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CLI > SEC Filings for CLI > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for MACK CALI REALTY CORP

Form 10-K for MACK CALI REALTY CORP


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements of Mack-Cali Realty Corporation and the notes thereto (collectively, the "Financial Statements"). Certain defined terms used herein have the meaning ascribed to them in the Financial Statements.

Executive Overview

Mack-Cali Realty Corporation together with its subsidiaries, (the "Company") is one of the largest real estate investment trusts (REITs) in the United States. The Company has been involved in all aspects of commercial real estate development, management and ownership for over 60 years and has been a publicly-traded REIT since 1994. The Company owns or has interests in 279 properties (collectively, the "Properties") consisting of 267 commercial properties, primarily class A office and office/flex buildings, totaling approximately 31.0 million square feet, leased to approximately 2,000 commercial tenants and 12 multi-family rental properties containing over 3,600 residential units. The Properties are located primarily in suburban markets of the Northeast, some with adjacent, Company-controlled developable land sites able to accommodate up to 8.4 million square feet of additional commercial space and up to 5,824 apartment units.

The Company's historical strategy has been to focus its operations, acquisition and development of office properties in high-barrier-to-entry markets and sub-markets where it believes it is, or can become, a significant and preferred owner and operator. With changing work force demographics and reduced demand for suburban office properties in its current markets, the Company intends to leverage its experience and expertise in its core Northeast markets to aggressively pursue multi-family rental investments in those markets, both through acquisitions and developments, both wholly owned and through joint ventures. This strategy includes selectively disposing of office and office/flex assets and re-deploying proceeds to multi-family rental properties, as well as the repositioning of a portion of its office properties and land held for development to multi-family rental properties.

As an owner of real estate, almost all of the Company's earnings and cash flow is derived from rental revenue received pursuant to leased space at the Properties. Key factors that affect the Company's business and financial results include the following:

the general economic climate;
the occupancy rates of the Properties;
rental rates on new or renewed leases;
tenant improvement and leasing costs incurred to obtain and retain tenants;
the extent of early lease terminations;
the value of our office properties and the cash flow from the sale of such properties;
operating expenses;
anticipated acquisition and development costs for multi-family rental properties and the revenues and earnings from these properties;
cost of capital; and
the extent of acquisitions, development and sales of real estate.

Any negative effects of the above key factors could potentially cause a deterioration in the Company's revenue and/or earnings. Such negative effects could include: (1) failure to renew or execute new leases as current leases expire; (2) failure to renew or execute new leases with rental terms at or above the terms of in-place leases; and (3) tenant defaults.

A failure to renew or execute new leases as current leases expire or to execute new leases with rental terms at or above the terms of in-place leases may be affected by several factors such as: (1) the local economic climate, which may be adversely impacted by business layoffs or downsizing, industry slowdowns, changing demographics and other factors; and (2) local real estate conditions, such as oversupply of the Company's product types or competition within the market.

The Company's core office markets continue to be weak. The percentage leased in the Company's consolidated portfolio of stabilized operating commercial properties aggregating 28 million, 31 million and 31 million square feet at December 31, 2013, 2012 and 2011, respectively was 86.1 percent leased at December 31, 2013 as compared to 87.2 percent leased at December 31, 2012 and 88.3 percent leased at December 31, 2011. Percentage leased includes all leases in effect as of the period end date, some of which have commencement dates in the future and leases that expire at the period end date. Leases that expired as of December 31, 2013, 2012 and 2011 aggregate 690,895, 378,901 and 193,213 square feet, respectively, or 2.5, 1.2 and 0.6 percentage of the net rentable square footage, respectively. Rental rates (including escalations) on the Company's commercial space that was renewed (based on first rents payable) during the year ended December 31, 2013 (on 2,420,483 square feet of renewals) decreased an average of 7.1 percent compared to rates that were in effect under the prior leases, as compared to a 2.4 percent decrease in 2012 (on 2,221,503 square feet of renewals) and a 3.3 percent decrease in 2011 (on 2,592,017 square feet of renewals). Estimated lease costs for the renewed leases in 2013 averaged $2.22 per square foot per year for a weighted average lease term of 3.8 years, estimated lease costs for the renewed leases in 2012 averaged $2.06 per square foot per year for a weighted average lease term of 4.0 years and estimated lease costs for the renewed leases in 2011 averaged $2.85 per square foot per year for a weighted average lease term of 4.3 years. The Company believes that commercial vacancy rates may continue to increase and commercial rental rates may continue to decline in some of its markets in 2014 and possibly beyond. For example, two significant tenants, aggregating 780,971 square feet and approximately $17.8 million in annualized base rent, whose leases expire over the next 12 months are not renewing their leases. As of December 31, 2013, commercial leases which comprise approximately 10.3 percent of the Company's annualized base rent are scheduled to expire during the year ended December 31, 2014. With the decline of rental rates in the Company's office markets over the past few years, as leases expire in 2014, assuming no further changes in current market rental rates, the Company expects that the rental rates it is likely to achieve on new leases will generally be lower than the rates currently being paid, thereby resulting in less revenue from the same space. As a result of the above factors, the Company's future earnings and cash flow may continue to be negatively impacted by current market conditions effecting its commercial portfolio.


The Company expects that the impact of the current state of the economy, including high unemployment will continue to have a negative effect on the fundamentals of its business, including lower occupancy, reduced effective rents, and increases in defaults and past due accounts in respect of the Company's commercial properties. These conditions would negatively affect the Company's future net income and cash flows and could have a material adverse effect on the Company's financial condition.

As a result of the continued weakness in the Company's core office markets, the Company intends to expand its holdings in the multi-family rental sector, which it believes has traditionally been a more stable product type. The Company believes that the opportunity to invest in multi-family development properties at higher returns on cost will position the Company to potentially produce higher levels of net operating income than if the Company were to only purchase stabilized multi-family rental properties at market returns. The Company anticipates that it will be several years before its multi-family development projects are income-producing. The long-term nature of the Company's multi-family strategy coupled with the continued weakness in the Company's core office markets and the disposition of income producing non-core office properties, to fund the Company's multi-family rental acquisitions and development will likely result in declining net operating income and cash flows relative to historical returns. As the Company continues to execute its multi-family residential strategy, the Company believes that over the long-term its net operating income and cash flows will stabilize at levels less than historical or current returns.

The remaining portion of this Management's Discussion and Analysis of Financial Condition and Results of Operations should help the reader understand our:

recent transactions;
critical accounting policies and estimates;
results of operations for the year ended December 31, 2013 as compared to the year ended December 31, 2012;
results of operations for the year ended December 31, 2012 as compared to the year ended December 31, 2011 and
liquidity and capital resources.


Recent Transactions

In October 2012, the Company acquired the real estate development and management businesses of Roseland Partners, L.L.C. ("Roseland Partners"), a premier multi-family rental property developer and manager based in Short Hills, New Jersey, and the Roseland Partners' interests, principally through unconsolidated joint venture interests in various entities which, directly or indirectly, own or have rights with respect to various multi-family rental, commercial properties and vacant land (collectively, the "Roseland Transaction").

Acquisitions
The following multi-family rental properties were acquired during the year ended
December 31, 2013 (dollars in thousands):




Acquisition                                       # of      # of     Acquisition
                                                       Apartment
Date        Property         Location       Properties     Units            Cost
            Alterra at
            Overlook Ridge   Revere,
01/18/13    1A               Massachusetts           1       310   $      61,250 (a)
            Alterra at
            Overlook Ridge   Revere,
04/04/13    1B               Massachusetts           1       412          87,950 (a)
                             Rahway, New
11/20/13    Park Square      Jersey                  1       159          46,376 (b)
            Richmond Ct /
            Riverwatch       New Brunswick,
12/19/13    Commons          New Jersey              2       200          40,983 (c)

Total Acquisitions 5 1,081 $ 236,559

(a) The acquisition cost was funded primarily through borrowings under the Company's unsecured revolving credit facility.
(b) The acquisition cost consisted of $43,421,000 in cash consideration and future purchase price earn out payment obligations, subsequent to conditions related to a real estate tax appeal, recorded at fair value of $2,955,000 at closing. $42,613,355 of the cash consideration was funded from funds held by a qualified intermediary, which were proceeds from the Company's prior property sales. The remaining cash consideration was funded primarily from available cash on hand. $2,550,000 of the earn-out obligation amount was paid in January 2014, with the remaining balance still potentially payable in the future.

(c) $12,701,925 of the acquisition cost was funded from funds held by a qualified intermediary, which were proceeds from the Company's prior property sales. The remaining acquisition cost was funded primarily from available cash on hand.

Consolidation
On August 22, 2013, the Company contributed an additional $4.9 million and the operating agreement of Eastchester was modified which increased the Company's effective ownership to 76.25 percent, with the remaining 23.75 percent owned by HVLH. The agreement also provided the Company with control of all major decisions. Accordingly, effective August 22, 2013, the Company consolidated Eastchester under the provisions of ASC 810, Consolidation. As the carrying value approximated the fair value of the net assets acquired, there was no holding period gain or loss recognized on this transaction.

On October 23, 2012, as part of the Roseland Transaction, the Company had acquired a 26.25 percent interest in a to-be-built, 108-unit multi-family rental property located in Eastchester, New York (the "Eastchester Project") for approximately $2.1 million. The remaining interests in the development project-owning entity, 150 Main Street, L.L.C. ("Eastchester") was owned 26.25 percent by JMP Eastchester, L.L.C. and 47.5 percent by Hudson Valley Land Holdings, L.L.C. ("HVLH"). The Eastchester Project began construction in late 2013. Estimated total development costs of $46 million are expected to be funded with a $27.5 million construction loan and the balance of $18.5 million to be funded with member capital.

Properties Commencing Initial Operations The following properties commenced initial operations during the year ended December 31, 2013 (dollars in thousands):

                                                                           Garage        Development         Development
                                                         # of    Rentable Parking     Costs Incurred           Costs Per
Date     Property/Address Location      Type           Bldgs. Square Feet  Spaces         by Company         Square Foot
                          Parsippany,
06/05/13 14 Sylvan Way    New Jersey    Office           1        203,506       -   $         51,611 (a)   $         254
         Port Imperial    Weehawken,
08/01/13 South 4/5        New Jersey    Parking/Retail   1         16,736     850             71,040 (b)             N/A

Totals                                                   2        220,242     850   $        122,651

(a) Development costs included approximately $13.0 million in land costs and $4.3 million in leasing costs. Amounts are as of December 31, 2013.
(b) Development costs included approximately $13.1 million in land costs. Amounts are as of December 31, 2013.


Property Sales
The Company sold the following office properties during the year ended December
31, 2013 (dollars in thousands): See Note 7: Discontinued Operations to the
Company's Financial Statements.




                                                    Rentable          Net           Net
Sale                                         # of     Square        Sales          Book        Realized
Date     Property/Address Location         Bldgs.       Feet     Proceeds         Value     Gain (loss)
         19 Skyline Drive Hawthorne, New
04/10/13 (a)              York               1       248,400   $   16,131     $  16,005   $         126
         55 Corporate     Bridgewater, New
04/26/13 Drive            Jersey             1       204,057       70,967        51,308          19,659
                          Little Ferry,
05/02/13 200 Riser Road   New Jersey         1       286,628       31,775        14,852          16,923
         777 Passaic      Clifton, New
05/13/13 Avenue           Jersey             1        75,000        5,640         3,713           1,927
         16 and 18 Sentry Blue Bell,
05/30/13 Parkway West (b) Pennsylvania       2       188,103       19,041        19,721           (680)
         51 Imclone Drive Branchburg, New
05/31/13 (c)              Jersey             1        63,213        6,101         5,278             823
         40 Richards      Norwalk,
06/28/13 Avenue           Connecticut        1       145,487       15,858        17,027         (1,169)
                          Bernards
                          Township, New
07/10/13 106 Allen Road   Jersey             1       132,010       17,677        15,081           2,596
         Pennsylvania     Suburban

office portfolio Philadelphia,
08/27/13 (d) (e) Pennsylvania 15 1,663,511 207,425 164,259 43,166

Totals: 24 3,006,409 $ 390,615 (f) $ 307,244 $ 83,371 (g)

(a) The Company recognized a valuation allowance of $7.1 million on this property identified as held for sale at December 31, 2012. In connection with the sale, the Company provided an interest-free note receivable to the buyer of $5 million (with a net present value of $3.7 million at closing) which matures in 2023 and requires monthly payments of principal. See Note 5: Deferred charges, goodwill and other assets.

(b) The Company recorded an $8.4 million impairment charge on these properties at December 31, 2012. The Company has retained a subordinated interest in these properties.

(c) The property was encumbered by a mortgage loan which was satisfied by the Company at the time of the sale. The Company incurred $0.7 million in costs for the debt satisfaction, which was included in discontinued operations: loss from early extinguishment of debt for the year ended December 31, 2013.

(d) In order to reduce the carrying value of five of the properties to their estimated fair market values, the Company recorded impairment charges of $23,851,000 at June 30, 2013. The fair value used in the impairment charges was based on the purchase and sale agreement for the properties ultimately sold.

(e) The Company completed the sale of this office portfolio and three developable land parcels for approximately $233 million: $201 million in cash ($55.3 million of which was held by a qualified intermediary until such funds were used in acquisitions), a $10 million mortgage on one of the properties ($8 million of which was funded at closing) and subordinated equity interests in each of the properties being sold with capital accounts aggregating $22 million. Net sale proceeds from the sale aggregated $207 million which was comprised of the $233 million gross sales price less the subordinated equity interests of $22 million and $4 million in closing costs. The purchasers of the Pennsylvania office portfolio are joint ventures formed between the Company and affiliates of the Keystone Property Group (the "Keystone Affiliates"). The mortgage loan has a term of two years with a one year extension option and bears interest at LIBOR plus six percent. The Company's equity interests in the joint ventures will be subordinated to Keystone Affiliates receiving a 15 percent internal rate of return ("IRR") after which the Company will receive a ten percent IRR on its subordinated equity and then all profit will be split equally. In connection with these partial sale transactions, because the buyer receives a preferential return, the Company only recognized profit to the extent that they received net proceeds in excess of their entire carrying value of the properties, effectively reflecting their retained subordinate equity interest at zero. As part of the transaction, the Company has rights to own, after zoning-approval-subdivision, land at the 150 Monument Road property located in Bala Cynwyd, Pennsylvania, for a contemplated multi-family residential development.

(f) This amount excludes approximately $535,000 of net closing prorations and related adjustments received from sellers at closing.

(g) This amount, net of impairment charges recorded in 2013 of $23,851,000 on certain of the properties prior to their sale (per Note [d] above), comprises the $59,520,000 of realized gains (losses) and unrealized losses on disposition of rental property and impairments, net, for the year ended December 31, 2013. See Note 7: Discontinued Operations.

On February 24, 2014, the Company entered into agreements with affiliates of Keystone Property Group ("Keystone Entities") to sell 15 of its office properties in New Jersey, New York and Connecticut, aggregating approximately 2.3 million square feet, for approximately $230.8 million, comprised of: $201.7 million in cash from a combination of Keystone Entities senior and pari-passu equity and mortgage financing; Company subordinated equity interests in each of the properties being sold with capital accounts aggregating $22.2 million; and pari passu equity interests in three of the properties being sold aggregating $6.9 million. The purchasers of the office properties will be joint ventures to be formed between the Company and the Keystone Entities. The senior and pari-passu equity will receive a 15 percent internal rate of return ("IRR") after which the subordinated equity will receive a ten percent IRR and then all distributable cash flow will be split equally between the Keystone Entities and the Company. As part of the transaction, the Company will participate in management, leasing and construction fees for the portfolio, and the Company and the Keystone Entities will jointly provide leasing representation for the properties.

The formation of the joint ventures and the completion of the sale of the properties to the joint ventures are subject to the Keystone Entities' completion of due diligence by March 31, 2014, which may be extended for two 30-day periods, and normal and customary closing conditions. The consummation of the transactions between the Company and the Keystone Entities also is subject to the waiver or non-exercise of certain rights of first offer with respect to 11 of the properties by certain affiliates of the Company and other third parties who are limited partners of the Company. There can be no assurance that the transaction will be consummated.


Impairments on Properties Held and Used
For the year ended December 31, 2013, the Company recorded impairment charges of $110.9 million on 18 office properties. Nine of the 18 properties located in Roseland, Parsippany, Warren and Lyndhurst, New Jersey, aggregating approximately 1.3 million square feet, are collateral for mortgage loans scheduled to mature on August 11, 2014 and May 11, 2016, with principal balances totaling $160 million as of December 31, 2013. Seven of the 18 properties located in Fair Lawn, New Jersey, Woodcliff Lake, New Jersey, Stamford, Connecticut and Elmsford, New York, aggregating 646,000 square feet are being considered for disposition (six of which are part of the Keystone Entities transaction described above). Two of the 18 properties, located in Morris Plains and Upper Saddle River, New Jersey, aggregating approximately 550,000 square feet, are being considered for repositioning from office properties into multi-family rental properties. The Company estimated that the carrying value of the 18 properties may not be recoverable over their anticipated holding periods. The impairments in 2013 resulted primarily from the recent decline in leasing activity and market rents of the properties identified.

Joint Venture Activity
On March 20, 2013, the Company entered into a joint venture with a fund advised by UBS Global Asset Management ("UBS") to form Crystal House Apartments Investors LLC which acquired the 828-unit multi-family property known as Crystal House located in Arlington, Virginia ("Crystal House Property") for approximately $262.5 million. The Company acquired a 25 percent interest in the Crystal House property and a 50 percent interest in the vacant land for approximately $30.2 million. The acquisition included vacant land to accommodate the development of approximately 295 additional units of which 252 are currently approved.

On April 23, 2013, the Company and JPM sold their interests in the Boston Downtown Crossing joint venture for $45 million, of which the Company's share was $13.5 million. The Company realized its share of the gain on the sale of $754,000 which was included in equity in earnings for the year ended December 31, 2013. The venture previously recorded an impairment charge of approximately $69.5 million on its development project in 2008 (of which the Company's share of the impairment charge was $10.0 million).

On December 9, 2013, the Company entered into a new joint venture with the Keystone Property Group and Parkway Corporation to form KPG-P 100 IMW JV,
LLC. The Company acquired a 33.33 percent indirect interest in KPG-IMW Owner, LLC, an entity that owns a nine-story, approximately 400,000 square-foot office building located at 100 Independence Mall West in Philadelphia, Pennsylvania for $2.8 million. The 100 IMW Property was acquired for approximately $40.5 million. As part of a more than $20-million reinvestment strategy for 100 IMW Property, the partnership is planning upgrades to the building's common areas, as well as build-out of offices and the conversion of approximately 55,000 square feet of lower-level space into a 110-stall parking garage that will be managed by Parkway Corporation.

On December 23, 2013, the Company entered into a joint venture with FB Capitol Place LLC to form Capitol Place Mezz LLC. The Company acquired a 50 percent ownership interest in an entity that is developing a 377-unit multi-family complex that includes approximately 25,000 square feet of retail space and a 309-space underground parking garage, currently under construction, located at 701 2nd Street, NE in Washington, D.C. for approximately $46.5 million. It is expected that the project will be completed by mid-2015. The venture expects to incur approximately $120.7 million in total estimated costs to complete the WDC Project, of which $38.5 million has been incurred through December 31, 2013. The Company is not required to fund any additional costs (with some limitation) for the completion of the WDC Project beyond its $46.5 million initial contribution. The joint venture includes specific provisions, including a right of first offer on all development deals in the D.C. metro area that involve either party, with specific qualifications on any properties in Arlington County, Virginia.

Critical Accounting Policies and Estimates

The Financial Statements have been prepared in conformity with generally accepted accounting principles. The preparation of the Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Financial Statements, and the reported amounts of revenues and expenses during the reported period. These estimates and assumptions are based on management's historical experience that are believed to be reasonable at the time. However, because future events and their effects cannot be determined with certainty, the determination of estimates requires the exercise of judgment. The Company's critical accounting policies are those which require assumptions to be made about matters that are highly uncertain. Different estimates could have a material effect on the Company's financial results. Judgments and uncertainties affecting the application of these policies and estimates may result in materially different amounts being reported under different conditions and circumstances.


Rental Property:
Rental properties are stated at cost less accumulated depreciation and amortization. Costs directly related to the acquisition, development and construction of rental properties are capitalized. Acquisition-related costs are expensed as incurred. Capitalized development and construction costs include pre-construction costs essential to the development of the property, development and construction costs, interest, property taxes, insurance, salaries and other project costs incurred during the period of development. Interest capitalized by the Company for the years ended December 31, 2013, 2012 and 2011 was $12.9 million, $4.3 million and $1.1 million, respectively. Ordinary repairs and maintenance are expensed as incurred; major replacements and betterments, which improve or extend the life of the asset, are capitalized and depreciated over their estimated useful lives. Fully-depreciated assets are removed from the accounts.

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