI. We believe that net income, as defined by GAAP, is the most appropriate earnings measure. See Note 16 to the Consolidated Financial Statements for a reconciliation of NOI to our consolidated net income. Comparison of the Three-Month Periods Ended June 30, 2013 and June 30, 2012 The table below shows selected operating information for the "Same Store Property Portfolio" and the "Total Portfolio." The Same Store Property Portfolio consists of 204 properties containing an aggregate of approximately 23.1 million net rentable square feet, and represents properties that we owned for the entire three-month periods ended June 30, 2013 and 2012. The Same Store Property Portfolio includes properties acquired or placed in service on or prior to January 1, 2012 and owned through June 30, 2013. The Total Portfolio includes the effects of other properties that were either placed into service, acquired or redeveloped after January 1, 2012 or disposed prior to June 30, 2013. A property is excluded from our Same Store Property Portfolio and moved into the redevelopment column in the period that we determine that a redevelopment would . . .

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