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GOV > SEC Filings for GOV > Form 10-K on 19-Feb-2014All Recent SEC Filings

Show all filings for GOVERNMENT PROPERTIES INCOME TRUST

Form 10-K for GOVERNMENT PROPERTIES INCOME TRUST


19-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with our consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K.

OVERVIEW

As of December 31, 2013, we owned 68 properties (87 buildings), excluding three properties (three buildings) classified as discontinued operations, located in 31 states and the District of Columbia containing approximately 10.3 million rentable square feet, of which 66.3% was leased to the U.S. Government, 18.7% was leased to 11 state governments, 1.8% was leased to the United Nations, an international intergovernmental organization, 8.0% was leased to various non-governmental organizations and 5.2% was available for lease. The U.S. Government, 11 state governments and the United Nations combined were responsible for 92.6% and 93.8% of our annualized rental income, as defined below, as of December 31, 2013 and 2012, respectively.

Property Operations

    As of December 31, 2013, excluding properties classified as discontinued
operations, 94.8% of our rentable square feet were leased, compared to 93.6% of
our rentable square feet as of December 31, 2012. Occupancy data for our
properties as of December 31, 2013 and 2012 is as follows (square feet in
thousands):

                                                                     Comparable
                                            All Properties(1)       Properties(2)
                                              December 31,          December 31,
                                             2013        2012      2013      2012
       Total properties (end of period)            68        63        53        53
       Total buildings (end of period)             87        79        66        66
       Total square feet                       10,317     9,644     8,380     8,380
       Percent leased(3)                         94.8 %    93.6 %    93.6 %    92.6 %


--------------------------------------------------------------------------------
    (1)


Based on properties we owned on December 31, 2013, and excludes properties classified as discontinued operations.

(2)
Based on properties we owned on December 31, 2013 and which we owned continuously since January 1, 2012, and excludes properties classified as discontinued operations. Our comparable properties for the period January 1, 2011 through December 31, 2012 were 41 properties (50 buildings). Our comparable properties for the period January 1, 2012 through December 31, 2013, increased to 53 properties (66 buildings) as a result of our acquisition of 12 properties (16 buildings) during the year ended December 31, 2011, less two properties (two buildings) we sold during the year ended December 31, 2013, and three properties (three buildings) we classified as discontinued operations as of December 31, 2013.

(3)
Percent leased includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any, as of the measurement date.


The average annual effective rental rate per square foot for our properties for the years ended December 31, 2013 and 2012 are as follows:

Year ended December 31, 2013 2012 Average annual effective rental rate per square foot:(1) All properties(2) $ 24.73 $ 25.01 Comparable properties(3) $ 25.49 $ 25.21


(1)
Average annual effective rental rate per square foot represents total rental income during the period specified divided by the average rentable square feet leased during the period specified. Excludes properties classified as discontinued operations.

(2)
Based on properties we owned on December 31, 2013, and excludes properties classified as discontinued operations.

(3)
Based on properties we owned on December 31, 2013 and which we owned continuously since January 1, 2012, and excludes properties classified as discontinued operations.

We currently believe that U.S. property leasing market conditions are slowly improving, but remain weak in many U.S. markets. Our historical experience with respect to properties of the type we own that are majority leased to government tenants has been that government tenants frequently renew leases to avoid the costs and disruptions that may result from relocating their operations. We believe that budgetary pressures may cause an increased demand for leased space by government tenants, as opposed to new buildings built on behalf of government tenants. However, these same budgetary pressures could also result in a decrease in government sector employment, government tenants improving their space utilization or consolidation into government owned properties, thereby reducing the demand for government leased space. Accordingly, we are unable to reasonably project what the financial impact of market conditions or changing government financial circumstances will be on our financial results for future periods.

As of December 31, 2013, excluding properties classified as discontinued operations, we had leases totaling 361,360 rentable square feet that were scheduled to expire through December 31, 2014. Based upon current market conditions and tenant negotiations for leases scheduled to expire through December 31, 2014, we expect that rental rates we are likely to achieve on new or renewed leases will, in the aggregate and on a weighted (by annualized revenues) average basis, be higher than the rates currently being paid, thereby generally resulting in slightly higher revenue from the same space absent a decrease in occupancies. However, we can provide no assurance that the rental rates we expect will occur or that we will not experience material declines in our rental income due to vacancies upon lease expirations. Prevailing market conditions and government tenants' needs at the time we negotiate our leases will generally determine rental rates and other terms for leased space in our properties; and market conditions and government tenants' needs are beyond our control. As of December 31, 2013,


lease expirations at our properties, excluding properties classified as discontinued operations, by year are as follows (square feet and dollars in thousands):

                            Expirations                                 Annualized
              Number of      of Leased                   Cumulative       Rental                     Cumulative
               Tenants        Square        Percent      Percent of       Income        Percent       Percent
Year(1)       Expiring        Feet(2)       of Total       Total        Expiring(3)     of Total      of Total
2014                  47             361          3.7 %          3.7 %  $      7,890          3.4 %          3.4 %
2015                  37           1,287         13.2 %         16.9 %        29,656         12.8 %         16.2 %
2016                  40             972          9.9 %         26.8 %        32,537         14.0 %         30.2 %
2017                  34             650          6.6 %         33.4 %        13,480          5.8 %         36.0 %
2018                  32           1,082         11.1 %         44.5 %        28,662         12.4 %         48.4 %
2019                  21           1,384         14.2 %         58.7 %        32,419         14.0 %         62.4 %
2020                  17           1,027         10.5 %         69.2 %        23,985         10.3 %         72.7 %
2021                  11             855          8.7 %         77.9 %        16,471          7.1 %         79.8 %
2022                   8             644          6.6 %         84.5 %        13,732          5.9 %         85.7 %
2023 and
thereafter            19           1,517         15.5 %        100.0 %        32,972         14.3 %        100.0 %


Total                266           9,779        100.0 %                 $    231,804        100.0 %

Weighted
average
remaining
lease term
(in years) 5.6 5.4


(1)
The year of lease expiration is pursuant to current contract terms. Some government tenants have the right to vacate their space before the stated expirations of their leases. As of December 31, 2013, government tenants occupying approximately 7.9% of our rentable square feet and responsible for approximately 6.1% of our annualized rental income as of December 31, 2013 have currently exercisable rights to terminate their leases before the stated expirations. Also in 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2022 and 2023, early termination rights become exercisable by other tenants who currently occupy an additional approximately 3.8%, 5.5%, 6.4%, 2.6%, 1.0%, 4.1%, 2.5%, 1.3% and 1.4% of our rentable square feet, respectively, and contribute an additional approximately 4.3%, 3.2%, 9.2%, 3.5%, 1.3%, 4.7%, 2.6%, 1.0% and 1.2% of our annualized rental income, respectively, as of December 31, 2013. In addition as of December 31, 2013, six of our state government tenants have currently exercisable rights to terminate their leases if these states do not appropriate rent in their respective annual budgets. These six tenants occupy approximately 7.4% of our rentable square feet and contribute approximately 7.3% of our annualized rental income as of December 31, 2013.

(2)
Leased square feet is pursuant to leases existing as of December 31, 2013, and includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any.

(3)
Annualized rental income is the annualized contractual base rents from our tenants pursuant to our lease agreements as of December 31, 2013, plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization.

Acquisition and Disposition Activities (dollar amounts in thousands)

During the year ended December 31, 2013, we acquired five properties (eight buildings) for an aggregate purchase price of $99,518, excluding acquisition costs. We acquired these properties at a range of capitalization rates from 7.2% to 10.7%, with a weighted (by purchase price) average capitalization rate of 8.8%. We calculate the capitalization rate for property acquisitions as the ratio of (x) annual straight line rental income, excluding the impact of above and below market lease amortization, based on leases in effect on the acquisition date, less estimated annual property operating


expenses as of the acquisition date, excluding depreciation and amortization expense, to (y) the acquisition purchase price, including the principal amount of assumed debt, if any, and excluding acquisition costs.

In November and December 2013, we entered agreements to acquire two office properties (three buildings) for an aggregate purchase price of $133,025, including the assumption of $97,576 of mortgage debt and excluding acquisition costs. These acquisitions are subject to closing conditions typical of commercial real estate transactions and lender approval of our assumption of mortgage debt; accordingly, we can provide no assurance that we will acquire these properties or that these acquisitions will not be delayed or that the terms will not change.

In February and March 2013, we sold two properties (two buildings) for an aggregate sales price of $18,489, excluding closing costs.

During the year ended December 31, 2013, we began marketing for sale three office properties (three buildings) with an aggregate net book value of $25,604 at December 31, 2013. In January 2014, we entered an agreement to sell one of these properties with a net book value at December 31, 2013 of $2,300 for $5,000, excluding closing costs. In February 2014, we entered an agreement to sell one of these properties with a net book value at December 31, 2013 of $12,289 for $15,750, excluding closing costs. These dispositions are subject to various terms and conditions typical of commercial real estate transactions; accordingly we can provide no assurance that we will sell these properties or that these dispositions will not be delayed or that the terms will not change.

For more information about these transactions, please see Note 4 to our Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.

Our strategy related to property acquisitions and dispositions is described in "Business-Our Growth Strategy" of this Annual Report on Form 10-K. We continue to explore and evaluate for possible acquisition additional properties that are majority leased to government tenants; however, we cannot assure that we will reach any agreement to acquire such properties, or that if we do reach any such agreement, that we will complete the acquisitions. Except as described above, we currently do not plan to dispose of any of our other properties; however we may on occasion offer for sale additional properties. Future changes in market conditions, property performance, our expectation regarding lease renewals or our plans with regard to particular properties, or other strategic considerations or opportunities may change our disposition strategy.


RESULTS OF OPERATIONS (amounts in thousands, except per share amounts)

Year Ended December 31, 2013, Compared to Year Ended December 31, 2012

                                                                                          Acquired
                                                                                         Properties
                                                                                         Results(2)
                            Comparable Properties Results(1)                             Year Ended                     Consolidated Results
                                 Year Ended December 31,                                December 31,                   Year Ended December 31,
                                                     $               %                                                                  $          %
                 2013             2012             Change          Change              2013         2012       2013        2012       Change     Change
Rental
income          $ 197,257     $      194,498     $     2,759             1.4 %     $      29,653   $ 9,202   $ 226,910   $ 203,700   $ 23,210       11.4 %


Operating
expenses:
Real
estate
taxes              23,337             21,679           1,658             7.6 %             2,373       806      25,710      22,485      3,225       14.3 %
Utility
expenses           15,015             15,246            (231 )          (1.5 )%            2,101       521      17,116      15,767      1,349        8.6 %
Other
operating
expenses           36,140             35,617             523             1.5 %             4,994     1,457      41,134      37,074      4,060       11.0 %


Total
operating
expenses           74,492             72,542           1,950             2.7 %             9,468     2,784      83,960      75,326      8,634       11.5 %


Net
operating
income(3)       $ 122,765     $      121,956     $       809             0.7 %     $      20,185   $ 6,418     142,950     128,374     14,576       11.4 %




Other
expenses
Depreciation and amortization                                                                                   55,699      49,070      6,629       13.5 %
Acquisition related costs                                                                                        2,439       1,614        825       51.1 %
General and administrative                                                                                      12,710      11,924        786        6.6 %


Total other expenses                                                                                            70,848      62,608      8,240       13.2 %


Operating income                                                                                                72,102      65,766      6,336        9.6 %
Interest and other income                                                                                           37          29          8       27.6 %
Interest expense (including net amortization of debt premiums and deferred financing fees of $1,340 and
$1,332, respectively)                                                                                          (16,831 )   (16,892 )       61       (0.4 )%


Income from continuing operations before income tax expense and equity in earnings of an investee               55,308      48,903      6,405       13.1 %
Income tax expense                                                                                                (133 )      (159 )       26      (16.4 )%
Equity in earnings of an investee                                                                                  334         316         18        5.7 %


Income from continuing operations                                                                               55,509      49,060      6,449       13.1 %
Income (loss) from discontinued operations                                                                        (889 )       900     (1,789 )   (198.8 )%


Net income                                                                                                   $  54,620   $  49,960   $  4,660        9.3 %




Weighted average common shares outstanding                                                                      54,680      48,617      6,063       12.5 %




Net income from continuing operations per common share                                                       $    1.02   $    1.01   $   0.01        1.0 %
Net income from discontinued operations per common share                                                     $   (0.02 ) $    0.02   $  (0.04 )   (200.0 )%
Net income per common share                                                                                  $    1.00   $    1.03   $  (0.03 )     (2.9 )%
Calculation of Funds From Operations and Normalized Funds From Operations(4)
Net income                                                                                                   $  54,620   $  49,960
Plus: Depreciation and amortization from continuing operations                                                  55,699      49,070
Plus: Depreciation and amortization from discontinued operations                                                 1,025       2,096
Plus: Loss on asset impairment from discontinued operations                                                     10,142         494
Less: Net gain on sale of properties from discontinued operations                                               (8,168 )         -


Funds from operations                                                                                          113,318     101,620
Acquisition related costs                                                                                        2,439       1,614


Normalized funds from operations                                                                             $ 115,757   $ 103,234

Funds from operations per common share $ 2.07 $ 2.09

Normalized funds from operations per common share $ 2.12 $ 2.12


(1)
Comparable properties consist of 53 properties (66 buildings) we owned on December 31, 2013 and which we owned continuously since January 1, 2012, and exclude properties classified as discontinued operations.

(2)
Acquired properties consist of 15 properties (21 buildings) and 10 properties (13 buildings), which 10 properties are included in the previously referenced 15 properties, we owned on December 31, 2013 and December 31, 2012, respectively, and which we acquired during the period from January 1, 2012 to December 31, 2013.

(3)
We calculate net operating income, or NOI, as shown above. We define NOI as income from our real estate less our property operating expenses. NOI excludes capitalized tenant improvement costs and leasing commissions. We consider NOI to be an appropriate supplemental measure to net income because it may help both investors and management to understand the operations of our properties. We use NOI


internally to evaluate individual and company wide property level performance, and we believe that NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level and may facilitate comparisons of our operating performance between periods and with other REITs. The calculation of NOI excludes certain components of net income in order to provide results that are more closely related to our properties' results of operations. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered as an alternative to net income, operating income or cash flow from operating activities, determined in accordance with GAAP, or as an indicator of our financial performance or liquidity, nor is this measure necessarily indicative of sufficient cash flow to fund all of our needs. This measure should be considered in conjunction with net income, operating income and cash flow from operating activities as presented in our Consolidated Statements of Income and Comprehensive Income and Consolidated Statements of Cash Flows. Other real estate investment trusts, or REITs, and real estate companies may calculate NOI differently than we do.

(4)
We calculate funds from operations, or FFO, and Normalized FFO as shown above. FFO is calculated on the basis defined by The National Association of Real Estate Investment Trusts, or NAREIT, which is net income, calculated in accordance with GAAP, plus real estate depreciation and amortization, excluding loss on asset impairment of real estate assets and any gain or loss on the sale of properties, as well as certain other adjustments currently not applicable to us. Our calculation of Normalized FFO differs from NAREIT's definition of FFO because we exclude acquisition related costs. We consider FFO and Normalized FFO to be appropriate measures of operating performance for a REIT, along with net income, operating income and cash flow from operating activities. We believe that FFO and Normalized FFO provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation expense, FFO and Normalized FFO may facilitate a comparison of our operating performance between periods and with other REITs. FFO and Normalized FFO are among the factors considered by our Board of Trustees when determining the amount of distributions to our shareholders. Other factors include, but are not limited to, requirements to maintain our status as a REIT, limitations in our revolving credit facility and term loan agreements, the availability of debt and equity capital to us, our expectation of our future capital requirements and operating performance, and our expected needs and availability of cash to pay our obligations. FFO and Normalized FFO do not represent cash generated by operating activities in accordance with GAAP and should not be considered as alternatives to net income, operating income or cash flow from operating activities, determined in accordance with GAAP, or as indicators of our financial performance or liquidity, nor are these measures necessarily indicative of sufficient cash flow to fund all of our needs. These measures should be considered in conjunction with net income, operating income and cash flow from operating activities as presented in our Consolidated Statements of Income and Comprehensive Income and Consolidated Statements of Cash Flows. Other REITs and real estate companies may calculate FFO and Normalized FFO differently than we do.

We refer to the 53 properties (66 buildings) we owned on December 31, 2013 and which we have owned continuously since January 1, 2012, excluding properties classified as discontinued operations, as comparable properties. We refer to the 15 properties (21 buildings) and 10 properties (13 buildings), which 10 properties are included in the previously referenced 15 properties that we owned as of December 31, 2013 and 2012, respectively, which we acquired during the period from January 1, 2012 to December 31, 2013, as acquired properties. Our consolidated income statement for the year ended December 31, 2013 includes the operating results of 10 acquired properties (13 buildings) for the entire year and five acquired properties (eight buildings) for less than the entire year, as we acquired those 10 properties (13 buildings) prior to January 1, 2013 and we acquired those five properties (eight buildings) during that period. Our consolidated income statement for the year ended December 31, 2012 includes the operating results of 10 acquired properties (13 buildings) for less than the entire year, as those properties were purchased during 2012.

References to changes in the income and expense categories below relate to the comparison of consolidated results for the year ended December 31, 2013, compared to the year ended December 31, 2012.

Rental income. The increase in rental income reflects the effects of acquired properties and an increase in rental income for comparable properties. Rental income for acquired properties increased $2,932 from properties acquired during 2013 and $17,519 from properties acquired during 2012. Rental income for comparable properties increased $2,759 primarily due to net increases in base rental income and real estate tax expense reimbursement income. Rental income includes non-cash straight line rent adjustments totaling approximately $2,739 in 2013 and $3,428 in 2012 and net amortization of acquired leases and assumed lease obligations totaling approximately ($1,123) in 2013 and ($2,056) in 2012.

Real estate taxes. The increase in real estate taxes primarily reflects the effects of acquired properties and an increase in real estate taxes for comparable properties. Real estate taxes for acquired properties increased $213 from properties acquired during 2013 and $1,354 from properties acquired during 2012. Real estate taxes for comparable properties increased $1,658 due to the effect of higher tax assessments at certain of our properties.


Utility expenses. The increase in utility expenses reflects the effects of acquired properties, partially offset by lower utility expenses for comparable properties. Utility expenses for acquired properties increased $196 from properties acquired during 2013 and $1,384 from properties acquired during 2012. Utility expenses at comparable properties declined $231 primarily due to lower utility rates and the impact of energy conservation efforts at certain of our properties, partially offset by an increase in usage at certain of our properties due to warmer than normal temperatures experienced in certain parts of the United States during the summer of 2013.

Other operating expenses. Other operating expenses consist of property . . .

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