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SLG > SEC Filings for SLG > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for SL GREEN REALTY CORP

Form 10-K for SL GREEN REALTY CORP


25-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
SL Green Realty Corp., which is referred to as SL Green or the Company, a Maryland corporation, and SL Green Operating Partnership, L.P., which is referred to as SLGOP or the Operating Partnership, a Delaware limited partnership, were formed in June 1997 for the purpose of combining the commercial real estate business of S.L. Green Properties, Inc. and its affiliated partnerships and entities. The Company is a self-managed real estate investment trust, or REIT, with in-house capabilities in property management, acquisitions, financing, development, construction and leasing. Unless the context requires otherwise, all references to "we," "our" and "us" means the Company and all entities owned or controlled by the Company, including the Operating Partnership.
Reckson Associates Realty Corp., or Reckson, and Reckson Operating Partnership, L.P. or ROP, are wholly-owned subsidiaries of the Operating Partnership.
The following discussion related to our consolidated financial statements should be read in conjunction with the financial statements appearing in Item 8 of this Annual Report on Form 10-K.
The New York City commercial real estate market continued to strengthen in 2013, and we took advantage of this strengthening market in improving occupancies and deploying capital in the borough of Manhattan to strategically position the Company for future growth.
Leasing and Operating
We have historically outperformed the Manhattan office market, and did so again in 2013. Our Manhattan office property occupancy on same-store properties based on leases signed increased to 96.6% from 95.1% in the prior year. During 2013, we signed office leases in Manhattan encompassing 5.2 million square feet, of which 4.3 million square feet represented office leases that replaced previously occupied space. Our mark-to-market on these 4.3 million square feet of signed Manhattan office leases that replaced previously occupied space was 9.5% for 2013. The highlight of our leasing activity during 2013 was the signing of an agreement extending Citigroup's triple-net lease covering 2,634,670 square feet at 388-390 Greenwich Street through December 31, 2035. The agreement includes an option for Citigroup to acquire the properties during the period from December 1, 2017 through December 31, 2020 for $2.0 billion. The mark-to-market based on Citigroup's cash rent in the extension period is 12.8 percent.
New leasing activity in Manhattan in 2013 totaled 25.7 million square feet, slightly below the ten-year average but higher than 2012. Of the total 2013 leasing activity in Manhattan, the Midtown submarket accounted for approximately 16.0 million square feet, or 62.3%. Midtown's overall office vacancy increased from 10.3% at December 31, 2012 to 11.2% at December 31, 2013. However, 1.2 million square feet of new office space was added to the Midtown office inventory, with approximately 2.2 million square feet (0.6% of the total 395.3 million square foot Manhattan office inventory) currently under construction and scheduled to be placed in service by 2015 or early 2016. Demand for space in certain sub-markets such as Midtown South and a lack of new supply created conditions in which asking rents for direct space in Midtown South increased during 2013 by 27.3% to $63.67 per square foot. Asking rents for direct space in Midtown increased during 2013 by 2.6% to $70.54 per square foot and have increased by 10.5% since the recessionary trough in in the first quarter of 2010. Over the same period, net effective rents (which take into consideration leasing concessions) have increased by 21.5%. Acquisition and Disposition Activity
Sales volume in Manhattan in 2013 increased 5.3% to $30.0 billion compared to $28.5 billion in 2012, partly as a result of a flurry of activity in the fourth quarter. Nevertheless, consistent with our multi-faceted approach to property acquisitions, we were able to source transactions that provide value enhancement opportunities, including the acquisition of equity interests in six office, retail and multi-family properties during 2013, representing total investments of $0.7 billion.
We also took advantage of the improving market conditions and interest by institutions and individuals seeking ownership interests in properties to sell assets, disposing of properties with more limited growth opportunities, and raising efficiently priced capital for reinvestment. During the year, we sold our fee interest in 333 West 34th Street, New York, New York, 300 Main Street, Stamford, Connecticut, and 44 West 55th Street, New York, New York, . Debt and Preferred Equity
Beginning in 2010, we saw an increase in opportunities to acquire existing debt and preferred equity positions in high quality Manhattan office properties at discounts that enabled us to generate high risk adjusted yields, and offer off-market access to property acquisitions. As 2013 progressed, and the availability of acquiring discounted debt and preferred equity in high quality properties waned, we began to focus on the origination of financings, typically in the form of preferred equity and mezzanine


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debt, for owners or acquirers seeking higher leverage than was available from traditional lending sources lending at modest leverage levels. Traditional sources of junior financings have not yet materialized. This provided us with an opportunity to fill a need for additional debt by providing more modest amounts of leverage. The typical investments made by us during 2013 were to reputable owners or acquirers, and at leverage levels which are senior to sizable equity investments by the sponsors. During 2013, our debt and preferred equity activities included purchases and originations, inclusive of accretion of reserves, previous discounts and pay-in-kind interest, of approximately $601.3 million, and sales, redemption and participations of approximately $644.9 million.
Highlights from 2013
Our significant activities for 2013 included:

            Directly acquiring four buildings for an aggregate gross purchase
             price of $533.0 million encompassing 0.6 million square feet.


            Investing in two properties through joint ventures at implied gross
             valuations of $151.1 million and encompassing 0.4 million square
             feet.


            Issuing 2.6 million shares of SL Green's common stock raising net
             proceeds of $248.9 million.


            Redeeming all 7.7 million outstanding shares of 7.625% Series C
             Cumulative Redeemable Preferred Stock.


            Closing on a $300.0 million refinancing of the Company's MRA
             facility which replaced the former $175.0 million facility.


            Closing on a $900.0 million mortgage refinancing which replaced the
             former $775.0 million mortgage.

Closing on two mortgages totaling approximately $297.0 million.

Signing 233 office leases totaling 5.2 million square feet in Manhattan.

Signing 143 office leases totaling 0.9 million square feet in our Suburban properties.

As of December 31, 2013, we owned the following interests in commercial office buildings in the New York Metropolitan area, primarily in midtown Manhattan. Our investments in the New York Metropolitan area also include investments in Brooklyn, Long Island, Westchester County, Connecticut and Northern New Jersey, which are collectively known as the Suburban properties:

                                                                       Weighted
                                        Number of                      Average
Location            Ownership           Buildings    Square Feet     Occupancy(1)
Manhattan    Consolidated properties           23     17,306,045          94.5 %
            Unconsolidated properties           9      5,934,434          96.6 %

Suburban     Consolidated properties           26      4,087,400          79.8 %
            Unconsolidated properties           4      1,222,100          87.2 %
                                               62     28,549,979          92.5 %



(1) The weighted average occupancy represents the total leased square feet divided by total available rentable square feet.

As of December 31, 2013, we also owned investments in 16 retail properties encompassing approximately 875,800 square feet, 20 development buildings encompassing approximately 3,230,800 square feet, four residential buildings encompassing 801 units (approximately 719,900 square feet), two land interests encompassing approximately 961,400 square feet. The Company also has ownership interests in 28 west coast properties encompassing 52 buildings totaling approximately 3,654,300 square feet. In addition, we manage two office buildings owned by third parties and affiliated companies encompassing approximately 626,400 square feet. As of December 31, 2013, we also held debt and preferred equity investments with a book value of $1.3 billion.

Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making


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judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Investment in Commercial Real Estate Properties On a periodic basis, we assess whether there are any indications that the value of our real estate properties may be impaired or that their carrying value may not be recoverable. A property's value is considered impaired if management's estimate of the aggregate future cash flows (undiscounted and without interest charges for consolidated properties) to be generated by the property is less than the carrying value of the property. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property. We do not believe that the values of any of our consolidated properties were impaired at December 31, 2013. We also evaluate our real estate properties for potential impairment when a real estate property has been classified as held for sale. Real estate assets held for sale are valued at the lower of their carrying value or fair value less costs to sell. In June 2013, we recorded a $2.2 million impairment charge in connection with the sale of 300 Main Street in Stamford, Connecticut. A variety of costs are incurred in the development and leasing of our properties. After determination is made to capitalize a cost, it is allocated to the specific component of a project that is benefited. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. The costs of land and building under development include specifically identifiable costs. The capitalized costs include, but are not limited to, pre-construction costs essential to the development of the property, development costs, construction costs, interest costs, real estate taxes, salaries and related costs and other costs incurred during the period of development. We consider a construction project as substantially completed and held available for occupancy upon the completion of tenant improvements, but no later than one year from cessation of major construction activity. We cease capitalization on the portions substantially completed and occupied or held available for occupancy, and capitalize only those costs associated with the portions under construction.
When we acquire partner's equity interests in an existing unconsolidated joint venture and gain control over the investment, we record the consolidated investment at fair value. The difference between the book value of our equity investment on the purchase date and our share of the fair value of the investment's purchase price is recorded as a purchase price fair value adjustment in our consolidated statements of income. In April 2013, we recognized a purchase price fair value adjustment of $(2.3) million in connection with the consolidation of 16 Court Street, which was previously accounted for as an investment in unconsolidated joint venture.
We allocate the purchase price of real estate to land and building (inclusive of tenant improvements) and, if determined to be material, intangibles, such as the value of above- and below-market leases and origination costs associated with the in-place leases. We depreciate the amount allocated to building (inclusive of tenant improvements) and other intangible assets over their estimated useful lives, which generally range from three to 40 years and from one to 14 years, respectively. The values of the above- and below-market leases are amortized and recorded as either an increase (in the case of below-market leases) or a decrease (in the case of above-market leases) to rental income over the remaining term of the associated lease, which generally range from one to 14 years. The value associated with in-place leases is amortized over the expected term of the associated lease, which generally ranges from one to 14 years. If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written off. The tenant improvements and origination costs are amortized as an expense over the remaining life of the lease (or charged against earnings if the lease is terminated prior to its contractual expiration date). We assess fair value of the leases based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known trends, and market/economic conditions that may affect the property. To the extent acquired leases contain fixed rate renewal options that are below market and determined to be material, we amortize such below market lease value into rental income over the renewal period. Investment in Unconsolidated Joint Ventures We account for our investments in unconsolidated joint ventures under the equity method of accounting in cases where we exercise significant influence over, but do not control, these entities and are not considered to be the primary beneficiary. We consolidate those joint ventures that we control or which are VIEs and where we are considered to be the primary beneficiary. In all these joint ventures, the rights of the joint venture partner are both protective as well as participating. Unless we are determined to be the primary beneficiary in a VIE, these participating rights preclude us from consolidating these non-VIE entities. These investments are recorded initially at cost, as investments in unconsolidated joint ventures, and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. Equity income (loss) from unconsolidated joint ventures is allocated based on our ownership or economic interest in each joint venture. When a capital event (as defined in each joint venture agreement) such as a refinancing occurs, if return thresholds are met, future equity income will be allocated at our increased economic interest. We recognize incentive income from unconsolidated real estate joint ventures as income to the extent it is earned and not subject


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to a clawback feature. Distributions we receive from unconsolidated real estate joint ventures in excess of our basis in the investment are recorded as offsets to our investment balance if we remain liable for future obligations of the joint venture or may otherwise be committed to provide future additional financial support. None of the joint venture debt is recourse to us, except for $218.4 million which we guarantee at two joint ventures and performance guarantees under master leases at two other joint ventures. See Note 6, "Investments in Unconsolidated Joint Ventures," in the accompanying consolidated financial statements.
We assess our investments in unconsolidated joint ventures for recoverability, and if it is determined that a loss in value of the investment is other than temporary, we write down the investment to its fair value. We evaluate our equity investments for impairment based on the joint venture's projected discounted cash flows. During the year ended December 31, 2011, we recorded a $5.8 million impairment charge on one of our equity investments, which we sold in July 2012. These charges are included in depreciable real estate reserves in the accompanying consolidated statements of income. See Note 6, "Investments in Unconsolidated Joint Ventures," in the accompanying consolidated financial statements. We do not believe that the values of any of our equity investments were impaired at December 31, 2013.
Revenue Recognition
Rental revenue is recognized on a straight-line basis over the term of the lease. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in deferred rents receivable on the accompanying balance sheets. We establish, on a current basis, an allowance for future potential tenant credit losses, which may occur against this account. The balance reflected on the balance sheet is net of such allowance.
Interest income on debt and preferred equity investments is recognized over the life of the investment using the effective interest method and recognized on the accrual basis. Fees received in connection with loan commitments are deferred until the loan is funded and are then recognized over the term of the loan as an adjustment to yield. Anticipated exit fees, whose collection is expected, are also recognized over the term of the loan as an adjustment to yield. Fees on commitments that expire unused are recognized at expiration. Income recognition is generally suspended for debt and preferred equity investments at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of interest income becomes doubtful. Interest income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our tenants to make required payments. If the financial condition of a specific tenant were to deteriorate, resulting in an impairment of its ability to make payments, additional allowances may be required. Reserve for Possible Credit Losses
The expense for possible credit losses in connection with debt and preferred equity investments is the charge to earnings to increase the allowance for possible credit losses to the level that we estimate to be adequate, based on Level 3 data, considering delinquencies, loss experience and collateral quality. Other factors considered relate to geographic trends and product diversification, the size of the portfolio and current economic conditions. Based upon these factors, we establish the provision for possible credit loss on each individual investment. When it is probable that we will be unable to collect all amounts contractually due, the investment is considered impaired. Where impairment is indicated on an investment that is held to maturity, a valuation allowance is measured based upon the excess of the recorded investment amount over the net fair value of the collateral. Any deficiency between the carrying amount of an asset and the calculated value of the collateral is charged to expense. The write off of the reserve balance is called a charge off. We continue to assess or adjust our estimates based on circumstances of a loan and the underlying collateral. If the additional information obtained reflects increased recovery of our investment, we will adjust our reserves accordingly. There were no additional loan reserves recorded during the year ended December 31, 2013. We recorded loan loss reserves of $3.0 million and $10.9 million on investments being held to maturity during the years ended December 31, 2012 and 2011, respectively. We also recorded recoveries of approximately $2.4 million and $4.4 million during the years ended December 31, 2012 and 2011, respectively, in connection with the sale of our investments. This is included in loan loss and other investment reserves, net of recoveries on the accompanying consolidated statements of income.
Debt and preferred equity investments held for sale are carried at the lower of cost or fair market value using available market information obtained through consultation with dealers or other originators of such investments as well as discounted cash flow models based on Level 3 data pursuant to ASC 820-10. As circumstances change, management may conclude not to sell an investment designated as held for sale. In such situations, the investment will be reclassified at its net carrying value to debt and


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preferred equity investments held to maturity. For these reclassified investments, the difference between the current carrying value and the expected cash to be collected at maturity will be accreted into income over the remaining term of the investment.
Derivative Instruments
In the normal course of business, we use a variety of derivative instruments to manage, or hedge, interest rate risk. We require that hedging derivative instruments be effective in reducing the interest rate risk exposure that they are designated to hedge if the hedge is to qualify for hedge accounting. Some derivative instruments are associated with an anticipated transaction. In those cases, hedge effectiveness criteria also require that it be probable that the underlying transaction occurs. Instruments that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract. To determine the fair values of derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the majority of financial instruments including most derivatives, long-term investments and long-term debt, standard market conventions and techniques such as discounted cash flow analysis, option-pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.

Results of Operations

Comparison of the year ended December 31, 2013 to the year ended December 31, 2012
The following comparison for the year ended December 31, 2013, or 2013, to the year ended December 31, 2012, or 2012, makes reference to the following:
(i) the effect of the "Same-Store Properties," which represents all operating properties owned by us in the same manner at January 1, 2012 and at December 31, 2013 and totaled 46 of our 49 consolidated operating properties, representing approximately 83.9% of our share of annualized cash rent, (ii) the effect of the "Acquisitions," which represents all properties or interests in properties acquired in 2013 and 2012 and all non-Same-Store Properties, including properties deconsolidated during the period, and (iii) "Other," which represents corporate level items not allocable to specific properties, as well as the Service Corporation and eEmerge Inc. Any assets sold or held for sale are excluded from the income from continuing operations and from the following discussion.


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                                       Same-Store                         Acquisition              Other                             Consolidated
                                                  $           %                                                                                    $           %
(in millions)           2013         2012       Change     Change       2013       2012       2013        2012        2013          2012        Change      Change

Rental revenue       $  983.2     $  966.2     $ 17.0        1.8  %   $ 99.3     $ 84.5     $  (1.8 )   $ 12.0     $ 1,080.7     $ 1,062.7     $  18.0        1.7  %
Escalation and
reimbursement           157.6        152.8        4.8        3.1  %     11.2       10.3         0.7        2.0         169.5         165.1         4.4        2.7  %
Investment income           -            -          -          -  %        -          -       193.8      119.2         193.8         119.2        74.6       62.6  %
Other income              6.1         10.8       (4.7 )    (43.5 )%      0.5        0.4        18.5       24.5          25.1          35.7       (10.6 )    (29.7 )%
Total revenues        1,146.9      1,129.8       17.1        1.5  %    111.0       95.2       211.2      157.7       1,469.1       1,382.7        86.4        6.2  %

Property operating
expenses                487.7        472.3       15.4        3.3  %     51.6       49.6        13.0       17.7         552.3         539.6        12.7        2.4  %
Loan loss and
other investment
reserves, net of
recoveries                  -            -          -          -  %        -          -           -        0.6             -           0.6        (0.6 )   (100.0 )%
Transaction
related costs, net
of recoveries               -            -          -          -  %      3.4        4.6         0.6        1.0           4.0           5.6        (1.6 )    (28.6 )%
Marketing, general
and administrative          -            -          -          -  %        -          -        86.2       82.8          86.2          82.8         3.4        4.1  %
                        487.7        472.3       15.4        3.3  %     55.0       54.2        99.8      102.1         642.5         628.6        13.9        2.2  %

Net operating
income               $  659.2     $  657.5     $  1.7        0.3  %   $ 56.0     $ 41.0     $ 111.4     $ 55.6         826.6         754.1        72.5        9.6  %

Other income
(expenses):
Interest expense,
net of interest
income                                                                                                                (346.9 )      (349.3 )       2.4       (0.7 )%
Depreciation and
amortization                                                                                                          (337.7 )      (325.7 )     (12.0 )      3.7  %
Equity in net
income from
unconsolidated
joint ventures                                                                                                           9.9          76.4       (66.5 )    (87.0 )%
Equity in net gain
on sale of
interest in
unconsolidated
joint venture/real
. . .
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