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DEI > SEC Filings for DEI > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for DOUGLAS EMMETT INC

Form 10-K for DOUGLAS EMMETT INC


27-Feb-2014

Annual Report


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

Forward Looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of Operations includes many forward-looking statements. For cautions about relying on such forward-looking statements, please refer to the section entitled "Forward Looking Statements" at the beginning of this Report immediately prior to Item 1.

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 December 31, 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 consisted of sixty office properties aggregating approximately 15.1 million rentable square feet, consisting of both our consolidated office properties and the 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 92.2% leased and 90.6% occupied and our total office portfolio was 92.2% leased and 90.4% occupied.

Our multifamily properties were 99.5% leased and 98.7% occupied.

Approximately 85.7% of the annualized rent of our consolidated portfolio was derived from our office properties and the remaining 14.3% 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 fourth quarter of 2013, we closed a revolving credit facility of $300.0 million with a floating rate of LIBOR+1.40%, and a maturity of December 2017. See Note 6 to our consolidated financial statements in Item 15 of this Report.

During 2013, we also paid off a $240.0 million loan that was scheduled to mature on April 2015. We repaid $90.0 million of this loan during the first quarter of 2013 using a portion of our cash on hand, and repaid the remaining $150.0 million in the fourth quarter using $110.0 million from cash on hand and $40.0 million from our revolving credit facility. See Note 6 to our consolidated financial statements in Item 15 of this Report.

On April 30, 2013, 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 proceeds of that loan, plus $40.0 million of additional cash, were used to pay down its outstanding debt of $365.0 million that was scheduled to mature in August 2013.

Acquisitions:
During the first quarter of 2013, we purchased an additional 3.3% interest in Fund X and an additional 0.9% interest in Partnership X, 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 2013.

Development: We are working on two multifamily projects, one in Brentwood in Los Angeles, and one in Honolulu. Each development is on land which we already own. We expect to break ground on an additional 452 apartments at our Moanalua Hillside Apartments in Honolulu by the middle of this year. Construction should take approximately 18 months and cost approximately $100.0 million, which includes the cost of upgrading the existing 696 apartments and building a brand new community center. In Los Angeles, we are seeking to build a high rise apartment project. Because development in our markets, particularly West LA, remains a long and uncertain process, even if successful, we would not expect to break ground in Los Angeles before at least mid 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 79,000 square foot office property in Honolulu in which we own a two-thirds interest.

Results of Operations and Basis of Presentation

The accompanying consolidated financial statements as of December 31, 2013 and 2012 and for the three years ended December 31, 2013, 2012 and 2011 are the consolidated financial statements of Douglas Emmett, Inc. and our subsidiaries including our operating partnership. All significant intercompany balances and transactions have been eliminated in our consolidated financial statements. The comparability of our results of operations during this period was affected by a number of acquisitions: two properties that we acquired in 2013, one property acquired by one of our Funds during 2011, and additional interests that we acquired in our Funds in 2012 and 2013. See Notes 3 and 18 to our consolidated financial statements in Item 15 of this Report.


Funds From Operations

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

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

For the reasons described below, our FFO (adjusted for our terminated swaps) increased by $24.7 million, or 10.5%, to $260.1 million for 2013 compared to $235.4 million for 2012. The increase was primarily due to (i) an increase in operating income from our office portfolio due to properties that we acquired in the second and third quarters of 2013, (ii) an increase in operating income from our multifamily portfolio due to increases in rental rates, (iii) an increase in our share of the FFO of our unconsolidated funds due to lower interest expense of one of our Funds as a result of a debt refinancing, as well as (iv) a decrease in interest expense as a result of the maturing of $340.0 million in notional amount of interest rate swaps in the first quarter of 2013. FFO (adjusted for our terminated swaps) increased by $14.2 million or 6.4% to $235.4 million for 2012 compared to $221.2 million for 2011, primarily as a result of a $10.1 million swap termination fee paid in 2011.

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

                                                          Year Ended December 31,
                                                   2013            2012            2011
Funds From Operations (FFO)
Net income attributable to common
stockholders                                   $    45,311     $    22,942     $     1,451
Depreciation and amortization of real estate
assets                                             191,351         184,849         205,696
Net income attributable to noncontrolling
interests                                            7,526           5,403             807
Less: adjustments attributable to
consolidated joint venture and
unconsolidated investment in real estate
funds                                               15,894          13,311          11,675
FFO (before adjustments for terminated
swaps)                                             260,082         226,505         219,629
Swap termination fee                                     -               -         (10,120 )
Amortization of accumulated other
comprehensive income
     as a result of terminated swaps (1)                 -           8,855          11,701
FFO (after adjustments for terminated swaps)   $   260,082     $   235,360     $   221,210


___________________________________________________

(1) We terminated certain interest rate swaps in November 2010 and December 2011 in connection with the refinancing of related loans. In calculating FFO, we make an adjustment to treat 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 2012 and 2011, GAAP net income was reduced by amortization expense as a result of swaps terminated in December 2011 and November 2010. We had no swap terminations in 2013 or 2012.


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:

                                                      Year Ended December 31,
Historical straight-line rents:(1)        2013       2012       2011       2010       2009
Average rental rate(2)                  $ 34.72    $ 32.86    $ 32.76    $ 32.33    $ 35.11
Annualized lease transaction costs(3)   $  4.16    $  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 affected in each period by factors such as buildings, submarkets, types of space and term involved in the leases executed during the period.

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

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

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 an increasing number of leases in West Los Angeles and Encino/Sherman Oaks incorporating annual rent escalations in excess of 3%. Over the next four quarters, we expect to see expiring cash rents as presented in the table below:

                                                         Three Months Ended
Expiring cash
rents:                  March 31, 2014        June 30, 2014       September 30, 2014       December 31, 2014
Expiring square
feet (1)                        285,078              538,318                 371,045                 609,438
Expiring rent per
square foot (2)       $           39.75     $          34.35     $             36.68     $             34.83


___________________________________________________

(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 renewed the lease prior to December 31, 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 December 31, 2013 but that had not commenced as of that date but (ii) do not include exercises of early termination options (unless exercised prior to December 31, 2013) or defaults occurring after December 31, 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 immediately following 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 fourth quarter of 2013 was 4.1% 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:

Year Ended December 31,
Average annual rental rate
- new tenants: 2013 2012 2011 2010 2009 Rental rate $ 27,392 $ 26,308 $ 24,502 $ 22,497 $ 22,776

Occupancy Rates

Occupancy Rates: The tables below present the occupancy rates for our total office portfolio and multifamily portfolio:

December 31,
Occupancy Rates(1) as of: 2013 2012 2011 2010 2009 Office Portfolio 90.4 % 89.6 % 87.5 % 86.9 % 89.0 % Multifamily Portfolio 98.7 % 98.7 % 98.4 % 98.4 % 98.0 %

                                            Year Ended December 31,
Average Occupancy Rates(1)(2) for:  2013     2012     2011     2010     2009
Office Portfolio                   89.7 %   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.


Comparison of year ended December 31, 2013 to year ended December 31, 2012

Revenues

Office Rental Revenue: Rental revenue includes rental revenues from our office properties, percentage rent on the retail space contained within our office properties and lease termination income. Total office rental revenue increased by $3.3 million, or 0.8%, to $394.7 million for 2013 compared to $391.4 million for 2012. The increase was primarily due to rental revenue of $6.4 million from properties that we acquired in the second and third quarters of 2013, partly offset by lower revenues from net accretion of above- and below-market leases which declined by $3.0 million in 2013 as the result of the ongoing expiration of leases that were in place at the time of our initial public offering (IPO).

Office Tenant Recoveries: Total office tenant recoveries increased by $1.1 million, or 2.4%, to $45.1 million for 2013, compared to $44.1 million for 2012. The increase was primarily due to an increase of $847 thousand in recoveries from the properties that we owned during both comparable periods, as well as recoveries of $203 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 an increase in recoveries related to prior year reconciliations.

Office Parking and Other Income: Total office parking and other income increased by $5.0 million, or 7.1%, to $74.7 million for 2013 compared to $69.7 million for 2012. The increase was primarily due to an increase of $4.0 million in parking and other income from properties that we owned during both comparable periods, as well as revenue of $1.0 million 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.

Multifamily Revenue: Total multifamily revenue increased by $3.2 million, or 4.4%, to $76.9 million for 2013 compared to $73.7 million for 2012. The increase is primarily due to increases in rental rates.

Operating Expenses

Office Rental Expenses: Total office rental expense increased by $4.2 million, or 2.5%, to $175.0 million for 2013 compared to $170.7 million for 2012. The increase was primarily due to office rental expenses of $3.1 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 $1.1 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, utilities expense and scheduled services.

Multifamily Rental Expenses: Total multifamily rental expense increased by $0.3 million, or 1.3%, to $19.9 million for 2013 compared to $19.7 million for 2012. The increase was primarily due to higher property taxes and utilities expense.

General and Administrative Expenses: General and administrative expenses decreased by $1.3 million, or 4.8%, to $26.6 million for 2013, compared to $27.9 million for 2012. The decrease is primarily due to a decrease in employee equity compensation expense as well as a decrease in accruals for legal contingencies.

Depreciation and Amortization: Depreciation and amortization expense increased by $6.5 million, or 3.5%, to $191.4 million for 2013 compared to $184.8 million for 2012. The increase was primarily due to depreciation and amortization of $4.0 million from properties that we owned during both comparable periods, as well as depreciation and amortization of $2.5 million from properties that we acquired in the second and third quarters of 2013. The increase in depreciation and amortization for our comparable properties reflects accelerated depreciation of tenant improvements as a result of a tenant bankruptcy at one of our office properties in Honolulu, as well as accelerated depreciation of a building for a property that we plan on redeveloping in 2015 in Los Angeles.


Non-Operating Income and Expenses

Other Income and Other Expenses: Other income increased by $3.6 million, or 126.9%. to $6.4 million for 2013, compared to $2.8 million for 2012, and other expenses increased by $2.3 million, or 123.0% to $4.2 million for 2013, compared to $1.9 million for 2012. This change primarily reflects the inclusion of the revenues and expenses of a health club at one of our office properties in Honolulu in other income and other expenses, respectively, commencing in the second quarter of 2013. In 2012 and the first quarter of 2013, the club was operated by a third party tenant, which paid us rent which was included in office revenues. Since that tenant rejected the lease after going bankrupt, a subsidiary of our consolidated joint venture has been operating the club while the building is being repositioned. In 2013, other income also included $431,000 of initial insurance proceeds that we received related to a fire at one of our residential properties.

Income (Loss), including Depreciation, from Unconsolidated Real Estate Funds:
This amount represents our equity interest in the operating results from our Funds, including the operating income net of historical cost-basis depreciation, for the full year. Our share of the income (loss), including depreciation, from our Funds improved by $4.8 million to income of $3.1 million for 2013 compared to a loss of $1.7 million for 2012. The difference was primarily due to lower interest expense of one of our Funds, as a result of the refinancing of debt with lower principal and a lower effective interest rate, at the beginning of the second quarter of 2013. See Note 18 to our consolidated financial statements in Item 15 of this Report.

Interest Expense: Interest expense decreased by $16.1 million, or 11.0%, to $130.5 million for 2013, compared to $146.7 million for 2012. The decrease was primarily due to lower cash interest expense of $8.3 million as a result of the expiration of certain interest rate swaps in the first quarter of 2013, as well as decrease in non-cash amortization of $8.8 million related to interest rate swaps that were terminated in 2012, partially offset by reduced amortization of loan premium of $1.1 million. See Notes 6 and 8 to our consolidated financial statements in Item 15 of this Report.

Acquisition Expenses: Our 2013 results included $607,000 of acquisition expenses related to both completed and terminated acquisitions. For 2013, the acquired properties included a 225,000 square foot office property in Beverly Hills acquired in May 2013 and a 191,000 square foot office property in Encino acquired in August 2013. See Note 3 to our consolidated financial statements in Item 15 of this Report. We did not acquire any properties in 2012.


Comparison of year ended December 31, 2012 to year ended December 31, 2011

Revenues
Office Rental Revenue: Total office rental revenue decreased by $2.8 million, or 0.7%, to $391.4 million for 2012 compared to $394.2 million for 2011. The decrease primarily reflects lower non-cash revenue from above- and below-market leases. Net accretion from above- and below- market leases declined by $2.3 million to $14.6 million for the year ended December 31, 2012, compared to $16.9 million for the year ended December 31, 2011, largely as the result of the ongoing expiration of leases that were in place at the time of our IPO.

Office Tenant Recoveries: Total office tenant recoveries remained relatively unchanged at $44.1 million for 2012, compared to $43.9 million for 2011.

Office Parking and Other Income: Total office parking and other income increased by $2.8 million, or 4.2%, to $69.7 million for 2012 compared to $67.0 million for 2011. The increase was primarily due to increases in rates as well as higher occupancy.

Multifamily Revenue: Total multifamily revenue increased by $3.5 million, or 4.9%, to $73.7 million for 2012 compared to $70.3 million for 2011. The increase is primarily due to increases in rental rates.

Operating Expenses

Office Rental Expenses: Total office rental expense increased by $1.9 million, or 1.1%, to $170.7 million for 2012 compared to $168.9 million for 2011. The increase is primarily due to modest increases in utilities expense, insurance and taxes, and payroll, partly offset by lower repairs and maintenance expenses and legal expenses.

Multifamily Rental Expenses: Total multifamily rental expense increased by $0.7 million, or 3.5%, to $19.7 million for 2012 compared to $19.0 million for 2011. The increase is primarily due to increases in scheduled services and utilities expense.

General and Administrative Expenses: General and administrative expenses decreased by $1.3 million, or 4.6%, to $27.9 million for 2012, compared to . . .

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