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DEI > SEC Filings for DEI > Form 10-Q on 7-Nov-2013All Recent SEC Filings

Show all filings for DOUGLAS EMMETT INC

Form 10-Q for DOUGLAS EMMETT INC


7-Nov-2013

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 2012 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.


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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, 2013:

Our consolidated portfolio of properties included fifty-two Class A office properties (including ancillary retail space) totaling approximately 13.3 million rentable square feet and nine multifamily properties containing 2,868 apartment units, as well as the fee interests in two parcels of land subject to ground leases.

Our total office portfolio included sixty office properties aggregating approximately 15.1 million rentable square feet, consisting of both our consolidated office properties and eight Class A office properties owned by our Funds (in which we own a weighted average of 60% based on square footage).

Our consolidated office portfolio was 92.0% leased and 90.0% occupied and our total office portfolio was 91.7% leased and 89.6% occupied.

Our multifamily properties were 99.5% leased and 98.5% occupied.

Approximately 85.6% of the annualized rent of our consolidated portfolio was derived from our office properties and the remaining 14.4% from our multifamily properties.

Approximately 86.3% of the annualized rent of our consolidated portfolio was derived from our Los Angeles County office and multifamily properties and the remaining 13.7% from our Honolulu, Hawaii office and multifamily properties.

Financings, Acquisitions, Dispositions, Development and Repositionings

Financings:

          During the first quarter of 2013, we used a portion of our cash on
           hand to pay down $90.0 million on a $240.0 million loan that was
           scheduled to mature on April 1, 2015.



          On April 30, 2013, Douglas Emmett Fund X, LLC, one of our
           unconsolidated Funds, closed a $325.0 million loan which matures on
           May 1, 2018 with a floating interest rate that we effectively fixed at
           2.35% per annum until May 1, 2017. The unconsolidated Fund used the
           proceeds of that loan, plus $40.0 million of additional cash, to pay
           down its outstanding debt of $365.0 million that was scheduled to
           mature on August 19, 2013.

Acquisitions:

          During the first quarter of 2013, we purchased an additional 3.3%
           interest in Douglas Emmett Fund X, LLC and an additional 0.9% interest
           in Douglas Emmett Partnership X, LP, for an aggregate of approximately
           $8.0 million in cash.



          On May 15, 2013, we used a portion of our cash on hand to purchase a
           225,000 square foot Class A office building located at 8484 Wilshire
           Blvd. in Beverly Hills for a contract price of $89.0 million, or
           approximately $395 per square foot.



          On August 15, 2013, we purchased a 191,000 square foot Class A office
           building located at 16501 Ventura Blvd. in Encino for a contract price
           of $61.0 million, or approximately $319 per square foot.

Dispositions: We had no property dispositions during the first nine months of 2013.


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Development: We have begun work on two multifamily projects, one in Brentwood in Los Angeles, and one in Honolulu. Each development is on land which we already own. Because development in our markets, particularly West LA, remains a long and uncertain process, even if successful, we do not expect to break ground in Honolulu until the second quarter of 2014, while groundbreaking on our Los Angeles project is not expected to occur before at least 2015.

Repositionings: We often strategically purchase properties with large vacancies or expected near-term lease roll-over and use our knowledge of the property and submarket to reposition the property for the optimal use and tenant mix. The work we undertake to reposition a building typically takes months or even years, and could involve a range of improvements from a complete structural renovation to a targeted remodeling of selected spaces. We generally select a property for repositioning at the time we purchase it, although repositioning efforts can also occur at properties we already own. During the repositioning, the affected property may display depressed rental revenue and occupancy levels which impacts our results and, therefore, comparisons of our performance from period to period. We are currently repositioning a seventy-nine thousand square foot office property in Honolulu in which we own a two-thirds interest.

Historical Results of Operations

Overview

Our results of operations for the three and nine months ended September 30, 2013 consisted of the rental operations of fifty consolidated office properties and nine consolidated multifamily properties, as well as (after the respective date of acquisition) two additional office properties that we acquired on May 15, 2013 and August 15, 2013. Our results of operations for the three and nine months ended September 30, 2012 consisted of the rental operations of fifty consolidated office properties and nine consolidated multifamily properties. Our share of results from our unconsolidated Funds, which owned an additional eight office properties for the three and nine months ended September 30, 2013 and September 30, 2012, is included through income (loss), including depreciation, from unconsolidated real estate funds. We acquired additional interests in our Funds in 2013 and 2012. See Note 3 and Note 16 to our consolidated financial statements in Item 1 of this Report.

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 GAAP 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) (i) for the three months ended September 30, 2013 increased by $6.7 million, or 11.7%, to $64.0 million compared to $57.3 million for the three months ended September 30, 2012 and (ii) for the nine months ended September 30, 2013 increased by $17.0 million, or 9.5% to $195.9 million compared to $178.8 million for the nine months ended September 30, 2012. The increases were primarily attributable to (i) increased office and multifamily revenue, due to increases in office occupancy and multifamily rental rates, as well as rent from two office properties that we acquired in 2013, partly offset by other factors, (ii) an increase in our share of our unconsolidated Funds' FFO, as well as (iii) a decrease in our interest expense, due to $340.0 million in notional amount of interest rate swaps that matured in the first quarter of 2013. GAAP net income attributable to common stockholders increased by $5.7 million, or 112.7%, to $10.8 million for the three months ended September 30, 2013, compared to $5.1 million for the three months ended September 30, 2012. GAAP net income attributable to common stockholders increased by $19.5 million, or 114.9%, to $36.5 million for the nine months ended September 30, 2013, compared to $17.0 million for the nine months ended September 30, 2012.


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The table below (in thousands) is a reconciliation of our FFO to net income attributable to common stockholders computed in accordance with GAAP:

                                       Three Months Ended September 30,     Nine Months Ended September 30,
                                             2013               2012              2013              2012
Net income attributable to common
stockholders                          $          10,751     $    5,055     $         36,468     $   16,968
Depreciation and amortization of real
estate assets                                    47,402         46,546              141,528        139,071
Net income attributable to
noncontrolling interests                          1,992          1,173                5,865          4,037
Adjustments attributable to
consolidated joint venture and
investment in unconsolidated real
estate funds                                      3,890          3,387               12,021          9,910
FFO (before adjustments for
terminated swaps)                                64,035         56,161              195,882        169,986
Amortization of accumulated other
comprehensive income as a result of
terminated swaps(1)                                   -          1,148                    -          8,855
FFO (after adjustments for terminated
swaps)                                $          64,035     $   57,309     $        195,882     $  178,841


 ____________________________________________________

(1) We terminated certain interest rate swaps in 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 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. For the three and nine months ended September 30, 2012, GAAP net income was reduced by amortization expense as a result of swaps terminated in December 2011. We had no swap terminations in 2012 and 2013.

Rental Rate Trends

Office Rental Rates: The table below presents the average effective annual
rental rate per leased square foot, and the annualized lease transaction costs
for leases executed in our total office portfolio:

                        Nine Months Ended           Twelve Months Ended December 31,
Historical
straight-line rents:(1) September 30, 2013     2012         2011        2010        2009
Average rental rate(2)        $34.78          $32.86       $32.76      $32.33      $35.11
Annualized lease
transaction costs(3)          $3.93            $4.06        $3.64       $3.68       $3.33


___________________________________________________

(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 are often significantly affected from period to 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 each office lease within our total office portfolio that were executed during the applicable period, divided by the number of years of that lease.

In the last two quarters, average starting cash rental rates on new leases in recent periods have been greater than the average ending cash rental rates on the expiring leases for the same space, although, as a result of our high annual rent escalations, less than the average ending cash rental rates on those expiring leases. However, net changes in our office rental rates did not have 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, were generally offset by the positive impact of the annual 3% rent escalations which have been contained in virtually all of our continuing in-place office leases. In recent periods, we are executing leases in West Los Angeles and Encino/Sherman Oaks incorporating annual rent escalations in excess of 3%.


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During the third quarter of 2013, we experienced positive rent roll up for the second straight quarter, with the average straight-line rent under new and renewal leases we signed averaging 1.5% higher than the average straight-line rent under the expiring leases for the same space. Going forward, we expect that these same overall improving trends to continue, although quarterly fluctuations in submarkets, buildings and term of the expiring leases make predicting the outcome in any specific quarter difficult. Over the next four quarters, we expect to see expiring cash rents as presented in the table below:

                                                       Three Months Ending
Expiring cash rents:   December 31, 2013       March 31, 2014       June 30, 2014       September 30, 2014
Expiring square feet
(1)                              150,160              357,206              541,373                 421,712
Expiring rent per
square foot (2)      $             33.93     $          38.33     $          34.49     $             37.92


____________________________________________________

(1) Includes scheduled expirations for our total office portfolio, including our consolidated portfolio of fifty-two properties totaling 13.3 million square feet, as well as eight 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, 2013. 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, 2013, but had not commenced as of that date, but (ii) do not include exercises of early termination options (unless exercised prior to September 30, 2013), or defaults occurring after September 30, 2013. We also exclude short term leases, such as month to month leases and other short term leases, from this table, because they are not included in our changes in rental rate data, have rental rates that may not be reflective of market conditions, and can distort the data trends, particularly in the first upcoming quarter. The variations in this number from quarter to quarter primarily reflects the mix of buildings/submarkets involved, although it is also impacted by the varying terms and square footage of the individual leases involved.

(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 2013 was 6.7% higher than the rent for the same unit at the time it became vacant. The table below presents the average effective annual rental rate per leased unit for leases executed in our residential portfolio:
Nine Months Ended Twelve Months Ended December 31, Rental rate - new tenants: September 30, 2013 2012 2011 2010 2009 Average annual rental rate $ 27,406 $ 26,308 $ 24,502 $ 22,497 $ 22,776

Occupancy Rates

Occupancy Rates: The tables below present the occupancy rates1 for our total
office portfolio and multifamily portfolio:
                                                            December 31,
Occupancy Rates as of: (1)  September 30, 2013     2012     2011     2010     2009
Total Office Portfolio                89.6 %      89.6 %   87.5 %   86.9 %   89.0 %
Multifamily Portfolio                 98.5 %      98.7 %   98.4 %   98.4 %   98.0 %



                        Nine Months Ended               Twelve Months Ended December 31,
Average Occupancy
Rates for: (1)(2)       September 30, 2013       2012           2011           2010         2009
Total Office Portfolio            89.6 %          88.3 %         87.0 %         88.0 %       90.3 %
Multifamily Portfolio             98.6 %          98.5 %         98.2 %         98.3 %       97.9 %


___________________________________________________


(1) Occupancy rates include the negative impact of property acquisitions, most of whose occupancy rates at the time of acquisition are well below that of our existing portfolio.

(2) Average occupancy rates are calculated by averaging the occupancy rates on the first and last day of the quarter, and for periods longer than a quarter, by taking the average of the occupancy rates for all the quarters contained in the respective period.


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Comparison of three months ended September 30, 2013 to three months ended September 30, 2012

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 $1.2 million, or 1.2%, to $99.8 million for the three months ended September 30, 2013, compared to $98.6 million for the three months ended September 30, 2012. The increase was primarily due to rental revenue of $2.4 million from properties that we acquired in the second and third quarters of 2013, partly offset by $1.2 million of lower rental revenue from the 50 office properties that we owned during both comparable periods. The decrease in revenue for our comparable properties was primarily due to (i) lower rental rates, and
(ii) lower revenues from net accretion of above- and below-market leases which declined by $902 thousand to $2.9 million for the three months ended September 30, 2013, compared to $3.8 million for the three months ended September 30, 2012, largely as the result of the ongoing expiration of leases in place at the time of our initial public offering (IPO).

Office Tenant Recoveries: Total office tenant recoveries increased by $530 thousand, or 4.7%, to $11.9 million for the three months ended September 30, 2013, compared to $11.3 million for the three months ended September 30, 2012. The increase was primarily due to an increase of $416 thousand in recoveries from the properties that we owned during both comparable periods, as well as recoveries of $114 thousand from properties that we acquired in the second and third quarters of 2013. The increase in recoveries for our comparable properties primarily reflects higher recoverable operating expenses, as well as the timing of common area maintenance (CAM) recoveries related to prior year reconciliations.

Office Parking and Other Income: Office parking and other income increased by $1.2 million, or 6.9%, to $18.7 million for the three months ended September 30, 2013, compared to $17.5 million for the three months ended September 30, 2012. The increase was primarily due to an increase of $806 thousand in parking and other income from properties that we owned during both comparable periods, as well as revenue of $393 thousand from properties that we acquired in the second and third quarters of 2013. The increase in parking and other income for our comparable properties reflects higher parking cash revenue primarily due to increases in rates as well as higher utilization.

Total Multifamily Revenue: Total multifamily revenue consists of rent, parking income and other income. Total multifamily revenue increased by $777 thousand, or 4.2%, to $19.3 million for the three months ended September 30, 2013, compared to $18.6 million for the three months ended September 30, 2012. The increase was primarily due to increases in rental rates.

Operating Expenses

Office Rental Expenses: Total office rental expenses increased by $2.2 million, or 5.0%, to $46.5 million for the three months ended September 30, 2013, compared to $44.3 million for the three months ended September 30, 2012. The increase was primarily due to office rental expenses of $1.2 million from properties that we acquired in the second and in the third quarters of 2013, as well as an increase in office rental expenses of $1.0 million from properties that we owned during both comparable periods. The increase in office rental expenses for our comparable properties primarily reflects higher property taxes and utilities expense.

Multifamily Rental Expenses: Total multifamily rental expense increased by $158 thousand, or 3.2%, to $5.2 million for the three months ended September 30, 2013, compared to $5.0 million for the three months ended September 30, 2012. The increase was primarily due to higher property taxes and repairs and maintenance expense.

General and Administrative Expenses: General and administrative expenses remained relatively unchanged at $6.5 million for the three months ended September 30, 2013, compared to $6.6 million for the three months ended September 30, 2012.

Depreciation and Amortization: Depreciation and amortization expense increased by $856 thousand, or 1.8%, to $47.4 million for the three months ended . . .

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